Venezuela is Defaulting, Maybe . . . Maybe Not

The news out of Venezuela with regards to its debt situation has been keeping investors (who love the high returns, but dislike the uncertainty) in a tizzy, to put it mildly. But today's news was perhaps the most bizarre yet.  Mr. Maduro, on the one hand, announced that PDVSA (the big state-owned oil company that produces 95% of Venezuela's foreign currency earnings) was making its latest payment to creditors (due today) and, on the other hand, announced that a restructuring was being planned immediately.

What? Why? How?

If the plan is to restructure because there is no money, then why were the payments today (and a few days ago) made? That makes no sense to my little brain.

And how in the world is there going to be a restructuring when there are US sanctions prohibiting just that? Through some Russian proxy? Or Chinese? Via a loophole in the sanctions regime?

Katia Porzecanski, sovereign debt guru, has a super article up on this puzzle already at Bloomberg (with co authors Patricia Laya, Ben Bartenstein, and Christine Jenkins).

Venezuelan Debt: Call a Spade a Spade

Adam Lerrick, of the American Enterprise Institute, has offered an intriguing approach to the Republic of Venezuela/PDVSA debt problem. Call a spade a spade. The distinction in the market between Republic of Venezuela and PDVSA bonds has always been artificial and the market has normally perceived it as such. Only recently have market participants begun trying to figure out which bonds -- PDVSA or Republic of Venezuela -- will be more likely candidates for a debt restructuring and therefore which should trade higher in the market.

PDVSA accounts for 95 percent for the foreign currency earnings of the entire country. Without PDVSA, there is no credit standing behind Republic bonds.  At base, there is only one public sector credit risk in the country and Lerrick invites us to acknowledge this fact.

He proposes that the Republic assume the indebtedness of PDVSA and proceed to restructure that debt as part of a generalized Republic debt workout. As part of this process -- and to discourage potential holdouts from the Republic's offer to exchange PDVSA bonds and promissory notes -- he suggests that the Government take back PDVSA's concession to lift and sell Venezuelan oil. This risk has always been prominently disclosed in the PDVSA offering documents and should not come as a surprise to anyone.

Lerrick's proposal adds to the growing list of suggestions for how a future Venezuelan debt restructuring (and there almost certainly will be such a debt restructuring) may be accomplished without holdout creditors devouring the process. No one wants to repeat the experience of Argentina.

Recently, in the context of trying to work out the knotty problem of how to restructure Venezuela’s promissory notes, Lee Buchheit and I made a similar suggestion along these lines. (our friends, Bob Lawless and Bob Scott, two gurus of this world of secured financing and contracts, were invaluable in helping us figure this structure out -- all blame for errors is ours, of course).

The structure we suggest differs from the Lerrick proposal mainly on the question of what should happen to the PDVSA oil assets, including receivables for the sale of oil.  We suggest that PDVSA pledge those assets to the Republic in consideration for the Republic's assumption of PDVSA bond/promissory note liabilities (as opposed to transferring title to the assets back to the Republic).  Such a pledge is expressly permitted by the terms of the PDVSA bonds and promissory notes and should operate to shield the assets from attachment by holdout creditors.

Catalonian Bonds, Anyone?

Joint post by Mitu Gulati and Mark Weidemaier.

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

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

If I Were a Holdout ...

Bond pricing has always been a puzzle to me, so I leave it to Mitu. But one thing has bugged me for more than a year. Ever since Venezuela has joined the ranks of the walking dead, market participants have differentiated among its bond contracts in a way that might seem sensible--even sophisticated--to those who think that investors do (or should) occasionally read the small print. In particular, Venezuelan bonds that require 100% of the holders to consent to an amendment of financial terms have fetched a higher price than comparable bonds with so-called collective action clauses, or CACs, which can be amended by either 85% or 75% of the holders, depending on the bond issue. The 100% bonds also have relatively more enforcement-friendly pari passu clauses, which could make it easier to replicate the fabulously successful holdout strategy in Argentina. The price premium must reflect rational investors on the eve of default paying for the power to veto a restructuring or drop out and get paid in full, right? Not quite. As you read the bond documents, the 100>85 reasoning unravels, and the 100% bond starts looking like a pretty fishy holdout vehicle.

Could Giving the Rohingya Refugees a Debt Claim Ameliorate the Current Crisis?

From Joseph Blocher & Mitu Gulati

Just a couple of weeks ago, the plight of the Rohingya, a muslim minority group in Myanmar, who are being oppressed (to put it mildly–they have been called “the most friendless people in the world”) was front page news. But, as has often been the case with the plight of the Rohingya over the years, news of their plight quickly receded as other human drama and tragedy took over (hurricane in Puerto Rico, Las Vegas shooting, Catalan secession vote/violence, North Korean craziness etc.)

We realize that we are likely engaged in a pointless task.  But we want to plead for the condition of the Rohingya, and indeed other refugees, not to be forgotten so quickly. As a threshold matter, we recognize that our government cannot be depended on to care much (if at all) about the plight of oppressed groups that are as far away, foreign and poor as the Rohingya. In other words, the top down mechanism isn’t going to work. The question then is whether, assuming that the oppression in question is clear and cognizable, there is some other solution—something bottom up--that the international legal system could provide to oppressed groups who are forced into refugee status that does not depend on other governments, such as the U.S., having a self interest in intervening.

