When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonorable to the debtor and least hurtful to the creditor.
Adam Smith, Wealth of Nations1
From November 2001 through April 2003, the International Monetary Fund (IMF) and its 184 member countries actively considered a fundamental change in the international financial system.2 The reform envisaged establishing, through an amendment of the IMF’s Articles of Agreement, a treaty-based framework to restructure sovereign debt,3 referred to as the Sovereign Debt Restructuring Mechanism (SDRM). By the end of a period of intensive discussion regarding the design of the SDRM proposal, a relatively detailed blueprint of the proposal had been endorsed by most Executive Directors of the IMF, evidencing broad support among member countries.4 However, while support for the SDRM proposal was strong, it was not strong enough. An amendment to the IMF’s Articles requires the approval of three-fifths of member countries, holding 85 percent of the total voting power.5 A number of emerging market countries were opposed to the SDRM proposal, and, by April 2003, the United States, which holds 17.14 percent of IMF voting power, had signaled that it could no longer support the proposal.6 At that point, the IMF discontinued further work on its development and decided to focus exclusively on more incremental reform measures.
As evidenced by Adam Smith’s statement, the notion of establishing some form of insolvency framework for sovereign states is hardly a novel one. The debt crisis that emerged in the 1980s engendered considerable discussion as to whether more forceful official intervention was needed to resolve creditor coordination issues, and, during the 1990s, various legal reforms were proposed to address growing discomfort with large IMF financing packages.7 Indeed, although the SDRM proposal was described as a “bombshell” when it was launched by Anne Krueger, First Deputy Managing Director of the IMF, in November 2001,8 the concept of establishing some form of statutory framework had in fact been considered within the IMF six years earlier.9
What distinguished the SDRM proposal from earlier proposals was the extent to which the mainstream of the official sector embraced it. The willingness of so many senior policymakers to support such a major reform was, in part, attributable to their frustration with the lack of progress on the implementation of market-based solutions. Although the official sector had, since 1996, exhorted emerging market sovereigns and their creditors to facilitate the restructuring process by including collective action clauses in their international sovereign bonds,10 there was still very little to show for it—at least with respect to bonds governed by New York law, which represent by far the largest percentage of international bonds issued by emerging market sovereigns.11
The official sector’s decision to give serious consideration to the SDRM proposal was also motivated by the tragedy unfolding in Argentina. By the fall of 2001, there was little doubt that Argentina’s sovereign debt had become unsustainable and that, accordingly, a restructuring was inevitable.12 While it was understood that any major reform would arrive too late to help Argentina, its circumstances highlighted the need to establish a framework that provided strong incentives for a sovereign debtor and its creditors to engage in the restructuring process at an early stage of a financial crisis—thereby limiting both the economic dislocation for the sovereign and the deterioration in the value of creditor claims.13 Moreover, the magnitude and complex structure of Argentina’s indebtedness called into question whether a decentralized contractual framework could adequately address the collective action and creditor coordination problems that arise when a sovereign attempts to reach a restructuring agreement with an atomized creditor community.14
Finally, in the absence of a sufficiently robust legal framework that addresses these issues in a predictable manner, there was a concern that the IMF would continue to be under pressure to provide additional financing to countries with unsustainable debt burdens because the alternative path—the restructuring of the sovereign’s debt—was perceived as being fraught with difficulty. As noted by Paul O’Neill, then–U.S. Secretary of the Treasury, in September 2002, “Today, with no clear process for sovereign debt restructuring in place, when a nation is on the brink of financial collapse, we have two stark and uninviting options—unwarranted lending or sending the nation off a cliff into a catastrophic default.”15
Whether interest in the SDRM proposal—or some other treaty-based framework—will reemerge within the official sector will depend on a number of factors, including the frequency of financial crises and the extent to which alternative, contractual-based frameworks are able to limit their severity. In the immediate term, however, one of the tangible benefits of the SDRM initiative is that market participants and emerging market sovereigns have finally agreed to include collective action clauses in their debt instruments. It would appear that a credible threat of official intervention prompted this degree of self-regulation.
This chapter discusses the underlying rationale for the SDRM proposal, its key features, and the lessons that can be distilled from the vigorous debate that it engendered. The first section discusses the motivations for reform. As will be seen, perceptions vary as to the nature of the weaknesses of the existing system. Not surprisingly, these differences define the contours of any discussion of the design of a new legal framework. The second section analyzes the key issues that arose in the design of the SDRM proposal—many of which will be of relevance to any type of statutory sovereign debt restructuring framework that may be considered in the future. The discussion concludes by setting forth some general observations as to the nature of the resistance to the SDRM proposal and the possible implications of this resistance to any future reform efforts.
The SDRM proposal was developed in the open. At each stage of its evolution, the IMF staff papers outlining the various issues and design options and the IMF Executive Board’s views of these papers were published.16 The financial press followed the SDRM proposal’s development closely; many editorial pages gave positive reviews. At the same time, the press observed that the SDRM proposal would continue to face significant political obstacles in attempting such ambitious reform.17 The feedback from legal and economic scholars, workout practitioners, nongovernmental organizations, and market participants helped shape subsequent versions and sharpened everyone’s understanding of the issues, not least that of the IMF’s staff.18 Not surprisingly, the analysis contained in this chapter has benefited considerably from this engagement.
Defining the Problem
While there is an emerging consensus that the crisis-resolution framework is in need of reform, views differ as to why. For example, many actors in this area, including the IMF, have emphasized that difficulties in securing collective action among a large and diverse group of private creditors unnecessarily delay the restructuring process, thereby increasing the costs for both the sovereign debtor and its creditors.19 While the private sector has acknowledged that the evolution of capital markets has exacerbated collective action difficulties, these actors point to debtor behavior as the primary barrier to restructuring. For example, they complain that sovereign debtors have, to date, sought, and in some cases achieved, restructurings through unilateral take-it-or-leave-it exchange offers where investors lack sufficient information to make informed decisions regarding such offers.20 More generally, once a crisis arises, it may be argued that the principal reason why the restructuring process may be slow and costly for all concerned is the debtor country’s inability to elaborate and implement appropriate corrective policies.
Separately, a number of observers within the official sector and academia see the IMF’s lending practices as the key shortcoming of the existing framework. There appear to be two related concerns. The first is that, in the absence of a predictable and transparent set of rules governing access policy, neither debtors nor creditors can assess the timing of when a restructuring is unavoidable.21 In these circumstances, the sovereign is tempted to “gamble for resurrection” with the willing participation of its private creditors. The second concern is that, more generally, the availability of IMF financing not only delays the restructuring process, but also conspires to create the crisis in the first place. Specifically, there is a view that IMF lending creates “moral hazard”; in other words, by shielding creditors from the risks that they should bear, IMF financing encourages imprudent lending, thereby increasing both the likelihood and severity of future financial crises.22
This section examines the relative merits of these concerns and the extent to which the perceived—and actual—weaknesses in the system are interrelated. In some respects, the complexity of the issues highlights the degree to which legal reform will never be a panacea. In particular, while a legal framework can help shape the incentives of a sovereign when it considers how and when to restructure its debt, it cannot substitute for coherent economic policies or for the political will that such policies require.
Collective Action Problems
As demonstrated on numerous occasions over the last seven years, circumstances arise where a sovereign’s debt becomes “unsustainable”; that is to say, where the resolution of the crisis requires a reduction of the net present value of the sovereign’s liabilities, rather than just a reprofiling of maturities. Of course, making judgments as to when the problem facing the sovereign is one of illiquidity—where a rescheduling would be sufficient—rather than one of unsustainability is hardly an exact science. A company is “insolvent”—rather than just illiquid—when the value of its liabilities exceeds its assets. In the case of a sovereign country, such a concept is of limited relevance. By virtue of its sovereign authority and, in particular, its fiscal powers, a country’s assets are theoretically inexhaustible. For this reason, an assessment of debt sustainability requires not only a judgment as to whether, for example, the projected primary fiscal surplus is sufficient to cover forthcoming debt payments, but also whether, as a political matter, such a surplus can actually be achieved and sustained.23
Notwithstanding the difficulties in making assessments of unsustainability, there will be situations where there is no feasible set of sustainable macroeconomic policies that would enable the country to resolve the crisis and regain medium-term viability without a significant reduction in the net present value of its debt. In these circumstances, it is in the interests of both the sovereign debtor and its creditors to reach a restructuring agreement that provides for sustainability as soon as possible. At that point, however, the question arises as to whether the ability to reach such an agreement is hampered by failures in collective action. More specifically, the parties must determine and measure the risk that individual creditors will decline to participate in a restructuring in the hope of recovering payment on the original contractual claims, even though creditors—as a group—would be best served by agreeing to a restructuring as soon as possible. If the perceived risk is significant, creditors may be unwilling to participate in the restructuring because of inter-creditor equity concerns. In such an uncertain environment, debtors would be understandably nervous about initiating the restructuring process.
For financially distressed companies, the problem of collective action is a form of market failure that provides one of the principal justifications for official intervention, normally through the establishment of liquidation and corporate reorganization laws.24 However, the collective action problems that arise in the sovereign context are of a rather special nature, and an understanding of them requires an analysis of the recent evolution of the financial and legal environment within which sovereigns borrow and, on occasion, default.
Developments in the Sovereign Debt Market
Over the years, the dynamics of the sovereign debt restructuring process have been shaped not only by the nature of the claims against the sovereign but also by the identity of the creditors holding the claims. During the 1980s, most of the debt being restructured was made up of syndicated commercial bank loans and a structured collective negotiating framework that was generally implemented through the operation of bank steering committees.25 While the sovereign was often in default during the restructuring period, litigation was not common and, more generally, the process was relatively predictable.26 Moreover, the banks in question often provided new financing to the sovereign during the restructuring period. While the willingness of banks to participate in such a framework was attributable to a number of reasons, two factors were particularly important.
First, as regulated institutions, banks acted under the influence of the official sector, which had a strong desire to ensure that the restructuring process proceeded in an orderly fashion. This influence was exercised through a combination of moral suasion and the rather generous implementation of provisioning regulations. Second, since banks had extensive business with both the sovereign borrowers and their residents, they had a strong interest in behaving in a manner that did not undermine these long-term relationships.
The process was not free of difficulties, however. During the early stages of the 1980s debt crisis, the official sector’s ability to exercise influence over the process was, in large part, due to the financial vulnerability of the creditors. Given their exposure in these countries, the banks needed some degree of forbearance from their regulators. By the end of the 1980s, however, the balance sheets of the commercial banks had improved to the point where they had sufficient loan-loss provisions to enable them to write down the value of their loans. Under these circumstances, they became increasingly reluctant to continue to participate in the restructuring.27 Moreover, while litigation was rare, there were cases in which banks refused to participate in the negotiating process and opted for enforcement through the court system.28
With the emergence of bonded debt as the primary source of financing for emerging market sovereigns during the 1990s, the restructuring process has become considerably less predictable. As a result of disintermediation, the creditor community has become relatively atomized, and, as a result, creditor coordination problems are far more pronounced. Perhaps more importantly, creditor incentives have been transformed by the liquidity of these instruments. Institutions that purchase emerging market sovereign bonds on the secondary market—purchases made at a discount due to emerging stresses on the instruments—are often unregulated and, accordingly, are not subject to the influence of the official sector. Moreover, as creditor purchasers as opposed to credit providers, these institutions will often have no long-term business relationship with the borrower. Rather, they approach the restructuring process with singular interests: they seek to maximize the value of the claims they possess at the time.
In some circumstances, a distressed debt purchaser’s objective of maximizing value can work to the advantage of the sovereign debtor: a creditor that has purchased a claim on the secondary market at a deep discount may be far more willing to agree to a reduction in the face value of the claim than a creditor who purchased the claim at face value. However, such creditors may also choose not to participate in a restructuring that has been agreed upon by most creditors, with a view toward extracting more favorable terms from the borrower.29 Indeed, the very possibility that some creditors may hold out for more favorable negotiable terms can make it far more difficult for more cooperative creditors to reach a settlement with the debtor. Concerns regarding inter-creditor equity will be exacerbated when they also have fiduciary obligations to end-investors, a situation that has become increasingly common with the repackaging of financial instruments.
The Legal Environment
Whether the existence of holdout creditors generates a collective action problem of such a magnitude that it undermines the capacity of a debtor and its creditors to secure a rapid restructuring agreement will depend on whether the holdout strategy is perceived to be credible. In the sovereign context, how likely is it that the holdout creditor will have sufficient leverage against the sovereign to extract preferential terms? Assuming the sovereign is in default, the answer turns on the ability of the holdout to legally enforce its claims.