Could Puerto Rico be Expelled for its "Tremendous" Debt?

From Joseph Blocher & Mitu Gulati

We would not exactly call ourselves avid readers of the US Navy blogs. But there is an interesting post on the U.S. Naval Institute Blog today on Puerto Rico and debt by Commander George Capen (retired).

The context that inspired his blog post was the behavior of our president toward the current crisis in Puerto Rico. To quote: 

“Ultimately, the government of Puerto Rico will have to work with us to determine how this massive rebuilding effort—will end up being one of the biggest ever—will be funded and organized, and what we will do with the tremendous amount of existing debt already on the island.” – President Donald J. Trump, 29 September 2017:

Commander Capen, whose post is worth reading in its entirety, writes:

Puerto Rico didn’t ask to become a U.S. territory in 1898; nor do they get to vote in U.S. elections; nor do they have voting representation in Congress. But they are Americans. And they also voted to become a state (over 97 percent) earlier this year.

As an unincorporated commonwealth, our Congress holds the fate of Puerto Rico in their hands. Following their vote for statehood, our Congress can make Puerto Rico a state. Congress could also vote to cast Puerto Rico aside as an independent nation.

That final statement raises a question that we have been fascinated by (and have struggled with). Could Congress really “cast Puerto Rico aside as an independent nation,” even stripping Puerto Ricans of their US citizenship, because they have a “tremendous debt”?

Your Friendly Neighborhood Sanctions Running Strategy

We are about to hit an anniversary of sorts, a year since Venezuela was surely going to default on its debt ... except that it still hasn't, so the U.S. government has decided to nudge it along. Retroactive debt sanctions imposed on August 25 prohibit, among other things, extending new credit to the government of Venezuela and its state oil company PDVSA beyond 30 days and 90 days, respectively, as well as any transactions in previously issued government debt, and, separately, any direct or indirect, old or new bond-buying from the Venezuelan government. The sanctions are a big headache for U.S. bank compliance departments, but they also got some glorious creative juices running. Mark & Mitu offer a contrarian reading of the sanctions order and one of the general licenses issued by the Treasury's Office of Foreign Assets Control (OFAC) as part of its implementation. As M&M read it, Venezuela cannot restructure all its debt in a debt swap (that would require issuing new bonds), but it could amend some of its old bonds using collective action clauses (CACs), and gain breathing room until oil prices recover, things change, or pigs fly. 

Do Sanctions Prevent Venezuela From Restructuring CAC Bonds?

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

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

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

How Easily Can Creditors Reach Venezuelan Oil Receivables?

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

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

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

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

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

Venezuela Is Like ... (Part II)

Last time on Super-Sad Updates, I speculated (i) that the Venezuelan people could be in for more suffering and bondholders for more coupon payments (see Romania), (ii) that Venezuela’s complex debt stock was prone to shell games and inter-creditor conflicts, which could delay a workout (see Puerto Rico), and (iii) that a bet on PDVSA bonds over sovereign bonds today required too many assumptions to hold my shrinking attention span (but see Turkmenistan … or not). Now I try to imagine what might happen if the government did decide to restructure. It brings back memories of …

Venezuela Is Like ... (Part I)

Market and civil society observers have taken Venezuelan debt restructuring as a certainty for more than two years, putting it in contention for the world’s slowest train wreck and quite possibly the messiest. Designs abound, but even after last weekend’s vote followed by new U.S. sanctions, too many variables remain too far up in the air to start laying the yellow brick pavers quite yet.

Depending on where you sit and how long you stare, Venezuela can present as some, none, or all of many past sovereign debt crises. The tour that starts below with broad-brush analogies is not exhaustive, but still plenty depressing.

Puerto Rico Bankruptcy: More on Audio

As my last post mentioned, release of hearing audio recordings does not appear to be standard practice in the District of Puerto Rico district court. But that isn't for lack of authority within that court. Standing Order 8, adopted in 2011, expressed with some pride that the District of Puerto Rico would be the "first in the entire Nation" after the pilot program (discussed in prior post) to make audio files available through PACER. The order makes clear that the recording is not the official record, preserving the role of court reporters. The use of the technology is left to the discretion of the presiding judge. The court's website indicates this order remains in effect.

Ideally recordings of the Puerto Rico hearings would be released for free on the court's website. But even if posted only on PACER for a flat fee, opting into this practice would increase accessibility. 

Puerto Rico Bankruptcy: Audio Recordings?

As noted as an update in the prior post, May 17 is the first hearing in Puerto Rico's PROMESA restructuring cases (which also have new case numbers). However much interest these cases hold for the professional bankruptcy world, they are of critical importance to Puerto Rico residents. The idea of a government unit being bankrupt is frightening, with the anxiety heightened when the extent to which one's elected officials remain in charge is unclear. Sensitive to the number of stakeholders and high public interest, the courthouse has overflow space reserved for the first hearing. But even a capacious courthouse imposes natural limits on the in-person population.

If the court released audio recordings of hearings for free on its website, as happened in the Detroit bankruptcy, that would provide a window into the federal court process that could help build trust and legitimacy. Ordering and using hearing transcripts is critical to many parties and their lawyers, but that process is not a feasible form of education and access for others. In addition to being prohibitively expensive for residents to acquire, especially on an expedited basis, written transcripts provide insufficient contextual cues for those less familiar with federal courts and lawyers.

Releasing digital recordings does not appear to be standard practice in the District of Puerto Rico. Might this be an opportune moment for an experiment, or at least an exception?*

Puerto Rico Bankruptcy: Week One

[May 10 update: a hearing has now been scheduled for May 17] 

It is nearing the one-week anniversary of the biggest government bankruptcy in U.S. history: the Commonwealth of Puerto Rico.

1. The debtor(s) and cases: So far, Puerto Rico's Oversight Board has filed the equivalent of a bankruptcy petition for the Commonwealth (17-1578) and COFINA (17-1599). Bond insurers have filed the equivalent of an adversary proceeding (17-1584). The Oversight Board has retained Prime Clerk, so dockets will be available to those who don't have access to PACER, Bloomberg Law, etc. In Detroit's bankruptcy, digital recordings of nearly all hearings were posted for the public, usually within 24 hours; I hope the same will be true for Puerto Rico, but so far I have not seen an indication either way on the District of Puerto Rico's PROMESA web page.
2. Presiding judge: PROMESA greatly restricted Chief Justice Roberts' choice of presiding judge by excluding bankruptcy judges. Thus, it is especially a relief that a wonderful district judge with bankruptcy court experience has accepted Chief Justice Roberts' request to preside. Judge Swain will sit by designation in the District of Puerto Rico. 
3. Venue: The Oversight Board filed in the District of Puerto Rico, rather than New York, which was also a venue option. Filing in San Juan makes hearings accessible for more residents (creditors or not) who are deeply affected by the Commonwealth's financial situation. Curiously, a New York Times story attributes to the Oversight Board's outside counsel the proposition that the presiding judge "has the option of holding proceedings" in Manhattan as well as in San Juan. I don't read the Judicial Code and Federal Rules of Bankruptcy Procedure, particularly 5001, to be so flexible (PROMESA makes the Federal Rules of Bankruptcy Procedure applicable to these actions). Absent venue transfer or an emergency, it is reasonable to expect hearings to take place in Puerto Rico.
4. Eligibility: PROMESA did not adopt the municipal bankruptcy eligibility test wholesale, although it incorporated parts. It sounds like some creditors may challenge eligibility and/or whether the Oversight Board satisfied the restructuring duties set forth in PROMESA. It is hard to imagine these cases getting dismissed on such grounds, but we will get a better sense from the parties' pleadings when and if they are filed.
5. What else is formally pending: The docket does not yet reflect the magnitude of the case to come. As in municipal bankruptcy, Puerto Rico's filings created no bankruptcy estate and the debtors do not need federal court approval for decisions and expenditures to the same extent as, say, chapter 11 debtors. Thus far, the court docket is populated primarily by requests for notice and pro hac vice admission by lawyers. Also pending is a motion for the appointment of a retiree committee. Retiree committees have been common in municipal bankruptcies, but there remains the question of who will pay the committee's expenses in this case. Another twist is that the motion asks the court to restrict the member appointment discretion of the United States Trustee, requiring that the committee be constituted from a preexisting ad hoc committee. Yet another indication, perhaps, that this case will be a challenge from top to bottom.

Puerto Rico: Just Another Deadline or the Big One?

Midnight came and went with no news of a debt deal in Puerto Rico, and no extension of a stay on creditor enforcement under PROMESA. It sure looks like we are careening into an actual sovereign-ish bankruptcy-ish filing under Title III of the law.

Judge Selection in Municipal Bankruptcy and PROMESA

In light of the timeline on the Puerto Rico debt situation, I have just posted on SSRN a contribution to the ABLJ/ABA symposium last fall. The paper examines PROMESA's judicial selection requirements applicable to a Puerto Rico Title III filing (the equivalent of a bankruptcy), and puts them in the context of municipal bankruptcy history.  This paper can be downloaded here.

More Thoughts on Ukraine

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

Ukraine's Loss: A Skid, Not a Crash

Mark posted a lucid analysis of Ukraine's loss to Russia in London yesterday (full 107-pp opinion here). The case will surely be appealed, and will drag on for a while, alongside the many other legal, political and military disputes between Russia and Ukraine. It will settle, if ever, as part of a grand-ish bargain between the two countries. For now, neither has any reason to fold, so I am not holding my breath for quick resolution.

While we wait, I wanted to think about what this ruling might mean for sovereign debt workouts, and for Ukraine's recently-restructured bonds.

Ukraine's Defenses to Russian Bond Claims Rejected

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

Inter-Creditor Duties in Sovereign Debt

This is a joint post by Mitu Gulati and Mark Weidemaier

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

Scotexit and Allocating the UK's Debt

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

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

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

Bankruptcy and Non-Bankruptcy Options for PDVSA

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

We have talked before about the possibility that Venezuelan state-owned oil company PDVSA will need to restructure. With oil prices still low, the early-2017 gloom about the company's economic prospects hasn't lifted. True, the company and its sovereign owner have managed to stave off default for a while now; perhaps this can continue. But restructuring is a real possibility. In our international debt finance class this year, we have been asking students to think about how a restructuring might work.  