For a creditor wishing to enforce its claims against a sovereign, obtaining a judgment is no longer a particularly onerous task. The traditional concept of absolute sovereign immunity has been significantly eroded over the years under the laws of those jurisdictions that typically govern international debt instruments.30 Perhaps even more importantly, these jurisdictions will give effect to those contractual provisions that include a broad waiver of these immunities. In the United States, for example, the Foreign Sovereign Immunity Act (FSIA) enables a court to exercise jurisdiction over a sovereign where it has waived explicitly or implicitly its immunity from suit,31 or where the action (1) is based on commercial activity carried on in the United States by the foreign state, (2) is based on an act in the United States in connection with commercial activity outside the United States, or (3) is taken in connection with commercial activity carried on outside the United States that causes a direct effect in the United States.32 Bonds issued by emerging market sovereigns that are governed by New York law typically provide for a comprehensive waiver of sovereign immunity, including immunity from suit, prejudgment attachment, attachment in aid of execution, and execution. Moreover, where an express waiver of immunity from suit is absent, the commercial activity exception has been interpreted to include circumstances where the sovereign has issued debt in a public marketplace and where its breach of a U.S. dollar debt obligation has caused a direct effect in the United States.33 What of the substantive defenses available to a sovereign that finds itself subject to the jurisdiction of a foreign court? While they exist, recent litigation demonstrates that they have been narrowed considerably.34
But while a creditor may obtain a judgment against the sovereign with increasing predictability, its ability to collect on that judgment is still somewhat uncertain. For a variety of reasons, the assets of a sovereign that are available to a judgment creditor are rather limited.35 First, even if the debt agreement provides for a broad waiver of sovereign immunity with respect to the attachment of assets, the laws of the sovereign will generally prevent a judgment creditor from seizing assets of the sovereign located within the sovereign’s territory.36 Second, not all assets located outside the sovereign’s territory are available for attachment. For example, under the FSIA, only property of a foreign state “used for a commercial activity in the United States” is available for attachment.37 It has generally been understood that diplomatic property is protected, even where the waiver contained in the contract is very broad.38 Third, under the FSIA, the assets of an agency or instrumentality of the sovereign will normally not be available to satisfy a judgment against the sovereign.39 Most importantly, perhaps, the reserves of the central bank—a potentially attractive target for a judgment creditor—will normally not be available for attachment unless the central bank is also liable under the terms of the debt instrument.40
Faced with the difficulty of locating assets of a sovereign debtor that are subject to execution, judgment creditors have developed an alternative strategy that involves seeking injunctive relief to interrupt the servicing of debt held by other creditors. The most celebrated—or notorious—case in this regard involved a successful collection effort by a distressed debt purchaser (Elliott) against the Republic of Peru. In that case, Elliott relied on a pari passu provision in the debt to obtain an ex ante order from a Brussels court preventing Euroclear from accepting an interest payment from Peru on its Brady holders of the bonds, thereby preventing Peru from servicing its restructured debt.41
Commentators have raised questions regarding the legal basis for the injunctive relief granted by the Belgian courts in these cases.42 In Elliott, the relevant agreement held by the distressed debt purchaser contained a pari passu provision, which the distressed debt purchaser argued precluded Peru from making payments to the Brady holders unless a ratable and simultaneous payment was made to Elliott, and that this obligation should be enforced through injunctive relief.43 It has been argued that this is a novel and overly expansive interpretation of a contractual provision that has generally been understood to limit the legal subordination of debt, but has not been read to preclude the making of payments to certain creditors or to require the simultaneous and ratable payment of debt to all creditors.44 In the context of the litigation arising from Argentina’s default on its external debt, the U.S. government, the New York Clearing House Association, and the Federal Reserve Bank of New York have emerged as new critics of this expansive definition of the pari passu provision. Each filed a submission supporting Argentina’s claim that a narrow interpretation of the pari passu provision should be recognized.45 It was also argued that the pari passu provision—whatever its interpretation may be—cannot be relied upon by a judgment creditor as a means of enforcing rights under a contract reduced to judgment because, under the doctrine of merger—long accepted under New York law—a judgment creditor no longer retains the contractual rights that it possessed prior to obtaining a judgment and, therefore, may not normally invoke provisions such as the pari passu provision when seeking relief before the court.46
As of the date of publication of this piece, the New York court presiding over the Argentine litigation had not yet ruled on either the scope or relevance of the pari passu provision for creditors that may seek to enforce their claims against Argentina. In the context of the litigation involving Nicaragua, however, the Court of Appeals of Brussels refused to use the pari passu provision as a means of preventing sovereigns from making payments through the settlement system. Reversing the order of the lower court that had enjoined Euroclear from Nicaragua’s interest payment to its bondholders, the Court of Appeals concluded that a violation by the sovereign debtor of its contractual obligations to a creditor should not lead to a third party (in this case Euroclear) being held responsible in any way for the violation.47
Even if the past-judgment enforcement of a pari passu provision is unlikely to provide a durable basis for this enforcement strategy, that does not necessarily signal its demise. In the context of an enforcement action brought by a distressed debt purchaser against the Democratic Republic of the Congo, a federal district court in California issued an order that limited the ability of the sovereign debtor to make payments to its creditors absent satisfaction of the judgment or the making of ratable payments to the judgment creditor.48 While the judgment creditor had sought this relief on the basis of the pari passu provision contained in the loan agreement, the order issued by the court reveals that the court denied specific performance of this provision.49 Although the record is silent on the question, the court’s reluctance to grant the request on the basis of the pari passu provision may have been due to its concern that the doctrine of merger precluded a judgment creditor from relying on a contractual provision for this purpose. Nevertheless, the court clearly took the view that—as a means of providing relief to a judgment creditor—it had the authority to fashion relief that had the same effect as an order based on a broad interpretation of the pari passu provision.50
As long as this enforcement strategy—whatever its legal basis—continues to be sufficiently credible, it will undermine the debt restructuring process in at least two respects. First, by making the holdout strategy more effective, holdouts may multiply. For inter-creditor equity reasons, creditors that were otherwise inclined to accept the terms of the restructuring may be less likely to do so. Second, since a key feature of the holdout strategy may be interruption of the sovereign’s payments to other creditors, those creditors that are considering whether to accept the restructuring offer may think twice if they perceive a risk that the sovereign may be unable to service the debt to be restructured.
The Pre-Default Problem
The above analysis has assumed that the sovereign has defaulted on its financial obligations before it approaches its creditors regarding a restructuring. In these circumstances, any analysis of the nature and the extent of the collective action problem necessarily focuses on the ability of the holdout creditor to extract preferential treatment through the legal enforcement of its claim. But what of collective action problems that may arise before the occurrence of a general default and the onslaught of a full economic crisis?
From the perspective of the sovereign, the crisis triggered by a default will cause considerable dislocation in the financial system and the economy more generally. For example, if the sovereign’s banks hold a significant amount of the claims that are in default, the loss in value of these claims can create an insolvent banking system. More generally, the disruption in debtor-creditor relations arising from a default can precipitate capital flight and a sharp decline in private investment. Such economic dislocation will have negative feedback effects for creditors; to the extent that a full-blown crisis leads to an insolvent banking system, the eventual need to recapitalize this system will divert/consume fiscal resources that could otherwise have been used to service the restructured debt (i.e., it will only deepen the debt relief that is needed to ensure sustainability).
Ironically, while the sovereign and its creditors have a strong interest in securing a restructuring prior to default, the collective action problem may be most acute during this pre-default period. A creditor facing the decision whether to accept the terms of a restructuring offer prior to default will find the holdout option particularly tempting; if the restructuring goes forward, it will not have to sue the sovereign, opting instead, perhaps, to wait in anticipation that its unrestructured claim will continue to be serviced. This anticipation will be well-placed if a sufficient number of creditors agree to the restructuring. In these circumstances, the sovereign will have been able to engineer and achieve a sustainable debt burden and will be tempted to continue to service the claims of the holdouts so as to avoid the reputational implications of a default. Of course, if most creditors adopt this strategy, there will not be sufficient participation to achieve a sustainable debt burden.
The Existing Tools: Collective Action Clauses
Much of the discussion regarding both the need for and design of reform centers around the question of whether a legal framework based on contract would be sufficiently robust to neutralize the types of collective action problems described above. More specifically, could one rely on the collective action clauses that are typically found in certain types of international sovereign bonds and simply take the step of ensuring that they are included in all such bonds—particularly those governed by New York law, which continue to constitute the largest portion of emerging market bond issuances?51
Although the terms of collective action clauses vary, they normally include two types of provisions. Perhaps the most important is the provision that enables a qualified majority of bondholders (typically 75 percent) to bind all bondholders within the same issue to the financial terms of a restructuring, either before or after a default. This provision—a “majority amendment” or “majority restructuring” provision—is typically included in sovereign bonds that are governed by the laws of either England or Japan.52 Until very recently, however, they have generally not been included in bonds governed by the laws of New York.53 As of the date of this publication, they still do not exist in bonds governed by German law.54 The second type of provision, the “majority enforcement” provision, is designed to limit the ability of a minority of bondholders to disrupt the restructuring process by enforcing their claim after a default but prior to a restructuring agreement. Two elements of this provision can already be found in bonds governed by English and New York law: (1) an affirmative vote of a minimum percentage of bondholders (typically 25 percent) required to accelerate claims after a default; and (2) a simple or qualified majority can reverse an acceleration after the default—on the originally scheduled payments—has been cured.55 Trust deeds governed by English law contain an even more effective type of majority enforcement provision: under this structure, the right to initiate legal proceedings on behalf of all bondholders is conferred upon the trustee, who is required to act only if, among other things, it is requested do so by the requisite percentage of bondholders (typically more than 25 percent).56 As a consequence of the trustee’s authority to initiate legal proceedings on behalf of all bondholders, any amounts recovered by the trustee through such proceedings are for the benefit of all of the bondholders and therefore must be distributed pro rata among them.
Experience demonstrates that collective action clauses can play an important role in facilitating the restructuring process. When Ukraine restructured its debt in 1999, its use of the majority restructuring provisions was an important reason why it was able to achieve a participation rate of 99 percent of creditors.57 Similarly, in the context of its successful debt exchange operation, Uruguay used a majority restructuring provision to restructure its Samurai bond.58
Until recently, one of the major problems of relying on a legal framework based on collective action clauses has been the difficulty of actually putting such a framework in place. In a seminal 1996 report, senior representatives of the leading 11 industrial countries set forth a number of recommendations to strengthen the framework for crisis resolution. While it considered the desirability and feasibility of establishing some form of statutory framework for the restructuring of debt, it concluded that it would be far more practical to resolve problems of collective action and creditor coordination through the inclusion of collective action clauses and recommended that majority restructuring provisions be included in all bonds governed by New York law.59
For eight years, however, the market largely ignored this call: bonds issued in New York continued to represent the instrument of choice for emerging market sovereigns, and very few such bonds contained these provisions.60 From early 2003 onward, however, majority restructuring provisions have become standard in bonds governed by New York law.61 As recognized by a number of commentators, this important breakthrough was attributable to concerns among both market participants and emerging market issuers that, absent some demonstrable progress in this area, there was a greater likelihood that the official sector would proceed with more forceful intervention, that is, the establishment of some form of statutory debt restructuring framework.62
Now that collective action clauses have become a standard feature in new international sovereign bond issuances, the most important outstanding question is whether a framework based on contract will prove to be sufficiently robust to address the type of collective action problems that arise in the current environment. If one concludes that collective action problems are exacerbated by the multiplicity of instruments issued in different jurisdictions, the question arises as to whether traditional collective action clauses—which only bind bondholders within the same issuance—will prove to be sufficiently robust.63 Provided that a holdout creditor acquires a sufficient percentage of a particular issuance, it can effectively neutralize the operation of the collective action clause in that issue. In these circumstances, creditors holding other issuances may not be willing to restructure their own instruments because of their inability to ensure that the “holdout issue” will be bound by the same terms.
In some respects, the ability of a creditor to obtain such a blocking position is facilitated by the liability management operations that are conducted by emerging market sovereigns on a periodic basis. To avoid the bunching of maturities, an issuer will often exchange existing instruments for new bonds with slightly longer maturities. Since not all of the original instruments will be tendered in such exchanges, these operations will often leave behind relatively small residual amounts of the original issue. Creditors may easily purchase a controlling position in these “orphan” issuances in anticipation of a future restructuring, at which time they may try to use this position as leverage for preferential terms.
Theoretically, bonds issued under trust deeds could undermine such a multiple-instrument holdout strategy. As discussed above, such a structure creates a de facto sharing arrangement inasmuch as proceeds recovered by the trustee through litigation are distributed pro rata among all bondholders. Accordingly, even if a bondholder wishing to pursue litigation has managed to acquire a sufficient percentage of bonds to enable it to instruct the trustee to initiate legal action (25 percent of outstanding principal is normally required), the pro rata distribution of any amounts recovered among all bondholders in the issuance will act as a disincentive for the controlling bondholder to pursue this route.64 As a matter of practice, however, this disincentive may be more apparent than real. Even when bonds contain collective action clauses, it is very likely that restructurings will continue to involve an exchange of instruments when, as a condition for tendering the bonds, a bondholder must first agree to amend the terms of the bond being exited so that the payment terms are consistent with the bond it is accepting. This is the approach followed in the case of Ukraine and is designed to enable the sovereign to increase the liquidity of its external debt by reducing the number of issuances outstanding.65 The difficulty with this approach from a collective action perspective is that it may result in a residual bond issuance that would have effectively been emptied out through the exchange, leaving a controlling holdout that would only be required to share with itself.
The potential problems arising from a large number of debt instruments are not necessarily limited to the multiplicity of different bond issuances. Given the evolution of capital markets, for example, it can no longer be assumed that the restructuring of syndicated bank debt will be an orderly one. While in the 1980s commercial banks generally refrained from litigation, the growing securitization of these claims means that they can now be easily purchased by vulture creditors that specialize in these techniques. In recognition of this fact, the official sector has advocated that syndicated bank loan agreements also include collective action clauses.66 However, such a framework will face the same limitation: a restructuring could be undermined where a number of different syndicates and bond issuances (all of which contain collective action clauses) are reluctant to participate in the restructuring because another bank syndicate is controlled by a holdout creditor.
There is not yet sufficient experience to draw firm conclusions as to the dimensions of the above problems. However, the potential benefits of a framework that aggregates claims for voting purposes are recognized even among those that oppose a statutory framework and have led to a discussion of whether one could achieve some degree of aggregation under contract.67 Indeed, in the context of Uruguay’s recent exchange of instruments, a first—albeit small—step was taken in that direction. In the context of a bond exchange achieved in 2003, Uruguay issued a number of different bond series under a single trust indenture.68 The terms of the trust indenture included an innovative voting clause that gave the sovereign the option of aggregating voting across the affected bond series (which could include new series). Specifically, the traditional 75 percent majority needed for changing payment terms on an individual bond issuance was lowered to 66⅔ percent, provided that at least 85 percent of the aggregate outstanding principal of all issuances to be affected support the amendment.
Of course, this aggregation feature has two important limitations. First, while the required 66 ⅔ percent threshold for each individual series is easier to achieve than the typical 75 percent, it still enables a creditor to obtain a blocking position with respect to particular issuances, albeit with greater difficulty. Second, the aggregation would only apply to new bonds governed by New York law that are issued under the same trust indenture. Would it be possible, through contract, to aggregate claims of instruments that are governed by different laws or different jurisdictions? In the event that a dispute arose regarding the application or interpretation of the voting provisions, there is a risk that holders of different bond issues would find themselves in different courts—which could provide different interpretations. How serious a problem this would be would depend on whether the sovereign issuer chooses to issue in different jurisdictions.