For PDVSA the options basically come down to bankruptcy and the use of exit consents. We talked about the latter option--basically a voluntary exchange offer in which participating bondholders also vote to eliminate contractual protections in the old bonds, making them less attractive to hold--in an earlier post. For many corporations, bankruptcy would be the preferred option, if only to benefit from the automatic stay of creditor collection efforts. But PDVSA's bankruptcy options are limited. It is a Venezuelan company, and Venezuelan bankruptcy law is not ideal for debtors seeking to restructure. Plus, in order to be worth anything, a Venezuelan bankruptcy proceeding would need to be recognized in the United States, likely under Chapter 15 of the Bankruptcy Code. It isn't clear that a Venezuelan proceeding would merit such recognition. Nor is it clear that PDVSA meets eligibility requirements under US bankruptcy law. Still, bankruptcy offers the only mechanism for imposing restructuring terms on dissenting creditors, and that is what PDVSA most needs (with regard to its bond debt, anyway).

Euro-Area Redenomination Risk and the Gold Clause Cases

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

Odds seem to be against a Marine Le Pen victory in the French presidential election, though a victory by Emmanuel Macron is hardly assured. And there continues to be chatter about redenomination risk in Europe, to the point that, according to a recent Deutsche Bank estimate, even short-term German bonds were factoring in a 5% risk of redenomination. Last week, in our class on international debt finance, we discussed the so-called Gold Clause cases from the 1930s. Though ancient history in some respects, the cases offer important lessons for some of the debates regarding redenomination risk. First, though, some background.

Brooklyn Law School Conference on Public Debt

On March 1, 2016, Credit Slips commenced a virtual symposium on Puerto Rico's financial crisis. Where do things stand today, a year later? And what governance lessons can be learned from municipal bankruptcy cases like Detroit for the public debt problems of tomorrow? Thanks to a fortuitously timed conference at Brooklyn Law School, a subset of Slipsters will be considering these very questions on Friday March 3, 2017. Check out the agenda and join us in Brooklyn - register here today.

Marblegate and the Use of Exit Consents to Restructure (Venezuelan) Sovereign Debt

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

About a decade and a half ago, exit consents were a big deal in sovereign debt restructuring. At the time, sovereign bonds governed by New York law required unanimous bondholder approval before any modification to the payment terms of the bonds. The result was that creditors could easily hold out from a restructuring. Needing to mitigate the holdout problem in Ecuador in 2000, sovereign debt guru Lee Buchheit borrowed a technique from corporate bond restructuring practice in the United States. There, the Trust Indenture Act forbids out-of-court bond exchanges that modify "the right of any holder ... to receive payment ... or to institute suit" without the consent of each affected bondholder. To oversimplify, Buchheit leveraged the fact that other terms of the bonds could be amended with a lesser vote, often a simple majority or 66.67% of the bonds. This meant that potential holdouts risked having key protections stripped from their bonds in a restructuring that won the approval of a majority of bondholders.

Stripping PDVSA's Assets

This is a joint post by Mark Weidemaier and Mitu Gulati

In a previous post, we talked about how ordinary corporate-law principles, and especially the rules concerning piercing the corporate veil, might play an important role in any debt restructuring conducted by Venezuela or PDVSA, the state oil company. As an example, we cited the fact that PDVSA doesn't own the oil reserves it exploits and the possibility that Venezuela might transfer the right to exploit these reserves to a new entity. Readers who have been following the Venezuelan crisis will recognize that we were not-too-subtly referring to a proposal floated back in October 2016 by Ricardo Hausmann and Mark Walker, writing on Project Syndicate. (Registration required.) In a nutshell, their proposal with regard to PDVSA is that Venezuela can induce PDVSA creditors to participate in a restructuring--conducted either in bankruptcy or through the use of exit consents--by withdrawing or modifying PDVSA's right to exploit hydrocarbon reserves. Essentially, that is, Venezuela can strip the company of its primary productive asset.

Veil Piercing When a Sovereign Owns the Shares; Venezuela Edition

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

At least in the short term, the odds of Venezuela continuing to service its mountain of external debt are looking slightly better, though long-term prospects remain bleak. State-owned oil company PDVSA may be even worse off. A default or restructuring by one or both borrowers will raise issues that are typically peripheral in a sovereign debt crisis. If Argentina's pari passu saga tested the willingness of courts to approve novel injunctions, Venezuela's debt crisis will test the willingness of courts to disregard the legal fiction that corporations are separate legal "persons." That fiction means that a corporation's shareholders are not liable for corporate debts (or vice versa), unless a creditor can "pierce the corporate veil"--i.e., prove the shareholder abused the corporate form to engage in "fraud or inequitable conduct."

Paul Blustein's Laid Low, and Some Musings on the Next Crisis

(This is a joint post by Mark Weidemaier and Mitu Gulati)

We jointly teach a class on international debt, focusing on what happens when sovereign governments and the entities they control go bust. We love this class, because we work with our students to design a restructuring plan for a country in financial distress, and our students often come up with terrific ideas. This semester, we're focusing on Venezuela, which would involve an enormously complicated restructuring. One reason is that Venezuela has not exactly cozied up to the IMF, which typically plays a key role in a restructuring. To get a sense of the IMF's role and limitations, we asked our students to read Laid Low, Paul Blustein's new book about how the IMF played a part in managing (and mismanaging) the Greek debt crisis. Blustein is a terrific story-teller, with rare access to key players at the IMF and elsewhere. Although we followed the European debt crisis closely, much of what's in Laid Low was new to us.