A very different question regarding the durability of a contractual framework relates to its application to a judgment creditor. As noted earlier, it has been argued that the doctrine of merger that is well accepted under New York law normally precludes a judgment creditor from relying on the underlying contractual provisions—including a pari passu provision—when seeking to enforce its judgment, the law of merger in England being substantially the same.69 The reverse side of this doctrine, however, is that it may also preclude a sovereign and a qualified majority of bondholders from using a collective action clause to restructure the claim of a bondholder that has already obtained a judgment against the sovereign on the basis of that contractual claim. Because the bondholder’s claim has now been reduced to a judgment, it no longer has a contractual claim against the sovereign and, therefore, should be immune from any amendments that are affected with respect to any contractual claims. Of course, the ability of a creditor to obtain a judgment for the purpose of insulating itself from the operation of a majority restructuring provision will be complicated if the bond also contains a majority enforcement provision that limits the ability of the creditor to accelerate and or to initiate legal proceedings in the first place.70 Moreover, the question also arises as to whether it would be feasible to design a collective action provision in a manner that would enable it to survive the entry of judgment, similar to those provisions of contracts that address enforcement of judgments, such as waivers of sovereign immunity.71
The Role of IMF Financing
No matter how orderly and rapid the restructuring process can be made, it is still likely to be a painful one for the sovereign. The economic dislocation caused by the restructuring process will often be severe, and, as can be expected, the associated political costs will be foremost in the minds of government officials. Because the concept of debt sustainability in the sovereign context is necessarily probabilistic, a minister of finance will often be able to convince himself or herself that a restructuring—no matter how likely it may seem to an outside observer—can be avoided if certain additional adjustment measures are taken and additional financing obtained.72 Yet these delays—and the contortions that the economy is put through while the government gambles for resurrection—are likely to reduce the available policy options when the crisis eventually arrives and, more generally, exacerbate the economic dislocation that occurs when the country is forced to default. This dislocation may include a severe decline in output and real incomes, a reduction in investment, distress within the financial sector, and a drain in foreign exchange reserves.
In light of the above, how can sovereigns be encouraged to restructure unsustainable debt earlier rather than later? Providing a sovereign debtor with the legal tools to resolve collective action problems may give it greater confidence that it can attract a critical mass of creditor support for the restructuring, but the economic costs of restructuring may mean that the availability of these tools alone is unlikely to push authorities to initiate the restructuring process. Rather, a sovereign is most likely to initiate the restructuring process only when it understands that it will no longer receive financial support from the IMF unless it does so. In recognition of this fact, many are of the view that the area where greatest reform is needed is the design and application of the IMF’s policy on the availability of its financial resources.73
Any assessment of the role of the IMF in the resolution of crises—and of the criticisms of this role—requires both an analysis of the legal basis for the IMF’s financial assistance and an understanding of the types of problems that countries have been facing when they approach the IMF for this assistance. One of the general purposes of the IMF is “to shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members.”74 When the IMF extends financial assistance to a country, it must satisfy itself that two conditions have been met. First, the IMF’s Articles of Agreement require that its resources may only be used for the purpose of helping a country resolve its balance of payments problems.75 For this reason, the IMF must be of the view that the country in question is implementing policies that will address—rather than simply delay—the resolution of its external difficulties. Second, the IMF must also have assurances that the country will be in a position to repay the IMF within the relatively short period required under the Articles.76 The primary policy tool used by the IMF to ensure that these two conditions have been met is its “conditionality,” which requires that the member be implementing an appropriate economic adjustment program.77 The adoption of corrective economic policies is designed to provide some assurance that the underlying problem will be resolved but also that, because of this favorable outcome, the country will have adequate foreign exchange to repay the IMF.
The current debate on IMF financial assistance in this area arises in large part from the unprecedented scale of IMF financing packages that have been provided during the last nine years. Under the IMF’s current access policy, which provides guidance as to the amount that the IMF will normally provide to its members in support of their economic reform programs, the annual limit is set at 100 percent of quota. While this policy authorizes the IMF to exceed this limit in exceptional circumstances, prior to Mexico’s financial crisis in 1994, recourse to financing above the normal limits had been rare.78 The amount provided during the Mexican crisis was the equivalent of 688 percent of quota. Financial support in Asia established new records: when calculated as a percentage of the quota of the member in question, the arrangements approved for Thailand, Indonesia, and Korea were 600 percent, 490 percent, and 1,939 percent, respectively. The scale of recent IMF lending is largely due to the nature of the problems that precipitated the crises in question. While the ability of many emerging market countries to access the global capital markets has brought many benefits, the risks have also become painfully clear. A buildup in the stock of debt—particularly short-term debt—through such borrowing creates the potential for massive capital outflows, where changes in market perceptions make investors unwilling to roll over their debt. Whether the borrowing is conducted by the banking sector, the enterprise sector, or the sovereign itself, perceptions regarding overindebtedness can also precipitate capital flight by the country’s own residents. The potential for volatility is exacerbated by the herd mentality of the market: creditors often ignore signs of economic vulnerability for too long, but, when they do become aware of them, they can overreact. In these circumstances, the objectives of IMF financing have been to catalyze a return of market confidence in the country; to wit, by providing a large amount of financing in support of a strong economic adjustment program, the aim is to slow and stop capital outflows and initiate the transition back to access to private capital markets. One of the features of this strategy—often referred to as the “catalytic” approach—is that it seeks to resolve the member’s balance of payments problem without having to restructure the sovereign’s own debt obligations.79
One of the perceived weaknesses of the existing crisis-resolution framework is that there is inadequate predictability as to how much financing the IMF would be willing to commit in support of the catalytic approach described above. In the absence of clarity in this area, it has been argued that both the debtors and creditors delay discussions regarding the need for restructuring in the hope that such a painful event may be avoided through additional financing from the IMF.80 While, in some cases, the financing package has been successful and a restructuring of sovereign debt has been avoided (e.g., Mexico in 1994 and Brazil in 2001), in other cases the program did not succeed in sparing the country and its creditors from default (e.g., Russia in 1998 and Argentina in 2001). It may be argued that the financing provided by the IMF in the latter set of cases merely delayed a restructuring that had become unavoidable, and that these delays merely increased the cost of restructuring for all concerned.
A related—but far more fundamental—criticism of IMF financing policy is that it engenders what is generally referred to as “creditor moral hazard.”81 Specifically, even where the financing provided by the IMF under the catalytic approach actually succeeds in avoiding a restructuring of sovereign debt, it is perceived by some as having the negative effect of shielding creditors from the risks they incurred and were paid for when they extended credit to the emerging market country in question. From a systemic perspective, the concern—which has been expressed both by academics and some within the official sector—is that protecting creditors from these losses only encourages further reckless lending, and as a consequence, engenders further instability in the international financial system. In sum, while the absence of predictability in IMF financing policy is perceived as raising the cost of resolving crises, concerns have been expressed that the moral hazard created by such financing may actually increase the likelihood that these crises will occur in the first place.82
How valid are these criticisms? Regarding moral hazard, it may be said that—at some level—this will always be an unavoidable outcome of IMF financing. As noted earlier, the purpose of IMF financing is to “shorten the duration and limit the degree” of disequilibrium in the international balance of payments of members. If this objective is achieved and the financial costs of crises are contained, the country and its creditors are likely to be more relaxed about the risk of a crisis than they would have been if IMF financing had not been forthcoming. However, perhaps a more relevant question is whether there is evidence that the additional moral hazard created by the significant financing packages from the IMF is so large that it outweighs the benefits of IMF financing for these countries and for the international financial system more generally. Is the problem of moral hazard so great that it would have been better to withhold financing to Mexico in 1995 or Brazil in 1999 and 2002, notwithstanding the economic and financial costs that an ensuing restructuring would have created both for these countries and for other IMF members?
Even those that express great concern over the increased scale of IMF financing concede that there is little empirical evidence to suggest that such financing has engendered reckless lending by private creditors.83 Moreover, notwithstanding the IMF’s large financing packages, investors now understand that there will indeed be circumstances where emerging market economies may have no choice but to restructure their claims. The defaults of Russia, Ukraine, Ecuador, and Argentina have sent a particularly powerful signal in this regard. Even in those countries where there has been no sovereign default or where the crisis has been avoided without resort to exchange controls, it would be wrong to assume that investors have been shielded from losses. In particular, while the IMF provided an unprecedented amount of financing during the Asian financial crisis, investors holding equity or long-term debt issued by corporations and financial institutions were forced to incur significant losses.
The criticism regarding the unpredictability of the IMF’s access decisions raises difficult issues. On the one hand, the development of clearly defined hard limits on the amount of financing provided by the IMF would help shape expectations of both the countries and their creditors; this would ideally result in unavoidable restructurings taking place earlier rather than later, a benefit to all. At the same time, however, this predictability would come at a cost. Specifically, the imposition of absolute, quantitative limits (expressed as a percentage of a member’s quota in the IMF) would preclude the IMF from providing financing above those limits in circumstances in which large amounts of financing, coupled with strong economic policies, would catalyze a return of market confidence and, thereby, avoid a costly restructuring.
This does not mean that there should be no limits on IMF financing; rather, it suggests that any limits need to be designed in a manner that gives due regard to the overall objectives of such financing. Most importantly in that regard, the IMF should not provide additional financing once it has formed the judgment that the member’s debt is unsustainable, unless the member commits to a restructuring process. When a member’s debt is unsustainable, providing IMF support without restructuring the sovereign’s debt would run counter to the IMF’s mandate; in other words, the financing would simply delay the resolution of a member’s external problems, and such delays would most likely exacerbate the crisis when it arises. Moreover, given the overindebtedness of the country, there would be a significant risk that the IMF would not be repaid.
Another consideration that will need to shape the design of IMF access policy is the fact that its resources are finite. The continued provision of large financing packages to certain members runs the risk of undermining the IMF’s ability to provide financing to others.84 Moreover, the absence of portfolio diversification creates its own financial risks: a large concentration of IMF exposure in several countries would create significant financial problems in the event that the catalytic approach is unsuccessful and the ensuing financial crisis results in the country defaulting on the IMF loan.
While the above considerations provide an appropriate basis for the design of an IMF access policy, the implementation of such a policy has proven difficult. Most importantly, even where the IMF has determined that a member’s debt is most likely unsustainable, it has come under considerable pressure to continue to provide financing, the hope being that a little more financing, when coupled with further adjustment, may restore market confidence and avoid a painful restructuring. Not surprisingly, the intensity of the pressure arises, at least in part, from the uncertainty of the restructuring process. As stated by Stanley Fischer, shortly after he stepped down from the position of First Deputy Managing Director of the IMF in August 2001, this uncertainty “distorts the behavior of the international system”:
Nonetheless, the absence of procedures for dealing with situations where debts have a very high probability of becoming unsustainable distorts the behavior of the international system. Under present circumstances, when a country’s debt burden is unsustainable, the international community—operating through the IMF—faces the choice of lending to it or forcing it into a potentially extremely costly restructuring, whose outcome is unknown. I believe the official sector should go very far to help countries that are willing to take the necessary measures to avoid debt defaults, but debts will sometimes have to be written down. That should be costly for the country concerned, but not as costly as it is now.85
Policies, Process, and Equity
Let us assume that a sovereign can be given adequate incentives to restructure unsustainable debt earlier rather than later and that effective mechanisms can be established to resolve collective action problems. Even under these conditions, the restructuring process will be excessively painful for all if, once the crisis arises, the debtor fails to adopt appropriate policies. These policies may be described as falling into two categories.
The first category embraces a broad range of substantive economic policies. Unless the sovereign is willing and able to formulate and implement appropriate economic policies that have a credible chance of achieving balance of payments viability, there will be no predictability regarding the medium-term prospects of the country and, more specifically, no clarity as to the country’s payments capacity. In these circumstances, creditors are likely to prefer retaining the “option” value associated with their original claim and will understandably eschew entering into a new agreement that the debtor may not be able to honor.
The second category includes policies that define the process by which the restructuring will actually take place. The general perception among many market participants is that sovereign debtors often fail to engage in a constructive dialogue with creditors regarding the possible terms of a restructuring, favoring instead take-it-or-leave-it exchange offers in circumstances in which creditors do not have sufficient information to make informed decisions.86 Such an approach creates a suspicion among market participants that debtors may deliberately be taking actions to generate uncertainty in the restructuring process (through intermittent delays in moving forward in an exchange offer or public statements) so as to drive down the price of their claims on the secondary market, thereby creating substantial room for an exchange offer that will give substantial gains.87 In any event, the unwillingness to negotiate with creditors in an organized framework and, in certain circumstances, the failure to provide adequate information have had the effect of ensuring that it is the debtor rather than the creditor who maintains the initiative during the restructuring process.
While the above strategy may help the debtor obtain more favorable restructuring terms and may also be of benefit to the distressed debt purchasers—who, having bought at a steep discount, are able to reap a considerable profit in the exchange—investors who extended the credit in the first place or purchased the debt at or near face value clearly have much to lose from this strategy. Managers of emerging market funds that attempt to attract this latter type of investor have noted that the absence of a fair restructuring process will make it more difficult to attract such “buy-side” investors, with the effect that there will be a decline in capital flows to emerging market economies.88 Of course, one must carefully evaluate statements made by the private sector suggesting that future capital flows will dry up absent adequate reform. In this era of globalized financial markets, investment banks compete to seek new mandates and fund managers find it difficult to turn away the potential profits that can be generated by lending to an emerging market country at a significant risk premium.
The IMF has been criticized for not using its leverage over debtors more forcefully to support a more collaborative restructuring process. Under its “lending into arrears” policy, the IMF is authorized to provide financing to a member that is in arrears to its private creditors. Originally established in 1989, the policy enables the IMF to provide balance of payments support to countries that are implementing a strong economic adjustment program but have not yet reached a restructuring agreement with their private creditors. The policy effectively precludes private creditors from exercising a de facto veto over IMF financing. However, as a condition for providing financing under the policy, the IMF must make a determination that the member country is making a “good-faith effort to reach a collaborative agreement with its creditors.”89 The requirement that there be some progress in the normalization of the member’s relations with its creditors is derived from the fact that, for these countries, their ability to re-access capital markets in the medium term is judged to be a critical element of medium-term viability. Moreover, such re-access will also provide an important means by which the member will repay the IMF. When the policy was applied in the context of the restructuring of Ecuador’s external debt in 1999–2000, the IMF was criticized by creditors for applying this requirement too liberally when it continued to provide financing even though—at least in the views of Ecuador’s creditors—Ecuador’s restructuring strategy was not a collaborative one.90
The ire of the market has also been directed at official bilateral creditors, whose claims on sovereign debtors are restructured under the auspices of the Paris Club. The practices that have been developed by the Paris Club regarding the restructuring of bilateral debt have evolved over time.91 As a general rule, though, Paris Club restructurings consist of the rescheduling of principal and the deferral of interest payments (“flow restructuring”) rather than the reduction in the stock of debt. Decisions by the Paris Club to restructure are normally taken in conjunction with the approval of an IMF financing arrangement. On the one hand, an IMF arrangement provides the Paris Club creditors with the signal that the members are conducting appropriate adjustment policies. On the other hand, a Paris Club restructuring allows for the resumption of export credit cover that is often critical to the implementation of the IMF-supported economic program.