Pari Passu Nevermind

One last (I hope) gift from the pari passu litigation against Argentina: this opinion ruling that Argentina does not breach its pari passu obligations by paying holdouts like NML (who recently settled claims against the country) or by paying bondholders who had previously participated in its 2005 and 2010 exchange offers. The result was basically a given. The judge was hardly going to lift the injunction only to reinstate it when the next holdout came along. The interesting question was how the judge would distinguish bondholders who refused Argentina's latest settlement offer from bondholders who had refused prior offers.

There was an obvious and sensible answer. Because holdouts already have claims for money damages, the meaning of the pari passu clause isn't all that important unless violation produces a different remedy, such as an injunction. But an injunction is appropriate only when the benefits to the plaintiff exceed the costs to the defendant and third parties. Now that Argentina has made a reasonable settlement offer (in the court's judgment) and obtained the assent of the vast majority of bondholders, an injunction might do more harm than good. Thus, in the opinion linked above, the court holds that, whatever the meaning of the pari passu clause, an injunction would be inappropriate because "significantly changed circumstances have rendered the pari passu injunctions 'inequitable and detrimental to the public interest'" (p. 9). So far, so good. But the opinion doesn't stop there. Instead, the court's primary ruling is that the selective payments Argentina is currently making do not violate the pari passu clause at all.

Venezuela

John Dizard has a useful, and clearly written, piece on the lay of the land in this morning's FT. What puzzles me is why PDVSA, the national oil company,  has not done a UK scheme of arrangement or a US prepack to exchange the bonds, instead of messing around with an exchange offer. But the entire situation is rather opaque.

Disarming Holdouts in Sovereign Debt Restructurings

The pari passu litigation against Argentina—discussed extensively here on Credit Slips, on FT Alphaville, and elsewhere—caused many people to worry that future government debt restructurings would become more difficult. Some have their eye on Venezuela as the next to default, though the country and its troubled state-owned oil producer PDVSA stubbornly continue to pay external creditors despite dire economic and humanitarian circumstances. Wherever the next crisis occurs, there will be interest in devising ways to avoid the fate that befell Argentina.

A quick re-cap: federal courts in New York (i) interpreted the pari passu clause in Argentina’s contracts to forbid the country to keep current on its restructured debt unless it also paid holdout creditors in full and (ii) implemented this ruling through an injunction preventing financial and other intermediaries from helping Argentina continue making payments. Some worry that this remedy, if widely applied, could make it impossible to restructure.

So…what to do? Here’s a new proposal from Lee Buchheit (Cleary Gottlieb) and Mitu Gulati (Duke). It’s cute. And it has a clever name: the Cryonic Solution.

Further Thoughts on Puerto Rico v. Franklin California Tax-Free Trust

The opinion is a good reminder that oral argument impressions don't always carry over to the final written product. In short, both the majority and dissent approach this as a simple matter of statutory construction, and in that regard the majority opinion is simply a more clearly articulated version of the First Circuit's opinion.

Neither the majority or dissent address the 10th Amendment implications of saying that states have to use chapter 9 if they want to reorganize their municipalities. After this opinion, there is no other option. This might suggest that the 10th Amendment concerns that once hovered around chapter 9 are effectively gone.

I find the majority's approach to the placement of the 1946 addendum to section 903 unconvincing, but of course I've already written that I saw section 903 as only coming into force when a state accepts the chapter 9 "bargain."

Is there any other provision of the Code in one of the operative chapters (7 and onward) that applies even when there is no eligible debtor? Here we have Justice Thomas telling us that part of section 903 applies to Puerto Rico right now, while the opening paragraph of the section is apparently hanging around "just in case."  

The end result is that Puerto Rico now faces the unattractive choice of attempting an Argentina/Greece style workout (with likely lesser sovereign immunity than either of those debtors had) or swallowing PROMESA, along with its oversight board.

The composition of the former is an issue that Puerto Ricans might understandably worry about, especially since the board, and not the Commonwealth, has final say on what a reorganization plan looks like. Indeed, it is not so much a matter of "final say," as whether the oversight board will listen to Puerto Rico at all. There is no formal requirement in PROMESA that they do so. Nonetheless, given the alternatives, Puerto Rico might decide it has to hold its nose and take PROMESA.

The only thing we know for sure is that Puerto Rico is headed for a default on July 1. One branch of the decision tree has been taken away.

Ukraine's Defense: Russian Suit Part of a "Broader Strategy of Aggression"

It has taken several months, but the Russian Particulars of Claim and Ukraine's Defence (akin to complaint and answer in U.S. civil procedure) have now been filed. Distilled to its essence, Ukraine's response, as the Financial Times notes, is that "if you wanted your money back you should not have invaded our country." Or as Ukraine's lawyers put it in the Defence: "The [Russian] claim forms part of a broader strategy of unlawful and illegitimate economic, political and military aggression ... aimed at frustrating the will of the Ukrainian people to participate in the process of European integration." 

Russia's version of events is straightforward and looks like any other debt case: Russia lent the money, Ukraine committed a breach of contract by not repaying. Ukraine, by contrast, will have a harder time translating its defenses into the dry language of legal doctrine. But it can be done. As I have written here at Credit Slips, and in more detail elsewhere, contract law provides Ukraine with a number of potentially viable arguments. Now that we know the arguments asserted by Ukraine, here are some preliminary thoughts.