Complaints made by private creditors regarding the Paris Club are twofold. The first relates to process. The Paris Club creditors generally reach agreement on the terms of a restructuring earlier than private creditors, reflecting, in part, the delays that arise as a result of private sector debt being held by a diffuse group of creditors rather than a handful of banks. Private creditors thus complain that the Paris Club establishes the minimum terms of the private sector’s restructuring through the application of the Club’s “comparability of treatment” provision, yet the private sector does not have the opportunity to provide input into the process. This provision commits debtors to seek “comparable treatment” from other creditors, with the Club creditors retaining discretion in the assessment of comparability. The second complaint relates to the terms themselves. While sovereign debtors have often sought significant debt and debt-service reduction from their private creditors, the Paris Club has often been willing to reschedule only maturities falling due within a specified period, thereby requiring repeated reschedulings.
The above complaints against the Paris Club need to be seen in perspective. The cases where a sovereign debtor has significant exposure to both the private sector and the official bilateral creditors are relatively rare. Not surprisingly, the claims of official bilateral creditors normally constitute a significant portion of debt for those countries that have not yet been able to access private capital. Moreover, it is not entirely clear whether official bilateral creditors do, in fact, receive preferential treatment. Paris Club creditors typically reschedule over extended periods at interest rates linked to their cost of funds. When calculated on a net present value basis (i.e., when discounted at the secondary market yield on the debtor’s other liabilities), these reschedulings may imply a significant reduction in the net present value of the claims. Moreover, debtors have run arrears to official creditors for extended periods while remaining current on their debt to private creditors.
Notwithstanding these considerations, however, there is an emerging consensus that the overall restructuring process could be improved through greater coordination between official and bilateral creditors. Even if the differentiated treatment between these creditors is justified, greater coordination, information exchange, and overall dialogue would go a long way toward deflating suspicions regarding inter-creditor equity.
The Design of the SDRM
Overview
The IMF launched the SDRM proposal in November 2001, and its design evolved considerably over the subsequent 18 months. A review of the features of the SDRM proposal that were endorsed by most of the IMF’s Executive Directors in April 2003 (Proposed Features)92—the text of which appears in Appendix III—reveals a framework that seeks to address many of the perceived weaknesses identified in the previous section. An underlying assumption behind the Proposed Features is that, because there is an important relationship among these weaknesses, reform in one area would also facilitate progress in another.93
Improving collective action among creditors is clearly an area of primary focus under the SDRM proposal. As a means of addressing the problem of holdout creditors, the Proposed Features envisage a legal framework that would enable a qualified majority of creditors to make critical decisions, including—but not limited to—the acceptance of the final restructuring terms, that would be binding on all private creditors holding external claims.94 While this decision-making process is similar to that utilized in collective action clauses, the SDRM outlined in the Proposed Features is more ambitious—and intrusive—than collective action clauses in several important respects. First, consistent with the approach followed in domestic corporate rehabilitation laws, the SDRM would “aggregate” claims across different instruments—irrespective of whether there is a contractual voting framework that links these instruments.95 More specifically, the qualified majority needed to make decisions—and the overall creditor body being bound by such a decision—would be calculated on the basis of all of the creditors affected by the restruc-turing.96 The Dispute Resolution Forum, a centralized body, would be given exclusive jurisdiction over all disputes that may arise during the restructuring proceeding. Second, the voting provisions of the Proposed Features would be applied to the stock of claims in existence at the time of its establishment. Finally, the Proposed Features would bind not only contractual claims but also judgment creditors.97
Another objective of the SDRM proposal is to catalyze a more predictable, equitable, and collaborative debt restructuring “process”—in terms of both debtor engagement with creditors and interaction among creditors. Several elements of the Proposed Features are of particular relevance in this regard. First, the sovereign debtor would be required to provide comprehensive information to creditors at an early stage in the process.98 Second, the fact that claims are aggregated across instruments for voting purposes would, in and of itself, foster greater inter-creditor dialogue and coordination. To the extent that such coordination resulted in the creation of an identifiable and credible creditor counterpart from an otherwise atomized group of creditors, it would also increase the likelihood that the sovereign debtor would engage in a meaningful dialogue earlier rather than later in the process. In that regard, a representative creditors’ committee under the Proposed Features is envisaged as playing an important role in resolving both debtor-creditor and inter-creditor issues.99 Finally, the possible inclusion of official bilateral creditors under the SDRM proposal, albeit as a separate class, is designed to facilitate the resolution of the type of inter-creditor equity issues that have become the matter of increasing focus over the past several years.100
The relationship between the SDRM proposal and IMF financing is a nuanced one. The Proposed Features do not envisage mandatory quantitative limits on IMF financing.101 Despite the inherent uncertainty that arises when making judgments as to whether a member’s debt is sustainable, the IMF believed—and still believes—that this criterion is preferable to the mechanical application of mandatory limits. Any benefits of predictability that would arise from the use of such limits are still considered to be outweighed by the costs—both for the member and the system more generally—that would flow from the IMF’s inability to provide significant support in circumstances in which there was a good likelihood that such financing would facilitate a return to viability without a restructuring.
Nevertheless, when the SDRM proposal was developed, it was recognized that it would make it easier for the IMF to resist pressure to provide financing to a member whose debt is judged to be unsustainable. By establishing a legal framework, sanctioned by the international community, that made the restructuring process more rapid, orderly, and predictable—and therefore less costly—the assumption underlying the SDRM proposal was that it would produce a credible alternative to continued financing, on the one hand, and an uncertain and potentially chaotic restructuring process on the other.102
The premise of the SDRM proposal is that the costs of restructuring for both the sovereign and its creditors would be reduced by eliminating unnecessary delays—in terms of both the initiation and the completion of the restructuring process. Fully aware that the SDRM would make the IMF less indulgent in its financing decisions, a sovereign whose debt is becoming increasingly unsustainable would be more willing to initiate the restructuring process earlier rather than later. This incentive to move early would be enhanced by the availability of robust collective action provisions that would give the sovereign greater confidence that its restructuring efforts would be successful. For their part, creditors would be more willing to make decisions rapidly because of the availability of information from the debtor. Moreover, the establishment of a process that addresses inter-creditor equity issues with greater predictability—as a result of both collective action provisions and the possible inclusion of official bilateral claims—would give creditors the comfort that a decision to restructure their claims would not be taken advantage of by others.
If applied in a sufficiently predictable manner, the SDRM could create incentives for creditors and debtors to reach an agreement without actually having to use it. Moreover, it could also facilitate restructurings prior to defaults, thereby protecting asset values for debtors and creditors alike. In this respect, it would operate like the “prepackaged” insolvency proceedings under Chapter 11.103 Specifically, the very existence of voting provisions of the SDRM would encourage creditors to coordinate earlier rather than later, laying the foundation for negotiations between the debtor and its creditors. Potential holdout creditors would realize that, unless they were sufficiently flexible, the debtor and its creditors could use the mechanism to bind them to the terms of the agreement. If holdouts did continue to resist, the SDRM would be activated at the end of the process for the sole purpose of binding these creditors to the restructuring process.
Finally, in addition to reducing the costs of restructuring for both sovereigns and creditors, the SDRM proposal was seen as providing broader systemic benefits. To the extent that the absence of a fair and collaborative restructuring process does indeed make potential investors less willing to purchase sovereign debt, the above features could enhance emerging market debt as an asset class.104 In addition, if the features were able to make the restructuring process more rapid, it could also help in limiting the risk of contagion. Finally, and more generally, by increasing the predictability as to the how the process will unfold, creditors would presumably be in a better position to price and manage risk, thereby increasing the overall efficiency of the capital markets.
Despite its ambitions, the SDRM would be no panacea. First, while it would reduce the costs of restructuring, the costs would still be high for the sovereign, particularly where, for example, the banking system holds a large portion of the debt to be restructured. On one level, of course, the fact that costs would remain high is not problematic since it would serve to contain the risk of debtor moral hazard, that is, these costs would limit the likelihood of opportunistic defaults.105 Perhaps the SDRM proposal’s most significant limitation is that its effectiveness would, in the final analysis, depend on the coherence of the sovereign’s policies. No matter how effective the collective action mechanism, creditors would not be willing to agree to a restructuring unless and until the sovereign had formulated—and had made a credible commitment to implement—a medium-term macroeconomic framework that would provide adequate assurance that the country would be able to repay the restructured claims.
To the extent that domestic political constraints make it impossible for the sovereign to take such measures, the existence of the SDRM would not resolve this problem. At the same time, however, it is possible that these political constraints may be considerably less severe if the restructuring process is initiated earlier; if early initiation is successful in reducing—at least on the margin—economic dislocation, it may also serve to diminish the associated political and social constraints on economic policymaking.
The establishment of the SDRM would require a considerable exertion of political will by the international community. Since its provisions would supersede contractual terms, it would require a statutory basis. This would be achieved through an amendment of the IMF’s Articles of Agreement, a multilateral treaty that currently has 184 signatories.106 Under the IMF’s Articles, member countries have the obligation to ensure that all steps have been taken under their domestic law to ensure that the provisions of the agreement—and any amendments—will be given full force and effect in their territory.107 Since the amendment establishing the SDRM would interfere with the rights of private persons, the constitutional framework of some countries would require the adoption of domestic legislation. Not surprisingly, even as considerable progress was being made with respect to the design of the SDRM proposal, doubts continued to be expressed as to its political feasibility.108
General Design Issues
As discussions regarding the SDRM proposal advanced, it became increasingly clear that the design of its specific features was being guided by a number of general considerations, or “meta-design” issues.
The Corporate Rehabilitation Analogy
During the development of the SDRM proposal, nongovernmental organizations, legal and economic academics, and market participants contributed their own views as to whether a new legal framework was needed and, if so, how it should be structured. In that context, a number of commentators expressed the belief that the objectives and features of domestic insolvency legislation—particularly corporate rehabilitation legislation—provided important guidance when contemplating both the utility and design of the SDRM proposal.109 Indeed, even before the SDRM proposal was launched in November 2001, a number of important contributions had been written regarding the potential relevance of domestic statutory rehabilitation frameworks to the resolution of financial crises.110
At a certain level of abstraction, there is little question that corporate rehabilitation laws are of relevance when considering both the desirability and design of a statutory sovereign debt restructuring framework. As with the SDRM proposal, corporate rehabilitation laws are based on the assumption that collective action problems among creditors are a sufficiently important form of market failure to require intervention from the official sector in the form of a statutory framework.
Nevertheless, as the details of the SDRM proposal developed, it became increasingly clear that there are important limits to the corporate rehabilitation analogy. Corporate rehabilitation laws operate within the context of a broader set of rules that provide for the enforcement of creditor rights against the defaulting debtor.111 Perhaps most importantly, they function within the shadow of corporate liquidation; where a rehabilitation plan fails to muster adequate support from the creditor community, the company will normally be liquidated in accordance with the provisions of the liquidation law—an outcome that is not applicable in the sovereign context.112 While the existence of a liquidation law has an important disciplining effect on the debtor, it also provides an important benchmark for resolving inter-creditor problems when the terms of a restructuring plan are developed. For example, emerging best practices in this area require that, under a rehabilitation plan, a dissenting creditor may not receive less than what it would have received under liquidation, taking into consideration the creditor’s ranking under the liquidation priority rules.113 Given the unique qualities of attributes of a sovereign state, there are other aspects of corporate rehabilitation laws that could not be applied. For example, consistent with the objective of maximizing the value of creditors’ claims, many modern rehabilitation laws allow for the creditors to commence rehabilitation proceedings unilaterally and to acquire the company through a reorganization plan that includes debt-for-equity conversion. Moreover, rehabilitation laws also place legal constraints—to varying degrees—on the company’s activities during the proceedings. The ability to establish and enforce such limits against a sovereign state would clearly be problematic.114
For critics of the SDRM proposal, these differences serve to underline the difficulty of establishing a statutory framework to restructure the debt of a sovereign. In particular, the absence of an equivalent enforcement mechanism against a sovereign that would balance the protection provided to it under a statutory framework may be particularly problematic.115 More generally, would not the adoption of such a framework in the sovereign context create a problem of “debtor moral hazard”?
While such concerns are legitimate, the perspective of the IMF has been that the SDRM could nevertheless be designed to address the distinguishing features of a sovereign state and that a number of features of domestic insolvency laws (particularly those that relate to voting and the aggregation of creditor claims) may provide useful guidance in the sovereign context. To minimize the risk of debtor moral hazard and, more generally, any disruption in the operation of capital markets, the Proposed Features are designed so that they do not shift legal leverage from creditors to the debtor.116 Rather, the majority voting provisions of the SDRM proposal serve to increase the leverage of creditors as a group over individual creditors. Thus, for example, any stay on enforcement pending a restructuring agreement could only be established with the requisite creditor support.117
The Role of the IMF
One of the most difficult issues that arose during the discussion of the SDRM proposal was the role of the IMF in its establishment and operation. On the one hand, there are several advantages to establishing a statutory sovereign debt restructuring framework through an amendment of the IMF’s Articles of Agreement. First, by virtue of the amendment provisions of the IMF’s Articles, it provides a basis for establishing a universal framework (184 countries are currently signatories) without the need for unanimity. Under the terms of the Articles, an amendment approved by three-fifths of the IMF’s members holding 85 percent of the IMF’s total voting power will become binding on all members.118 Second, by relying on the IMF’s Articles, there is some assurance that the framework, once established, would remain universal. A country wishing to withdraw from the SDRM would need to bear in mind that it could only do so by depriving itself of the benefits of membership in the IMF, including the benefit of financial assistance. Replicating a similar incentive structure in a new stand-alone treaty would be difficult. Finally, given the mandate of the IMF in providing assistance to countries that are resolving their financial crises, it is inevitable that the IMF’s decisions would affect the operation of the SDRM, particularly with respect to judgments as to the sustainability of a member’s indebtedness.
At the same time, however, active participation by the IMF in the operation of the SDRM raises a number of difficult issues. First, there is the problem of a potential conflict of interest. As in the case of a domestic insolvency law, the operation of the SDRM will require the existence of an independent institutional infrastructure that will be able to resolve disputes that may arise between the debtor and its creditor and among creditors. It is clear that the IMF’s Executive Board could not play this role. Not only is the IMF a creditor, but the IMF’s Executive Directors also reflect the interests of IMF members, that is, national governments, some of which will also be creditors.119 Second, and perhaps even more important, concerns were voiced that, because of this governance structure, political considerations could also play a role in the Executive Board’s decisions.120 Finally, there was a fear of “mission creep”; for an institution that is already perceived by many as being excessively powerful, concerns have been expressed about any reform that would give it any further authority.
As the design of the SDRM proposal evolved, the IMF attempted to address these concerns by effectively eliminating any formal role of the Executive Board in the process. In effect, all decisions would be made by the debtor and a qualified majority of its creditors. The Articles of Agreement would merely provide the legal basis for making these decisions binding on the rest of the creditor body. With respect to the resolution of disputes, the amendment would establish a dispute resolution forum that would be independent of the Executive Board and all other organs of the IMF. As discussed below, certain features relied upon in other treaties would be used to ensure that this organ would operate—and would be perceived as operating—free of any influence of the IMF’s Executive Board.121
Of course, the IMF would still exercise considerable influence over the process through the exercise of its traditional financial powers. Perhaps most important, in circumstances in which it discontinues financing because of a determination that the member’s debt is unsustainable, this would probably leave a country with little choice but to initiate the SDRM. Moreover, the IMF would also play an important role at the end of the process, that is, when the sovereign’s creditors are asked to accept a restructuring offer. At that stage, it is very likely that an IMF-supported program would need to be in place to provide some assurance to creditors that the sovereign is implementing policies that will give it the capacity to service the restructured claims. In sum, while the SDRM would not give the IMF’s Executive Board any additional legal powers, its operation would rely on the exercise of the IMF’s existing financial powers.
The Benefits of Minimalism
The substantive and procedural rules of most modern domestic insolvency laws tend to be relatively detailed. Indeed, to the extent that such laws can anticipate and resolve most of the issues that can be expected to arise in their application, they are likely to enhance the overall predictability of the credit system. However, the establishment of detailed treaty obligations that provide guidance on all aspects of the restructuring process was not the approach followed by the IMF when developing the SDRM proposal. Rather, the Proposed Features provide for a relatively simple and streamlined framework that is designed to create incentives for early and expedited negotiations between the debtor and its creditors—not a fully elaborated blueprint for a restructuring. This approach was motivated in large part by a concern that, given the inevitable evolution of the capital markets, overly narrow and detailed rules would become outdated or subject to circumvention. While, in the domestic insolvency context, such risks can be addressed through periodic changes to the relevant law, this is more difficult to achieve where the legal instrument in question is an international treaty with 184 signatories. In addition, there was a concern that a complex mechanism with a number of moving parts would have unanticipated—and unwanted—consequences on the international financial system. As noted in the Proposed Features, while the SDRM would interfere with contractual relations, the objective is to limit such interference to the resolution of only the most important collective action problems and, as indicated earlier, to resolve them in a manner that does not create debtor moral hazard.122
The need to fashion a relatively minimalist framework was also dictated by the immovable reality of state sovereignty. Debtors are unlikely to accept the involuntary commencement of the SDRM, the establishment of onerous legal obligations, or, more generally, any significant interference with the exercise of their sovereign powers. In their final form, the Proposed Features can be described as establishing a legal instrument available to sovereigns to restructure their claims if they are of the view that it would be in their interest to do so. If a sovereign were to use the SDRM in a manner that was inconsistent with its terms, provisions of the Proposed Features would preclude the sovereign from enjoying its benefits. Such actions by the sovereign would not, however, constitute a violation of international obligations.
Concerns regarding interference with state sovereignty were not limited to potential debtors. For example, member countries whose citizens were likely to be private creditors under the mechanism were concerned about the establishment of a supranational entity that would exercise exclusive jurisdiction over the resolution of disputes involving these creditors and whose decisions would be binding on domestic courts. This was a key reason why the powers of the proposed Dispute Resolution Forum (DRF) are significantly circumscribed under the Proposed Features.123
Specific Design Issues
The Scope of Debt
When the debt burden of the sovereign is judged to be unsustainable, it is very likely that the scope of debt that requires restructuring will have to be comprehensive in order to achieve a reduction in the debt and debt-service burden of sufficient magnitude to restore sustainability. A comprehensive debt restructuring may also be required to address inter-creditor equity concerns; creditors holding one type of claim may only be willing to restructure their debt if other creditors also contribute to the restoration of sustainability.
However, while it is relatively clear that a restructuring of unsustainable sovereign debt may need to include a broad and diverse array of claims, it is less obvious whether it is feasible—or even desirable—for all of these claims to be restructured under the same legal framework. In that context, two broad issues emerged during the development of the SDRM proposal. First, the question arose whether all claims on the sovereign should be made subject to restructuring under the SDRM or should the scope of such claims be limited to sovereign claims held by private external creditors, where problems of collective action are most severe. Second, to what extent should debt owed by entities other than the sovereign (e.g., public and private companies and financial institutions) also be restructured under the SDRM in circumstances in which such a restructuring is a necessary condition for the resolution of the financial crisis faced by the sovereign?
With respect to the first issue—the scope of claims on the sovereign that should be restructured under the SDRM—it became increasingly clear during the relevant discussions that the broader the coverage of the SDRM, the more complex the framework would become. To the extent that the SDRM covered very different types of claims—secured and unsecured claims, domestic and external claims, and claims held by both private and official creditors—there would need to be important qualifications to the general principle that voting should take place on an aggregated basis. Otherwise, there would be a risk that a minority of creditors holding a particular type of claim would be unfairly treated by a majority of creditors holding very different claims.
In the context of some nonsovereign rehabilitation laws, the risk of inter-creditor discrimination that arises when aggregating “apples and oranges” is addressed through a classification system.124 Claims with different priorities under the liquidation law are placed in different classes for voting purposes. Support by the specified majority of creditors in each class would be required to approve the restructuring terms offered to all classes. While votes are aggregated across instruments—thereby reducing the leverage of holdouts within a class—there is no aggregation of votes across classes. However, if all classes were required to approve the overall restructuring, each creditor class would have effective veto power over the terms offered to other classes.125 Finally, while all creditors within the same class would need to receive the same restructuring terms (or menu of terms), treatment of creditors across classes could be different.126
Of course, one of the difficulties of introducing the above framework in the sovereign context is the fact that there is no liquidation law that provides a benchmark for classification. More generally, as has been pointed out recently by a number of observers, there is no clear priority structure for sovereign debt.127 Finally, there was a concern that the creation of multiple classes could make both the design and operation of the framework excessively complicated. As has been recognized in the nonsovereign context, such complexity would require greater reliance on the institutions charged to implement it—a reliance that would be particularly problematic given concerns about the creation of a supranational institution and the implications for state sovereignty.128
As discussed below, the approach eventually proposed for the SDRM took into account both the above considerations and the nature of the claims in question.
Domestic Debt
Corporate insolvency laws generally do not distinguish between domestic and external debt.129 Whether that debt is held by a resident or nonresident, or whether it is denominated in local currency or foreign currency, these factors have no legal significance. With the integration of capital markets, there are a number of reasons why a similar approach could be taken in the sovereign context. In an environment in which residents and nonresidents purchase the same types of instruments and trade with each other, creating a distinction based on residency would appear somewhat artificial. Similarly, making a distinction on the basis of the currency of payment or denomination is also not meaningful, at least from a balance of payments perspective. As long as the country does not maintain capital controls, a creditor that receives a payment in the domestic currency will be free to convert this payment into foreign currency and transfer it abroad.
Still, a closer analysis of the unique features of sovereign debt reveals that there are other distinctions between domestic and external debt that may be more meaningful from a restructuring perspective—at least in terms of resolving collective action and inter-creditor equity issues. Perhaps the most important is the legal nature of the claim. Specifically, if a creditor holds a claim that is both governed by the domestic law of the sovereign and subject to the jurisdiction of the domestic courts, its enforcement rights against the sovereign are somewhat limited: even if a creditor is able to obtain judgment in a court located within the territory of the sovereign, it is unlikely that a domestic court will authorize the attachment of assets of the government and central bank.130 In this respect, claims that are governed by foreign law or subject to the jurisdiction of the foreign courts may be viewed as more “senior” than domestic debt by virtue of the opportunities for both judgment and attachment that are provided under the foreign sovereign immunity laws of a number of countries.131
In light of these considerations, the IMF considered two different approaches with respect to the SDRM proposal’s coverage of domestic debt. Under the first, domestic debt (i.e., claims governed by domestic law and subject to the jurisdiction of the domestic courts) would be included under the SDRM, but as a separate class from external claims (i.e., claims governed by a foreign law or subject to the jurisdiction of a foreign court).132 Consistent with the approach followed in the nonsovereign insolvency context, an affirmative vote by a qualified majority of each class would be necessary for the overall restructuring to go forward, thereby giving holders of domestic claims and external claims a reciprocal veto over each other. In circumstances in which the majority of the claims are domestic, this approach would prevent holders of these claims from imposing restructuring terms upon a minority of creditors holding external claims—including terms that would involve stripping the superior enforcement rights from the minority.
Under the second approach, domestic debt (similarly defined) would be restructured outside, but parallel to, the SDRM. Where a restructuring of both domestic and external debt was judged necessary, creditors holding external claims would be able to take account of the terms being offered to domestic creditors outside the SDRM before voting on a restructuring agreement under the SDRM. If the terms offered to domestic creditors did not, in the view of external creditors, provide for adequate inter-creditor equity, external creditors would refuse to agree to a restructuring of their own claims. The transparency requirements of the SDRM, discussed below,133 would ensure that external creditors would have all relevant information regarding the treatment of domestic debt when they made this decision.
The second approach prevailed for a number of reasons. First, in terms of resolving collective action problems, the inclusion of domestic debt under the SDRM proposal was not considered necessary given the relative weakness of enforcement rights against the sovereign. Because of these perceived weaknesses, holdout creditors holding these claims would not have enough legal leverage to disrupt the restructuring process.134 Of course, there is always the risk that a holder of a domestic claim could take measures to enhance its enforcement rights. Specifically, if it is able to obtain a judgment but unable to enforce its claim in the courts of the sovereign debtor, it may attempt to enforce the judgment abroad pursuant to bilateral or multilateral treaties that provide for the recognition and enforcement of judgments. To address such a risk, the Proposed Features provide that a domestic claim would become an external claim (and therefore subject to the SDRM) once it is recognized and enforced outside the territory of the sovereign debtor.135
The second reason for excluding domestic debt from the coverage of the SDRM relates to inter-creditor equity. During the development of the SDRM proposal, considerable uneasiness was expressed by external creditors with any framework that would give domestic creditors—who possess inferior enforcement rights—an effective veto as to whether the restructuring of external debt could go forward. In contrast, while the second option gave external creditors the option of holding up their own restructuring if they felt the terms offered to domestic creditors were excessively generous, it did not preclude them from concluding a deal with the sovereign in circumstances in which the sovereign had not concluded an agreement with its domestic creditors.
Finally, including domestic claims under the SDRM—even as a separate class—was ultimately viewed as being excessively intrusive from the perspective of national sovereignty. A number of countries could not accept the possibility that debt issued within their own territories and subject to their own laws could be restructured under a legal framework that would be administered by an international dispute resolution body. Even among mature market countries—who were very unlikely to avail themselves of the SDRM to restructure their debt—there was likely to be a concern that the domestic legislature would be unwilling to adopt the SDRM if there was even the remotest possibility that it could be used to restructure domestic debt. The advantage of the second option was that, as long as a sovereign only issued debt governed by its own law and subject to its own jurisdiction, the SDRM could never be used to restructure its own debt.136
Official Bilateral Creditors
The proposed treatment of sovereign debt to official bilateral creditors under the SDRM received considerable attention both from the official and private sectors and is one of the few important substantive issues that remained unresolved when the Proposed Features were submitted to the IMF’s International Monetary and Financial Committee in April 2003. In one sense, it may be argued that the extension of the SDRM to official bilateral claims is unnecessary. As a general matter, the restructuring of official bilateral claims has not been hampered by problems of collective action. The nonbinding decisions of the Paris Club to provide debt relief are normally reached by consensus and are then given effect by individual official creditors pursuant to bilateral rescheduling agreements.137 This cohesion reflects the public interest that motivates the restructuring decisions of these creditors.
Rather, the potential benefits of including official bilateral claims under the SDRM relate to the resolution of the type of inter-creditor equity problems that have arisen between the Paris Club and the private sector, which have been described earlier.138 As with domestic debt, two options were considered. Under the first, official bilateral creditors would be included within the scope of the SDRM, but as a separate class from private creditors. While claims contained in each class would not be aggregated for voting purposes, approval of each class would be necessary for the overall restructuring to move forward. The use of separate classes would enable official bilateral creditors and private creditors to receive different terms, thereby taking into account their different interests. At the same time, the mutual veto would provide incentives for early dialogue between the two groups. The second option would involve restructuring official bilateral claims outside the SDRM, but developing procedures that would provide greater predictability with respect to inter-creditor dialogue. Moreover, as is the case with domestic debt, the transparency requirements imposed by the SDRM would ensure that private creditors obtained all relevant information regarding the treatment of official creditors.
Although the private sector was resistant to the SDRM proposal, it was clear that—if one were established—the private sector would prefer official bilateral claims to be included as a separate class. The fact that it would give official bilateral claims a veto over the restructuring terms provided to private creditors was not considered problematic since, unlike domestic creditors, official creditors were already perceived as having considerable leverage in this process and arguably a form of de facto seniority. To the extent that the SDRM gave private creditors an effective veto over the terms offered to the Paris Club, this would improve the fairness of the overall process from the perspective of private creditors.
Rather, concerns regarding the inclusion of official bilateral claims came from within the official sector, among them being an unease regarding the possible implications on the speed of the restructuring process.139 Specifically, if official bilateral claims were treated as a separate class within the SDRM, this would create a presumption that this debt would be restructured at the same time as the debt owed to private creditors. One structural concern regarded the flexibility of the SDRM; specifically, there is a concern that the SDRM must be sufficiently flexible to allow for a sequenced approach, so as to ensure that any delays encountered during negotiations between the sovereign and its private creditors would not prevent official bilateral creditors from restructuring their own claims. A second concern related to sovereignty; namely, official bilateral creditors might not be willing to implement a framework in which a restructuring of their claims could be implemented by a decision of a qualified majority, or in which the restructuring of their own claims could be made contingent upon the reaching of a restructuring agreement between the sovereign and its private creditors. Notwithstanding these concerns, there was sufficient recognition within the official sector of the potential benefits of including official bilateral claims within the SDRM that it was decided to leave this question open in the Proposed Features.140 In the event that the international community decides to return to the SDRM proposal or some other variation of it, one of the key challenges will be to design it in a manner that addresses these concerns while ensuring adequate dialogue and coordination between official bilateral and private claims.
Multilateral Debt
The treatment of debt owed to international financial institutions, including the IMF and the World Bank, raises a very different set of issues. The Proposed Features provide that claims owed to international financial institutions would not be eligible for restructuring under the SDRM.141 Unlike domestic debt, the proposed exclusion of these claims was not intended to suggest that they should be restructured outside the SDRM—but rather that, in keeping with existing practice, they should be exempted from the restructuring process altogether.