PROMESA and the Recovery Act

It has become something like conventional wisdom that the pending SCOTUS case involving the Recovery Act is no longer relevant. After all, the giant interest payment due July 1 is largely attributable to GO bonds, and the Commonwealth itself is not even subject to the Recovery Act. And the pending PROMESA bill would expressly override the Recovery Act.

Taking the last point first, we should not assume that PROMESA will be enacted before the Supreme Court rules. Indeed, there are many political reasons why Congress – the Senate in particular – might want to wait until the Supreme Court acts before advancing PROMESA. 

Moreover, what the Supreme Court says with regard to the Recovery Act matters. For example, what if they rule that the 1984 addition of section 101's definition of "State" was impermissible, in the way that it treated the Commonwealth? That might render the Recovery Act subject to section 903 preemption, while at the same time allowing Puerto Rico the ability to authorize its municipal entities to file under chapter 9.

That could possibly force some rethinking of PROMESA, although I think we will still see some legislation. The details might change, however, if SCOTUS effectively amends the current Bankruptcy Code.

On the other hand, if the Recovery Act is upheld, what would stop Puerto Rico from expanding it to cover much more of the overall capital structure at issue? And the Recovery Act might serve as a model for a statue that could apply to the Commonwealth itself.

That, of course, might provide further incentives to pass PROMESA.  Quickly.

In short, the Recovery Act is still important, just not in its present form. The current Recovery Act is too narrow to solve very much of the Commonwealth's problems. But what the Supreme Court has to say with regard to the Recovery Act might be very important.

To mention one final point in this regard, what if SCOTUS says that the Commonwealth is unlike other territories? PROMESA purports to be grounded in Congress' power over territories under Article IV, section 3 ...

PROMESA Observations

After taking a look at titles III and VI of the new draft, some quick observations:

• After some waffling between drafts, it is now clear that title III cases will be heard by district court judges. The judge for a case involving a territory (as opposed to a sub-entity) will be chosen by the Chief Justice. Venue will either be in the territory, or in another place where the oversight board has an office. As I've previously noted, that clearly opens up the possibility of New York.
• One draft of the bill had incorporated sections 327 et al. regarding professional retention and compensation. I noted that was inconsistent with chapter 9, and incorporation of those sections disappeared in the next draft. Now the new draft has its own professional compensation provision in proposed section 316 (see also section 317).
• Title VI continues to be a provision that is rather obviously stapled onto the larger bill:  see, for example, section 601, which redefines "Oversight Board" as "Administrative Supervisor" for purposes of Title VI alone.  I have a suggestion:  there is a "find and replace" function in Word ...
• I continue to worry that title VI's process for splitting bondholders up into various "pools" is a morass waiting to happen, especially given the possibility of competing workout proposals under title VI.
• That said, much of the "gating" features of the previous versions of title VI are now gone (i.e., it seems it would now be possible to go directly to title III, subject to the oversight board's 5 out of 7 vote).
• The composition of the oversight board gets more convoluted with each iteration of the bill.

Overall, although the bill is not necessarily "ideal" or "optimal," it seems to at least be making forward progress.  Of course, the Senate has not weighed in at all on this ... at least not publicly. And we should probably expect that even when enacted the bill is apt to be hit with a Recovery Act style Constitutional challenge.

PROMESA Amusement

I'm still working through the new draft of the PROMESA bill, which readers will recall provides new restructuring options for US territories (including Puerto Rico, of course). But I have to say I got a chuckle out of proposed section 303(3), which provides:

unlawful executive orders that alter, amend, or modify rights of holders of any debt of the territory or territorial instrumentality, or that divert funds from one territorial instrumentality to another or to the territory, shall be preempted by this Act.

If the orders are unlawful, do we really need a federal statute to preempt them?

Puerto Rico: Legislative Update

It appears that the House legislation has bogged down.  Two or three issues keep coming up, none of which make a whole lot of sense:

First, "bailouts."  I'm not sure if people making this argument actually believe it or are just using a convenient, politically toxic buzzword. But the claim that extending chapter 9 to include some or all of Puerto Rico constitutes a "bailout" can't really be taken seriously. A bailout involves (a) the use of taxpayer money to (b) help investors avoid realizing risks they voluntarily agreed to take.

Neither is applicable here. Instead, this is the basic insolvency process doing its thing. Namely, losses will be allocated pro rata if bankruptcy applies.  But no taxpayer money is involved, and in no case are investors being saved from their own poor investment choices.

Second, expanding chapter 9 does not raise takings or other scary "retroactivity" problems. If it did, then Congress could never have enacted chapter 9 in the first place. After all, there was no chapter 9 until there was a chapter 9.

More generally, it is quite clear that unsecured bondholders do not have a valid takings claim (under the Fifth Amendment) as a result of the enactment of a new bankruptcy law, in any context. For example, if a secured creditor is owed $1,000 and has a lien on a house worth $400, a new bankruptcy law that discharges the $600 unsecured portion of the claim raises no constitutional issues. That's Congress' power under the Bankruptcy Clause in action. A law that resulted in the creditor obtaining substantially less than $400 on the secured portion might raise a constitutional question, because the secured portion of a claim is "property" for these purposes. But that still does not prevent the rescheduling of secured debt, just the complete elimination of it.

And finally, no, no, no this does not open the door to Illinois filing for chapter 9. Illinois is a state, with full 11th Amendment and 10th Amendment powers. Puerto Rico is a territory of uncertain legal status. Apples ≠ Oranges.

 

Puerto Rico Restructuring Options That Don't Rely on Congress

The revised draft PROMESA bill (available here) is now under debate in Congress. The bill appears to respond to some early criticisms, although its length and complexity obscures answers to some important questions. Under the circumstances, it seems sensible for the Commonwealth to consider all of its options, including those that do not require Congressional action. These include, as Mitu Gulati and I write in the Financial Times (here, subscription required), changing Puerto Rico's own law in ways that might facilitate a restructuring. 

We asked law students in a class we taught jointly at the University of North Carolina and Duke to consider ways the Commonwealth could restructure without Congressional authorization. Working in groups, they came up with some answers that are both creative and plausible. That doesn't necessarily mean easy or agreeable from the perspective of Commonwealth politicians. Some proposals envision amending Puerto Rico's constitution, while others rely on provisions of Puerto Rico law that authorize collectively binding debt modifications but that haven't been previously applied in this context. The important point, however, is that Puerto Rico may have a wider range of options than many think. The attractiveness of these options is relative. If Congress cannot provide an effective restructuring mechanism that respects the Commonwealth's right to democratic governance, other lawful options will begin to seem more attractive. Two of the student groups have made their work available on-line; their short papers can be found at the links above.

Puerto Rico: PROMESA draft bill, title III revised

I again offer some initial thoughts on the revised draft bill, now subject to much debate in Congress:

• The bill now clearly provides for reference of cases from the district court to the bankruptcy court
• There is no longer a requirement that the oversight board have an office in D.C. But the board can have offices outside of the territory it is overseeing. As Jacoby has previously noted, this opens up the possibility that cases could be filed outside of the territory, which for present purposes of course means Puerto Rico. The most obvious locale would be New York, where an board office might make sense for negotiations with bondholders.
• I don't see a provision comparable to §921(b), which would allow for the selection of a specific judge to preside over the case.
• The provisions regarding professional compensation and retention are no longer incorporated into title III, so title III becomes more like chapter 9 in this respect.
• Those parts of chapter 9 that are not incorporated into title III are largely set forth within title III itself – e.g., §§929, 941, 943. Title III is chapter 9+ in all but name. The bill expressly provides that it will not be codified in title 11, however.
• I wonder if all the implications of the definition of "trustee" in title III to mean "the board" have been thought through. For example, do they intend this to apply with regard to section 926, which is incorporated into title III?
• The relationship between the board and the debtor during the case generally seems like it will be quite confusing. Under proposed section 315, the board will act on behalf of the debtor throughout the case, but in other instances the bill speaks as though the debtor itself will be taking action in the case.

Puerto Rico: The Commonwealth Plays Hardball

The question is whether it is playing against the House of Representatives, and its heavy handed PROMESA draft bill, or its creditors.

In any event, according to the Financial Times, Puerto Rico's legislature has passed a law giving its governor "the power to declare a state of emergency and halt payments to creditors until January 2017."

There is a long history of these sorts of laws in the United States, most from the Nineteenth Century, although there were a few in the Great Depression too.  Most were eventually struck down as violations of the Contracts Clause, but collection against Puerto Rico itself might run up against whatever sovereign immunity the Commonwealth might posses.

Puerto Rico: PROMESA draft bill, title III (initial thoughts)

Some quick thoughts on the "bankruptcy" part of the proposed bill:

• If we read Ry. Labor Execs.’ Ass’n v. Gibbons, 455 U.S. 457 (1982) carefully, especially its discussion of the Commerce Clause, I'm not sure it really matters that this is proposed under Congress' territories powers, rather than the Bankruptcy Clause.
• Proposed title III incorporates all of the same provisions that section 901 of the Code incorporates into chapter 9, other than section 301.
• The proposed title also incorporates section 327 to 331, so apparently the court will have oversight of professionals under the procedure.
• Speaking of courts, I see no provisions to move cases under title III to the local bankruptcy court. In short, these cases will stay with the district judges. It's unclear which district, as Jacoby notes.
• Presumably the lack of a reference concept is driven by the same considerations that keeps the district courts involved in the various proposed "chapter 14" procedures for financial institutions. On the other hand, the district judges in almost every district tend to be from public law backgrounds, and largely have no experience with insolvency law.

So this will be a chapter 9 preceding in all but name, with the oversight board acting for the debtor, whether the debtor likes it or not, in front of district judge who will be reading up on chapter 9 on the fly. In short, we are reinventing the wheel in a new, more complicated way.

Puerto Rico: Debt Restructuring and Takings Law

Per the last words of my PROMESA post, click here for an interview with Professor Charles Tabb, who discusses the (limited) impact of the Takings Clause on debt restructuring and moratorium legislation. 

Constitution image courtesy of Shutterstock.com

Puerto Rico: PROMESAnkruptcy

The House Natural Resources Committee has released draft legislation - with the acroynym PROMESA - in response to Puerto Rico's financial crisis and Speaker Ryan's call for action. The contents continued to shift over the past few days but a recent version is here. PROMESA spans many topics, including an oversight board, employment law, infrastructure, and beyond. Without detracting from the importance of this range of topics, this is Credit Slips, so these initial observations focus on debt restructuring provisions principally housed in Title III of the bill.