The tradition of excluding the IMF from the restructuring process reflects what is generally referred to as the “preferred creditor” status of the IMF. Until recently, it has been a practice accepted by official bilateral creditors, private creditors, and sovereign debtors as being in their own self-interest. By shielding the IMF from the risk of nonpayment and restructuring, the IMF can provide financing when other lenders would be unwilling to do so. Such financing—and the economic policies it supports—provides a framework for medium-term balance of payments viability, thereby enhancing the recovery value for all creditor groups. For a sovereign debtor, remaining current with the IMF and implementing an IMF-supported program enable it to unlock additional financing or debt relief from official or private creditors. Stated generally, the premise has been that the claims of these institutions should be treated preferentially because these institutions, by enhancing economic growth and financial stability, provide a public good that, in the long run, is in the interests of all stakeholders.142 At a certain level of abstraction, the preference given to the IMF can be compared to the priority that is afforded to creditors who provide new financing after the commencement of corporate reorganization proceedings.143
During the discussion of the SDRM proposal, questions were raised by nongovernmental organizations as to whether the IMF’s preferred-creditor status should be retained.144 In some respects, it is not entirely surprising that the IMF’s preferred-creditor status should be the subject of greater scrutiny. As the amount of financing provided by the IMF has increased over the years in the context of capital account crises, its share of the total debt owed by the country has also increased. When a restructuring becomes necessary and private creditors are asked to accept a significant reduction in the value of their claims, there may indeed be demands that the IMF not be excluded from the restructuring process.
Irrespective of the merits of such arguments, there should be no doubt as to the consequences they suggest, both for sovereigns and for creditors. The elimination of the preferred-creditor status of the IMF and other multilateral institutions would result in a decrease in the volume of financing provided by these institutions and an increase in the price of such financing through the addition of a risk premium to the relevant interest rates. Faced with the risk of being treated like any other creditor, these institutions would have no choice but to begin acting like them. In the case of the IMF, such a development would severely constrain its ability to play a catalytic role in the resolution of financial crises, that is, where significant financial assistance in support of strong adjustment programs engenders a return of market confidence, thereby obviating the need for a painful restructuring. The fact that, to date, private creditors have generally not challenged the IMF’s preferred-creditor status likely reflects a recognition on their part that—on balance—preserving this status continues to be in their own self-interest.
Secured Claims
Unlike corporations, sovereigns145 generally borrow on an unsecured basis.146 When they do offer security, it is subject to the constraints imposed by the “negative pledge” provisions contained in their existing credit agreements, which limit a debtor’s ability to collateralize their assets.147 When designing the SDRM proposal, consideration was given to treating secured claims in a manner similar to how they are treated under many insolvency laws: to the extent that the law permits a secured claim to be restructured without the creditor’s individual consent, the majority voting rules require that a secured creditor vote in a separate class from unsecured creditors.148 The desire to include secured claims under the SDRM was driven primarily by a concern that their exclusion could distort the structure of sovereign borrowing. Specifically, exclusion could create incentives for sovereigns to rely on collateral—rather than the adoption of sound economic policies—as a means of attracting finance.
As work on the SDRM proposal progressed, however, it was recognized that the inclusion of secured claims would complicate the operation of the mechanism in a number of respects. First, it would necessitate the imposition of some form of automatic stay upon the SDRM’s commencement. Faced with the prospect that the SDRM’s majority voting rules could result in a restructuring of its claims without its consent, a secured creditor would invariably foreclose upon its collateral, using, where possible, self-help remedies.149 Apart from the fact that such a stay would represent a significant interference with contractual relations, it would also require giving the secured creditor some form of protection regarding the value of its collateral during the period of the stay, as is required under many insolvency laws.150 Second, the classification system would not be entirely straightforward. In particular, differences in the types of collateral may make it difficult to place all secured creditors in the same class.
Given these potential complications, it was decided to exclude secured claims from the coverage of the SDRM and to rely on other instruments to ensure that this exclusion would not distort sovereign lending. Most importantly, by virtue of the existence of negative pledge clauses in all of the loans extended by multilateral development banks, it would be possible for the official sector—through these institutions—to control effectively the amount and type of security that is granted by sovereigns.151 Of course, secured claims would be excluded from the SDRM only to the extent of the value of the security. In the event that the value of the claim exceeded the value of the collateral, the unsecured portion would be subject to the operation of the mechanism.152 Accordingly, there would need to be an effective valuation process to determine the value of this deficiency.
Nonsovereign Debt
One of the lessons of the Asian financial crisis of 1997–98 is that such crises can be triggered by overindebtedness in the banking and corporate sectors, particularly where much of this debt is of a short-term nature (e.g., interbank credit).153 As a result of a sudden loss of confidence among external creditors, a large and sudden depletion of reserves can take place. Even when the crisis originates from a default by the government or the central bank on their own claims, this can lead to capital flight when the domestic banks hold a significant portion of the sovereign’s debt. Residents, in anticipation of the insolvency of the banking system, will rush to withdraw their deposits and sometimes transfer the proceeds abroad. As a means of stemming the outflow of capital in the above circumstances, a country may have little choice but to impose capital controls. Of course, resorting to such measures will have its own costs, including that of contagion. Moreover, controls lose their effectiveness over time, as residents find ways to circumvent their application. Nevertheless, they may be necessary for a temporary period while corrective policy measures take hold. In these circumstances, the scope of controls is likely to be broad and will therefore interrupt the ability of domestic banks and corporations to service their claims, resulting in widespread defaults.
During the development of the SDRM proposal, the above analysis raised the question of whether it should be designed to provide some limited protection to banks and corporations from creditor enforcement actions during the period when capital controls are in place, on the grounds that it is the state—rather than the debtor—who is responsible for the payments interruption. This would have required an amendment of Article VIII, Section 2(b) of the IMF’s Articles.154 The decision was ultimately made, however, not to include such an amendment in the SDRM.
This decision was particularly motivated by two considerations. First, upon close examination, staying creditor enforcement with respect to arrears arising from exchange controls would complicate both the design and implementation of the framework. For example, would it be feasible to distinguish between those debtors who, but for the exchange controls, would be in a position to repay their debt and other debtors who do not even have the domestic currency to purchase foreign exchange? It would be preferable for the claims of the latter category to be restructured under the terms of the insolvency law. Moreover, during the period of the stay, mechanisms would need to be established to give creditors the assurances that the owners of the enterprise were not stripping its assets.155
The second motivation behind the decision to exclude exchange controls from the SDRM proposal relates to the role of the IMF. As noted above, there was a strong desire to limit the role of the IMF in the operation of the SDRM. To the extent that the SDRM only applies to sovereign debt, this can be easily achieved, given that all decisions are made by the sovereign and a qualified majority of its creditors. However, in the context of exchange controls that give rise to the default of a multitude of debtors (each with its own group of creditors), such an approach would not be feasible. In these circumstances, the legal authority to approve a temporary stay would need to be vested with a body that had the expertise to determine whether such an action was justified by the circumstances. While the IMF has this expertise, in the end it was decided that providing the institution with such an enhancement of its legal powers would not be acceptable to the international community.
Commencement
The design of the SDRM proposal evolved considerably on the difficult issue of the “trigger,” the conditions precedent to the activation of the SDRM. Throughout the discussion, however, there was continuity with respect to two broad principles. First, to avoid excessive interference with the exercise of state sovereignty, it was recognized that the mechanism could only be initiated by the sovereign.156 Second—and consistent with the overall objective of the SDRM proposal—it was always understood that the SDRM should only be activated by a country if its debt was unsustainable. The evolution in the design of the SDRM proposal related to how this latter principle would actually be made operational; namely, should the country’s representation that its debt is unsustainable be subject to challenge, and, if so, by whom?
The initial position of the IMF was that, in order to prevent abuse of the SDRM, there would need to be some independent determination as to whether a country’s debt was truly unsustainable.157 Given its mandate and expertise in this area, the initial proposal envisaged that this role would be played by the IMF and, in particular, its Executive Board.158 This approach was not well received for a variety of reasons. As a general matter, there was some reluctance to establish any framework that would further enhance the IMF’s authority. For private creditors, the IMF’s role in activating the SDRM was particularly problematic given the fact that one of the consequences of activation under the original proposal was an automatic stay on en-forcement.159 To market participants, an IMF-imposed stay smacked of excessive official intervention on behalf of recalcitrant debtors. Concerns were also expressed regarding the basis for the IMF Executive Board’s judgments on sustainability. Specifically, would the IMF’s assessment be based exclusively on economic criteria, or would political factors enter into the decision-making process?
As a result of these concerns, the proposal was revised so that approval by the Executive Board would not be a condition for the activation of the mechanism. Accordingly, while the mechanism would require the member to represent that its debt was unsustainable, this representation would not be subject to challenge.160 There was a recognition that this approach was not without its drawbacks, however. Was there not a risk that the absence of any gatekeeper would create a form of debtor moral hazard? Specifically, even when a country’s debt is unsustainable, the existence of an internationally sanctioned restructuring framework that can be activated unilaterally could increase the domestic political pressure on governments to restructure sustainable debt for the sole purpose of liberating additional funds for other purposes.161 Among other things, such an outcome could severely undermine the availability of external financing for emerging market economies.
This risk was mitigated by two factors. First, in light of the economic costs associated with restructuring—no matter how orderly they proceed—most countries would only initiate the mechanism as a last resort, even if they could do so unilaterally.162 Indeed, the problem to date has been the fact that the restructurings are too late rather than too early. For this reason, it was considered more likely that most countries would only activate the SDRM once the IMF had determined that the member’s debt was unsustainable and that further financing from the IMF would not be available unless the member activated the mechanism. Second, the IMF recognized that the extent to which the absence of an independent check would actually increase the risk of abuse would depend on the extent to which the mechanism, once activated, provided the debtor with greater leverage over its creditors. The other features of the SDRM would not provide such leverage. Most important, and as discussed below, it would not provide for an automatic stay on enforcement. Rather, it would merely set in motion a procedure that would facilitate creditor organization and voting on an aggregated basis.
The Stay on Creditor Enforcement
As originally conceived, the SDRM proposal provided for the automatic imposition of a stay on creditor enforcement following its activation.163 As discussions progressed, however, consideration was given to a generalized stay that could only be imposed by an affirmative vote of a qualified majority of creditors that would be affected by the restructuring, at which point it would become binding on all affected creditors.164 In this respect, such a stay would mimic the majority enforcement provisions of collective action clauses.165 At a very general level, it may be said that the evolution in the thinking of IMF staff on this question reflected a recognition that, given the overall fragility of creditors’ enforcement rights against a sovereign, an automatic stay would constitute an unnecessary and inappropriate shift in legal leverage from creditors to debtors—one which, on the margin, could encourage (or be perceived as encouraging) defaults by debtors.166 However, as work on other features of the SDRM progressed, more specific reasons emerged as to why, in the sovereign context, an automatic stay would be problematic.
In the corporate rehabilitation context, an automatic stay on creditor enforcement is accompanied by a stay on payments by the debtor to other creditors.167 Indeed, these two measures, taken together, constitute a “standstill” that is designed not only to protect the business as a going concern but also to ensure inter-creditor equity. A creditor has the assurance that, during the period it is unable to enforce its rights, the debtor will be precluded from dissipating assets by making payments to other creditors. In the sovereign context, however, it would be very difficult to provide for—or enforce—the general cessation of payments that provides the necessary counterpart to the stay on creditor enforcement.
The first difficulty is an economic one. Even when a sovereign’s debt is unsustainable, it is very likely that it would wish to exclude certain claims from the restructuring process and continue servicing these claims—whether or not such claims are eligible to be restructured under the SDRM. For example, when the banking system holds a significant portion of the sovereign debt, a default is likely to trigger a run on deposits and, as a consequence, significant capital outflows. To the extent that this results in the insolvency of the banking system, this will have catastrophic consequences not only in the short term (with the resulting collapse of economic activity) but also in the long term, as the cost of recapitalization seriously undermines the country’s fiscal position—and, therefore, its ability to service its restructured debt. Notwithstanding inter-creditor equity concerns, a creditor whose debt is being restructured may, therefore, also be of the view that it is to its advantage for the sovereign to exclude certain claims from the restructuring process. For this reason, as discussed further below, the claims that would be subject to a restructuring would be limited to those identified by the sovereign.168 To the extent that such creditors—who would receive this information pursuant to the SDRM’s information requirements169—were of the view that the scope of the restructuring was unjustifiably narrow from an inter-creditor equity perspective, they would signal that their own support for a restructuring proposal would be contingent on an expansion.
This approach has important implications for the design of any stay on enforcement; in an environment in which it is highly likely that the sovereign will wish to interrupt the payment of certain claims but continue to service others, there are strong reasons why, from an inter-creditor equity perspective, any stay on enforcement should only be put in place following a vote by the creditors affected. Through such a vote, creditors could indicate whether the exclusion of certain creditors is justified, because, for example, such an exclusion was a necessary means of limiting economic dislocation.
Another difficulty with the concept of a general standstill in the sovereign context relates to its lack of enforceability against sovereign debtors. Assuming that a general cessation of payments were considered appropriate from an economic perspective, creditors would not have the assurance that payments by the sovereign would actually be prevented. In the corporate context, creditors have such an assurance, and it provides an important balance to the automatic stay. To that end, a court-appointed representative will often supervise the management of the corporation during this period to ensure that such payments are not being made and that assets are not being dissipated more generally.170 Under the SDRM proposal, how would creditors be given such an assurance without seriously compromising the principle of sovereignty? In the absence of an enforceable stay on payments by the debtor, a stay on creditor enforcement that requires some form of creditor approval was considered to be more appropriate. Before voting on whether to impose a stay, creditors could assess whether the sovereign debtor was pursuing economic and financial policies—including policies relating to the making of payments—that would enhance the value of their own claims.
Notwithstanding its merits, the creditor-approved stay has its drawbacks. Most important, a framework under which all creditor voting is to take place on an aggregated basis would inevitably include a time lag between the date of commencement and the date when creditors will be in a position to make decisions, including decisions regarding a stay. As discussed below, creditor claims would need to be verified, and, even when conducted on an accelerated basis, this process could take months.171 During this period, would there be a risk that creditors would enforce their claims and that such enforcement actions could disrupt the restructuring process?
On the one hand, it is clear that the “rush to the courthouse” that provides one of the justifications for an automatic stay under corporate rehabilitation laws does not exist in the sovereign context. While creditor enforcement rights against a sovereign have become increasingly more meaningful over the years, they do not yet benefit from the degree of speed and predictability that exists in the corporate context, particularly with respect to unsecured claims.172 On the other hand, there was a recognition that the SDRM—under an international treaty that could not be easily amended on a periodic basis—had to be designed so that it could accommodate an evolution in the legal environment, the direction of which could be affected by the SDRM itself. For example, while most litigation to date has taken place after a restructuring agreement has been reached, the majority voting provisions of the SDRM could change that dynamic; faced with the fact that any restructuring agreement could be made binding upon them without their consent, distressed debt purchasers could conclude that they had no choice but to enforce their claims before such an agreement was reached.
In light of the above, considerable attention was devoted within the IMF to designing measures that would supplement a creditor-approved stay, but which could be controlled by creditors (as a group) rather than by the debtor. In some respects, the scope of the problem was limited by the fact that the claims to be restructured under the SDRM would include judgments arising from external contractual claims.173 Accordingly, a litigating creditor could avoid being subject to the SDRM only if it were able to obtain a judgment and satisfy the judgment prior to the sovereign reaching a restructuring agreement with its creditors. Given the expense of litigation, this uncertainty would pose an important deterrent to litigation.174
In addition, two other measures were included in the Proposed Features for purposes of counteracting emerging litigation strategies that may evolve. The first was based on the “hotchpot” rule that was developed in nineteenth-century English bankruptcy law.175 Under the proposed rule, a judgment creditor that had managed partially to satisfy its claim through a collection prior to an SDRM restructuring agreement would have the value of its residual claim under the agreement reduced in a manner that ensures that all of the benefits of enforcement are neutralized—but with the added disadvantage of legal expenses.176 Consistent with the overall objective of not tilting the balance of leverage in favor of the debtor, this would approach the problem of litigation exclusively from an inter-creditor perspective, that is, creditors would have some assurance that their forbearance through the negotiating process would not be abused by an aggressive litigant.
The hotchpot rule is not without shortcomings, however. First, if the judgment creditor is able to obtain more through litigation than it would receive under the agreement, the agreement would not affect the creditor. Second, when a creditor had purchased its claim at a deep discount, the rule would still not deny the creditor a significant profit, even if it were only able to collect on its judgment in part. This could be particularly problematic when prospects for an early restructuring after activation are very uncertain; in such a case, the creditor may judge that, under the circumstances, it makes more sense to secure a profit immediately through litigation than to wait for a restructuring agreement to be reached.
The second measure, designed in part to address the above limitations, would enable creditors to prevent litigation even before the verification process had been completed, that is, before a general, creditor-approved stay could become operational.177 Upon the request of a representative creditors committee, specific creditor enforcement measures could be enjoined, that is, the stay would be of a targeted rather than of a general nature. Since, as discussed below, the SDRM would create incentives for the early establishment of creditors’ committees, such actions could occur relatively soon after activation. To avoid the risk of discrimination among different creditor groups, the activation of the stay would require a determination by the Dispute Resolution Forum that the litigation in question was particularly disruptive to the restructuring process.178 One of the disadvantages of this measure is that it would expand the role of the Dispute Resolution Forum, something that was of particular concern for members that had reservations about the adverse effect a new supranational entity would have on national sovereignty.
Notwithstanding the development of these various alternative measures, a number of the IMF’s Executive Directors remained convinced that the SDRM could only be effective if, upon activation, a general stay on enforcement was imposed automatically, albeit temporarily. Accordingly, the IMF was unable to make an unqualified recommendation on this important feature.179 Their perspective reflected, at least in part, a belief that the SDRM could only fulfill its objective if there was a general stay on payments by the debtor following activation. They were not convinced that a country whose debts were truly unsustainable would be able to engineer a restructuring without a general standstill on all payments. This view may have been shaped by sentiments within the official sector that firm access limits on IMF financing was the key to the orderly resolution of financial crises. There may have been a concern that such limits could only be effective if there were adequate assurances that, as an alternative to such financing, the members would stop the outflow of all capital once the restructuring process was launched.
Improving the Dialogue
The Proposed Features contain two elements tailored to improve both debtor-creditor and inter-creditor dialogue during the restructuring process. The first is the establishment of a requirement that the sovereign debtor provide comprehensive information to creditors at an early stage in the process.180 The second is the envisaged role of a representative creditors’ committee.181 The purpose of these components is not just to make the restructuring process more collaborative, but also to make it more rapid and predictable.
Provision of Information
As in the corporate context, a creditor will feel that it is in a position to accept or reject a restructuring proposal only if it has sufficient information. The absence of timely and relevant information will both fuel suspicion and delay completion of the restructuring process. In the sovereign context, this information will fall into two categories. The first category embraces information that explains the nature of the economic problems and the circumstances that justify the terms of the proposed restructuring. It also includes the broad outline of the economic strategy that will restore medium-term sustainability and, therefore, provide some basis for concluding that the debtor will, in fact, be able to service its restructured debt. The second category of information is designed, in large part, to address inter-creditor equity considerations: it includes a detailed description of the debt owed by the sovereign and how this debt will be treated under the restructuring proposal.
The establishment of an economic program supported by IMF resources will normally provide the basis for the availability of the first category of information. The macroeconomic program underlying an IMF arrangement would normally define the country’s economic situation, its present and future policies, and its medium-term payments capacity. Under the IMF’s existing policy on transparency, program documents are generally published at the time the arrangement is approved or when reviews under the arrangement are concluded.182
The features of the SDRM proposal focus on the timely disclosure of the second category of information. Upon activation of the SDRM, the sovereign would provide the Dispute Resolution Forum all known information regarding its indebtedness, which would be made available on a website maintained by the Dispute Resolution Forum.183 This information would be organized into three lists.
The first list would consist of all debt that the sovereign intends to restructure under the SDRM (SDRM Restructuring List). Claims included on this list would be identified as specifically as possible (face value, contracting and due dates, and identity of the holder of record). Since the only claims that could be restructured under the SDRM are those included on the SDRM Restructuring List, the sovereign would have an incentive to make the list as comprehensive as possible.
The second list would consist of claims that are being restructured outside the SDRM (Non-SDRM Restructuring List). This would include all domestic debt being restructured and—depending on the scope of the debt covered under the SDRM—would also include all official bilateral debt that is being restructured.
The third list would include all claims that the sovereign does not intend to restructure (Nonimpaired List). As noted earlier, it is likely that, in the sovereign context, there will be private claims that the sovereign wishes to continue to service and to exclude from the restructuring process.184
Thus, while certain claims would not be restructured under the SDRM, the procedure it establishes would provide for full transparency as to how this debt is being treated. The information provided by the sovereign debtor would be expected to evolve. For example, for reasons of inter-creditor equity, creditors that find themselves on the SDRM Restructuring List may insist that, as a condition for their support, certain claims be moved from the Nonimpaired List to the SDRM Restructuring List. Moreover, the SDRM Restructuring List may also expand in light of economic developments. Finally, when a sovereign has actually proposed a restructuring agreement, it would also be required to provide information as to the terms it is offering to creditors that are being restructured outside the SDRM.185
Creditors’ Committees
During the 1980s, most of the restructuring of sovereign debt occurred within a structured negotiating framework, with a representative creditors’ committee playing a central role.186 These committees performed a number of functions. First, they provided an important method of forging a common position among creditors. This was achieved through the reliance on a single financial and legal advisor who was responsible for negotiating among creditors and who was retained by the committee rather than by individual creditors. Second, they established an effective vehicle for assessing and “selling” a restructuring proposal. Although a committee could not legally bind the general creditor body, a decision by the creditors on the committee to accept the restructuring terms carried considerable weight. Third, and perhaps most important, creditors’ committees could serve as the negotiating counterpart for the sovereign debtor because they were able to provide credible assurances as to the confidentiality of information provided by the debtor, including preliminary restructuring proposals.
However, as a result of the evolution of capital markets, the establishment and operation of creditors’ committees has become more complicated. It is more challenging to secure adequate representation of creditors where the debt is widely dispersed among different creditors with diverse economic interests.187 The fact that debt instruments trade constantly on the secondary market also makes it more difficult to establish a stable representative group of creditors. Finally, there is also a perception that it has become more difficult for a committee to provide credible assurances that the information it receives from the debtor during the negotiations will be kept confidential. Unlike large commercial banks, a number of investors who purchase large amounts of emerging market debt are too small to implement firewalls capable of ensuring confidentiality.188
Notwithstanding these challenges, progress has been made in identifying best practices that could guide the formation and operation of creditors’ committees in this new environment. Not surprisingly, these principles draw upon the experience in the nonsovereign context, where the operation of creditors’ committees has also had to adjust because of the disintermediation of credit.189 The committees themselves have drawn on work principles established to guide the formation of committees in the nonsovereign context, perhaps the most elaborated being the “Principles for Sovereign Debt Restructuring” prepared by the Council of Foreign Relations.190 In light of progress in this area, creditors who have been complaining about the use of take-it-or-leave-it exchange offers by sovereigns have clamored for the actual application of such practices in the sovereign context. The IMF has also adjusted its lending policies to accommodate greater reliance on creditors’ committees. In 2000, it revised its lending-into-arrears policy to provide that, in circumstances in which an organized negotiating framework is warranted by the complexity of the case and by the fact that creditors have been able to form a representative creditors’ committee on a timely basis, there would be an “expectation” that the member would enter into good-faith negotiations with this committee.191 The failure of the member to satisfy this expectation would be taken into consideration by the IMF when determining whether it would continue to provide financing.192
Consistent with the above, the SDRM proposal also anticipates reliance on creditors’ committees. In addition to the general function of resolving both inter-creditor and debtor-creditor coordination, it was envisaged that, under a framework that aggregates creditor claims for voting purposes, the committee could play a number of additional specific roles. For example, during the voting process, a subcommittee could be established for the specific purpose of determining whether registered claims should be challenged when evidence suggests that the creditor is not independent of the sovereign. In addition, as noted earlier, approval by the creditors’ committee could also be a condition for approval of an order that would enjoin specific enforcement actions.193
The SDRM proposal would not mandate the formation of creditors’ committees. Consistent with the approach taken by the IMF under its lending-into-arrears policy, these committees would participate in the process in those circumstances in which creditors have taken the initiative to establish one.194 Drawing on the approach relied upon in the nonsovereign context, the Proposed Features contain two specific features that address issues relating to the establishment and operation of committees. The first relates to the question of when a committee would be “representative.” While several broad criteria could be relied upon to make this determination,195 it was recognized that the application of these criteria would give rise to disputes. Consistent with the approach taken in the insolvency context, where these disputes are brought before a court of competent jurisdiction, such disputes would be resolved by the Dispute Resolution Forum.
The second feature relates to the expenses of the creditors’ committees, an issue that has proved to be rather controversial. As noted earlier, one of the means by which creditors’ committees can assist in forging a common position among creditors is through the retention of a single financial and legal advisor that represents the committee as a whole rather than individual creditors. In the nonsovereign context, a number of laws provide that these fees, and other reasonable expenses associated with the operation of the committee, shall be borne by the debtor.196 As a matter of practice, a similar approach was taken during the sovereign debt restructurings that took place in the 1980s, in which the expenses of the steering committees were also borne by the sovereign.197 One of the advantages of this approach is that of inter-creditor equity. Although the fees are nominally paid by the debtor, they actually are paid with resources that would otherwise be made available to all creditors under the restructuring proposal. Accordingly, this ensures that costs are borne by creditors (in terms of a reduction in the payments that they would have otherwise received) on the basis of their exposure. On this basis, IMF staff proposed that the SDRM would clarify that the sovereign debtor would bear the reasonable costs incurred by a representative creditors’ committee. To the extent that the sovereign debtor and creditors disagreed on the fairness of such fees, such disputes would be resolved by the Dispute Resolution Forum.
During the external consultation process, however, this emerged as a polarizing issue. Several representatives of a number of emerging market sovereigns were of the view that the proposal was politically unacceptable. They noted that, during the debt crisis of the 1980s, it had been very difficult to explain to parliaments why it was necessary for a country in the midst of a crisis to bear the fees and expenses of well-heeled investment bankers and lawyers. For this reason, memorializing such an approach in the text of the SDRM was bound to attract considerable opposition. In the end, the question of the payment of fees for creditors’ committees remained one of the unresolved issues in the SDRM proposal.198
Priority Financing
During the restructuring that took place in the 1980s, it was relatively common for creditor banks to provide new financing to the sovereign while the negotiations were proceeding. Among other things, this financing allowed the sovereign to remain current on interest payments, thereby enabling the creditor bank to continue to classify the loan as a performing one for regulatory purposes.199 When such financing was provided, there was an understanding among all of the other banks engaged in the process that this debt would be given priority, inasmuch as it would be excluded from the debt restructuring process.200 However, this understanding was not reduced to a legally binding inter-creditor agreement.
During the development of the SDRM proposal, there was considerable discussion as to the potential benefits of including a provision that would create incentives for a similar type of priority financing. To the extent to which such financing was available, it would—among other things—reduce the amount of financing that would need to be provided by the official sector during this period. For those concerned with the moral hazard created by IMF financing, this has been considered a particularly important element of any potential legal framework.201 However, given the evolution of capital markets, it is unlikely that the informality of the incentive structure relied upon in the 1980s would be feasible.202 The banks that had been willing to provide priority financing did so, in part, because it would facilitate a more orderly restructuring of their own claims. In today’s environment, the holders of bonds that are subject to a restructuring would normally not be in a position to provide new financing. Moreover, the nonbinding understandings regarding the exclusion of priority financing were predicated on the existence of a small number of creditors with similar interests—hardly a description of the atomized and diverse creditor community that exists today.
In light of the above, a difficult issue was how to design the SDRM proposal so that creditors would have adequate assurances that any new financing by them would, in fact, be given priority. The approach that was eventually adopted would allow for a qualified majority of creditors whose claims are being restructured to decide that a certain financing would be excluded from the restructuring process. The exclusion of such financing from the SDRM would be made effective through the requirement that the Dispute Resolution Forum could not certify a restructuring agreement that contravened this exclusion, unless the creditor that had provided this priority financing agreed to allow its claim to be restructured.203 Creditors could decide to grant priority to a particular credit transaction or, alternatively, to a specified aggregate amount of financing that satisfies prespecified terms, such as maturity, and so forth.