1. PROMESAnkruptcy: The new territorial debt restructuring law would not be in title 11 (home of the Bankruptcy Code). But as shown in the visual, section 301 incorporates many key title 11/Bankruptcy Code provisions, including automatic stay, financing, majority voting rules, cramdown, discharge, and the discharge injunction. Other sections of PROMESA repurpose title 11 provisions with slight tweaks, while still others expressly depart from current bankruptcy law and make new rules. For the lawyers, also note that the Federal Rules of Bankruptcy Procedure also apply (section 308). Still, the drafters don't want to call it bankruptcy or chapter 9. Okay. I commend the drafters for recognizing the importance of a mechanism to bind holdouts and I'll call it whatever they want, within reason. PROMESAnkruptcy may sound a little funny, but let's be clear that Puerto Rico's dire situation is no joke. 

Puerto Rico: The Recovery Act's Potential Second Wind

 

This post continues the long-running Credit Slips discussion of Puerto Rico's Recovery Act, now the subject of U.S. Supreme Court review in Puerto Rico v. Franklin California Tax-Free Trust, 15-233, as indicated in Lubben's recent post and in last week's preview. In the video above, posted with permission of the American Bankruptcy Institute, I interview Bill Rochelle, who was at the Supreme Court for oral argument and makes some intriguing predictions on the vote, timing of issuing the opinion, judicial selection, and other matters. A few more reflections below the break.

Lessons for Puerto Rico from ... Arkansas?

I did not realize that a US state had defaulted on its bonds, offering a historical comparative example of the difficulties facing Puerto Rico, its creditors, and mostly its citizens if the mess there is not subjected to an orderly, judicially supervised debt cleanup process of some kind. In a new working paper from the Cleveland Fed, O. Emre Ergungor tells the interesting story of the Depression-era default by Arkansas on various road construction bonds and its messy and politically charged path to a workout. A couple of apparent lessons are troubling. First, reaffirming the aphorism that $#!@ rolls downhill, most of the pain was suffered by Arkansas citizens and ordinary creditors, with bondholders pulling every available lever to ensure a soft landing for themselves. Ergungor sums up this lesson nicely: "in the absence of a dedicated judicial process for preserving the governmental functions of a state in debt renegotiations, sovereignty offers meager protections for the interests of the general public." Second, in a prophetic warning about bailouts, Ergungor describes the intervention of the federal Reconstruction Finance Corporation to provide liquidity for a refinancing of the workout bonds years later. As one would expect, a Chicago Tribune article took the feds to task for helping Arkansas in this way, insisting that the RFC chief "ought to be willing to to do as much for Illinois, Indiana, Michigan, Iowa, and all the rest of the states." I know Illinois would surely appreciate some federal support for its current behemoth pension burden. If the Executive intervenes in the Puerto Rico situation today, will we see another Tribune article like the one that criticized selective federal intervention for Arkansas? Does it matter that, technically, it is Puerto Rico's sub-units that are in distress, not the Territory itself? I struggle to understand even what all the issues are in the Puerto Rico debate, but Ergungor's paper helps me to put at least the financial problems in some useful context.

Puerto Rico: Further Supreme Court Thoughts

So Noah Feldman has a column up on Bloomberg that suggests that section 903(1) of the Code should clearly apply to the Commonwealth. It's a sensible argument, if you read that section entirely in isolation and know nothing about the overall structure of the Bankruptcy Code.

And while I say that intending a bit of the obvious snark – what else could be expected, he’s suggesting that my analysis is essentially daft – it is important to remember that the Supreme Court is not made up of bankruptcy experts. Thus, his column provides a fairly clear analysis of how Puerto Rico might still lose, despite the apparent leanings of the Justices in yesterday’s oral argument.

So if there is a non-frivolous argument for preemption of the Recovery Act, why do I think the Court might still overturn the First Circuit? It could happen one of two ways.

Puerto Rico: Supreme Court Argument

The transcript can be found here.  Based on my initial read, it seems like the First Circuit might be reversed, which opens up all the issues Jacoby noted earlier (namely, will the statute pass Contracts Clause review – assuming the Clause even applies to the Commonwealth).

Puerto Rico: Help Still Wanted

For the past two weeks, Credit Slips posts have considered the role of the Executive Branch in facilitating a Puerto Rico debt restructuring in the absence of Congressional action. That constraint is hereby relaxed, and thus future posts may well include the role of Congress and the judiciary in various combinations. For example, whatever one's view of the GM and Chrysler bankruptcies, they show that the administration can shape a restructuring by working within the framework of formal bankruptcy law. Imagine, for example, that Congress adopts the most modest of the proposals, H.R. 870, which merely fixes the unfortunate exclusion of Puerto Rico municipalities from ordinary chapter 9. The administration could put together post-filing financing packages with the stream of loan proceeds conditioned on the inclusion of various covenants, including those imposing fiscal reforms.  

Meanwhile, March 22 is drawing near. On that date, the United States Supreme Court will review a legal challenge to the Puerto Rico Public Corporation Debt Enforcement and Recovery Act. Below the jump are reminders and new points about the role of this court fight in Puerto Rico's debt crisis and why Congress and the Executive Branch are not off the hook. 

Puerto Rico: Colonial Chickens, Structural Priority, and Contingent Debt

It has been a humbling torrent of creativity, and I am honored to chip in a tuppence at the eleventh hour. After an existential preface, I consider how one might use (or resist using) federal credit enhancement in the inevitable debt exchange.