There are shortcomings to this approach. Most important, the assurance provided to the priority creditor is a limited one, particularly when compared to those that are received by a creditor in the corporate context. Under many insolvency laws, in the event the reorganization process fails, the proceedings will be converted into a liquidation, at which point all creditors who have extended post-petition financing will receive priority in distribution vis-à-vis other unsecured creditors.204
To provide greater inducements for new financing, consideration was also given to establishing a form of inter-creditor subordination. When creditors voted to exclude a particular financing transaction from the restructuring process, they would also vote to approve an agreement that would bind them—and the minority of dissenting creditors—to a subordination agreement with the priority creditor: in the event that the priority creditor had not been paid in full by the sovereign debtor, existing creditors would agree to transfer to the priority creditor any amounts they might receive from the sovereign until the priority creditor was made whole. This feature was not included since it was considered to interfere with contractual relations to an unnecessary extent. A minority creditor that had dissented from the agreement would not only be forced to accept that a priority creditor would be excluded from the terms of the restructuring, but it would also be liable to this creditor for any amounts that it received from the sovereign until the priority creditor in question was made whole.
While the priority financing feature of the SDRM proposal is not particularly robust, there would, of course be other means of inducing a creditor to provide financing during the restructuring process. Perhaps most important, a sovereign could offer collateral.205 While its ability to do so could be constrained by the existence of negative pledge clauses contained in existing bonds, these provisions could be amended through the use of contractual provisions that allow for the amendment of nonpayment terms by a specified majority.206 Moreover, the official sector could facilitate the provision of such security by waiving the application of the negative clauses contained in loans provided by multilateral development banks.207
Voting and Classification
The perceived benefits of a legal framework that would enable different instruments to be aggregated for voting purposes was one of the key motivations behind the SDRM proposal. To the extent that one accepts the premise that collective action difficulties are exacerbated by the multiplicity of instruments and the growing diversity of creditor interest, this feature is critical. Moreover, if appropriately designed, it can enhance creditor coordination and, as observed below, may also provide greater clarity and predictability with respect to the resolution of inter-creditor equity issues.
At the same time, however, aggregation carries with it a number of risks, including the potential for manipulation, inter-creditor discrimination, and, finally, inflexibility. Accordingly, when the SDRM proposal was being designed, the key challenge was to minimize these risks while maximizing the benefits of aggregation. Fortunately, a number of these issues arise also in the context of the restructuring of corporate debt and, for this reason, the development of the SDRM proposal benefited considerably from the experience that had accumulated regarding both the design and implementation of the voting provisions of domestic insolvency laws.208
Ensuring Integrity
Any framework that allows for aggregation of claims for voting purposes may be subject to abuse unless certain safeguards are in place. In the sovereign context, there are several different types of risk. First, creditors may attempt to inflate the value of their claims. Moreover, to avoid being subject to the SDRM altogether, they could try to overstate the value of collateral that secures their claim. Second, a debtor may attempt to create fictitious claims by, for example, making a private placement to an entity that it controls, but without receiving any value from that entity. The creation of such fictitious claims can distort the voting process, since the sovereign debtor can ensure that these claims vote in a manner that results in onerous terms for the holders of valid claims. Moreover, since these claims would be recognized under any restructuring agreement, they would reduce the amount received by valid creditors. Finally, even if the claims in question are valid, there is a risk that, as noted above, the creditor would be owned or controlled by a sovereign debtor, such as a state-owned bank.
Drawing on the features of modern insolvency laws, the Proposed Features establish a claims verification and voting procedure designed to address these risks.209 As noted earlier, creditors whose claims appeared on the SDRM Restructuring List and who wished to participate in the voting process would have to register their claims within a specified period.210 To register, a creditor would identify itself as the holder of the claim in question and state the value of its claim. A registered claim would be considered to be verified unless it was challenged within a specified period after registration.211 This would give both the sovereign and the creditors the opportunity to challenge the value or validity of the claim; any dispute arising from this process would be resolved by the Dispute Resolution Forum. Even if the value or validity of the claim is not challenged, a verified claim could still be excluded from the voting process if, following a challenge by a creditor, it was determined that it was owned by a creditor that was owned or controlled, directly or indirectly, by the debtor. Such claims would nevertheless be considered as valid for distribution purposes.212
What of those entities over which the sovereign exercises influence but not ownership or control? This would include, for example, privately owned financial institutions that are subject to the regulatory powers of the government or the central bank. While the criteria of direct or indirect ownership and control are sufficiently objective to enable them to be effectively applied in a statutory framework, operationalizing the concept of “influence” is clearly more challenging. Since it would require the exercise of considerable discretion by the Dispute Resolution Forum, the decision was made not to include it within the Proposed Features. It was recognized, however, that the potential for abuse in this area was somewhat mitigated both by the aggregation process and by the proposed exclusion of claims governed by domestic law from the SDRM. Specifically, while it may be possible for a sovereign to exert enough influence over domestic banks and other domestic entities to distort the voting of a single bond issuance, it will be more difficult to do so when all foreign law instruments are aggregated.
Discrimination Among Private External Claims
The Proposed Features envisage that, as a general rule, all creditors that appeared on the SDRM Restructuring List would be bound to the restructuring terms that had been agreed to by creditors representing 75 percent of the outstanding principal of registered and verified claims.213 To avoid discrimination, the general rule would also require that all creditors receive the same terms—or menu of terms—under the restructuring agreement.214 This would prevent discrimination when all creditors have the same type of claims against the sovereign; the rule would prevent a majority from agreeing to terms that would give them preferential treatment vis-à-vis the minority of creditors holding the same claims.
Of course, if one aggregates claims that are of varying degrees of seniority, the application of the above rule can also result in discrimination. Although the concept of seniority in the sovereign context is not entirely straightforward, this concern was one of the motivations, as discussed earlier, for excluding secured and domestic law claims from the scope of the SDRM.215 It also explains why consideration was given to placing official bilateral claims in a separate class for voting purposes. During the discussion of the SDRM, the question also arose as to whether discrimination might also arise as a result of the aggregation of unsecured claims of private creditors that have different maturities or interest rates. For example, would there not be a risk that holders of long-term bonds representing more than 75 percent of all claims would vote for a restructuring that would provide, inter alia, for a significant lengthening of maturities of all short-term maturities?
In a post-default environment, the problem is easily resolved. As long as all claims are accelerated by the time the restructuring agreement is proposed, all creditors can be treated as having claims of the same maturity, since all amounts outstanding are due and payable.216 The concern remains, though, as to restructurings that are proposed prior to a general default and, therefore, prior to any acceleration. Offering unsecured creditors the same terms would presumably only be acceptable if the risk of imminent default were high enough that creditors were willing to treat all of their claims as having been accelerated. Interestingly, in the corporate context, this issue also arises under “prepackaged insolvency proceedings,” when the debtor and its creditors agree upon a restructuring arrangement prior to the commencement of formal insolvency proceedings and when the debtor is continuing to service its obligations.217 Under such arrangements, formal insolvency proceedings are commenced for the exclusive purpose of making the agreement binding on the entire creditor body. When the agreements are being negotiated, unsecured creditors holding claims with different maturities are generally willing to be given the same treatment under the restructuring agreement because they have reached the conclusion that a general default is imminent. Provided that the SDRM was only available for unsustainable cases, it is likely that creditors would also be willing to be treated in the same manner since, in such cases, a generalized default may be excepted in the absence of a restructuring.
Optional Classes
In the corporate insolvency context, a classification system also provides a means by which the debtor can enhance the chances that a restructuring proposal will be acceptable. Specifically, while the law gives it the right to place all unsecured creditors in the same class, it may find it in its interest to place them in separate classes so that they can be provided with different treatment, taking into account the different preferences of the creditors in question.218 This may also be of relevance in the sovereign context. For example, a sovereign may feel that it may be able to offer terms to domestic banks holding external claims that are less favorable than those offered to external creditors holding similar claims. Domestic banks may be willing to accept inferior claims in exchange for some regulatory forbearance. The creation of separate classes in these circumstances allows for differential treatment while, at the same time, preserving the antidiscriminatory principle that all creditors in the same class be offered the same terms or at least the same menu of terms.219
Given the above benefits, the Proposed Features gave the debtor the option to create such classes when it concluded that the provision of differential treatment could increase the likelihood of a successful restructuring.220 The key benefit of such “optional” classes was flexibility; while the SDRM proposal would allow for full aggregation of private claims within a single class, some degree of disaggregation—through the creation of different classes—could also be achieved if some differentiation in treatment among creditors provided the most effective means of achieving a sustainable restructuring.
Allowing for classification for this purpose raises potential for abuse. For example, there is a risk of “gerrymandering,” that is, a risk that creditors would be placed in artificial classes for the sole purpose of engineering a successful restructuring.221 To address this risk, the Proposed Features contained at least two important safeguards. First, as noted above, any restructuring proposal would only become effective if a qualified majority of creditors from each class supported the proposal. To the extent that a group of creditors objected to being placed in a separate class and being given separate treatment, they could simply exercise their veto to reject the proposal, in which case the sovereign would need to either make the offer more attractive or place these creditors in the general class. Second, the SDRM would include a rule to the effect that classes may not be created in a manner that could result in unjustified discrimination among creditor groups, taking into account their varying economic interests.222 No doubt, there would be disputes as to whether classification is discriminatory in a particular case. Such disputes would be resolved by the Dispute Resolution Forum, to which we now turn.
Dispute Resolution Forum
In developing the SDRM proposal, there was a recognition from the outset that the aggregation of claims for voting purposes would require the establishment of some independent and centralized forum that would oversee the implementation of the legal framework. This oversight would include both the administration of the registration, verification, and voting procedure and the resolution of disputes that would inevitably arise in that context. One of the recognized advantages of establishing such a forum through a universal treaty, such as the IMF’s Articles of Agreement, is that it would ensure that a centralized forum could be created with exclusive jurisdiction and authority over these matters.
Discussions surrounding the design of such a forum—the Dispute Resolution Forum—attracted considerable attention both within and outside the IMF, with two central issues emerging. First, there was the need to balance the imperative of giving the DRF adequate powers to facilitate an orderly and rapid restructuring process, against concerns regarding the establishment of a new supranational entity: would it impose some limits on state sovereignty? Second, was it possible to establish a dispute resolution forum through an amendment of the IMF’s Articles of Agreement that would be independent—and be perceived as being independent—from the IMF? The design of the DRF, outlined in the Proposed Features, was largely shaped by the discussion of these two issues.223
Powers of the DRF
In some respects, the dispute resolution functions of the DRF would resemble those of a court having jurisdiction over insolvency proceedings. In terms of subject matter, many of the disputes arising between the debtor and its creditors and among creditors would revolve around the registration, verification, and voting process; as is the case under typical insolvency proceedings, challenges would be made regarding the value or legitimacy of a claim submitted for verification.224 Even if a claim were valid, a creditor may wish to exclude it from the voting process on grounds that it is controlled by the sovereign. In addition, disputes may arise as to whether, for example, a creditors’ committee is adequately representative and whether its fees are excessive.225 As with most domestic courts, the DRF would play a purely reactive role in the dispute resolution process. Rather than issue its own challenges, it would rule on challenges brought by parties in interest.
Unlike domestic courts, there was a reluctance to give the DRF subpoena powers. Not only would the exercise of such powers against a sovereign debtor be problematic, but there was some discomfort expressed about such powers being used against creditors. This does not mean there would be no sanctions against misbehavior, however. To the extent, for example, a creditor did not provide adequate information to enable the DRF to determine whether a challenge to the validity of its claim had any merit, the claim would be excluded.
What law would the DRF apply when resolving disputes? In terms of the substantive law, there was consensus that the relevant national law would be used. Thus, for example, on questions relating to the validity of the claim, the law of the contract would apply, unless there was a dispute on whether the official of the debtor had the authority to enter into the underlying agreement, in which case the law of the sovereign debtor would be relied upon. However, on procedural issues that could be expected to arise during the implementation of the SDRM—for example, abuse of the voting process—it was agreed that the DRF would develop and apply its own rules.
Consistent with the desire to create a forum with very limited powers, there was considerable reluctance to give the DRF the authority to issue legal rulings in particular proceedings outside the context of a dispute. In the domestic insolvency context, the authority of the bankruptcy court to rule outside the context of a dispute often does exist, perhaps most importantly at the conclusion of the proceedings where some laws give the court the authority to veto a restructuring proposal that has been agreed upon by the debtor and the requisite majority of creditors, if it determines that the plan is not feasible.226 Under the SDRM, however, there would be no opportunity to second-guess judgments made by creditors regarding the viability of a restructuring plan.227 This reflected the more general belief that, to the extent possible, the DRF should not have the authority to exercise broad discretion on economic issues, particularly since, in the sovereign context, the resolution of such issues will often require making judgments on political matters.228
Nevertheless, the DRF would perform important administrative functions. To be effective, the SDRM proceedings would need to be organized and overseen by some independent body, and it was decided that the DRF would perform this task. This would involve ensuring that creditors were notified that a proceeding had been commenced; organizing the registration, verification, and voting process; and certifying that the requisite percentage of creditors had, in fact, voted in favor of a debt restructuring proposal. These administrative functions would be performed by a very small permanent secretariat, rather than by the members of the DRF itself.229
In that context, the issue of rule-making authority raised difficult issues. As work on the SDRM proposal progressed, it became increasingly clear that, no matter how streamlined its design, there would need to be a number of technical rules that it would be inappropriate to specify in the treaty itself.230 These rules ranged from procedural rules for registration, verification, and voting to those that would provide further definition to general concepts set forth in the treaty, such as when a creditor would be considered “under the control of the debtor.” Given the desire to circumscribe the DRF’s powers, there was some understandable reluctance to give it such rule-making authority. At the same time, however, the ability to promulgate—and amend—rules on relatively technical issues was critical if the SDRM was to be sufficiently flexible to adapt to the evolution of the international monetary system.231 As a means of addressing concerns regarding the granting of excessive powers to the DRF, the Proposed Features provide that rules adopted by the DRF would enter into force unless overruled by the IMF’s Board of Governors by an 85 percent majority of the total voting power.232
Legal Effect of DRF Actions
One of the lynchpins of the SDRM proposal is the legal effect of DRF actions, with perhaps the most profound action being a purely administrative one. Specifically, once the DRF has certified that a restructuring agreement has been reached between the debtor and the requisite majority of creditors, this certification would have a direct binding effect in all countries that are members of the IMF and could not be challenged in any domestic court. Accordingly, a creditor that had dissented during the voting process could no longer enforce its claim under the original agreement. Similarly, a certification by the DRF that creditors had voted for a stay on enforcement would also preclude enforcement actions in all domestic courts of IMF members. Finally, decisions rendered by the DRF in the dispute resolution process would not be subject to challenge in domestic courts during the restructuring process or after an agreement had been reached. For example, if, during the verification process, the DRF determined that the value of a claim was less than the value asserted by the creditor, the creditor could not reopen this issue in a local court once a restructuring agreement had been certified.
Of course, the binding effect of such actions assumes that all member countries have taken the necessary steps to ensure that the new treaty obligations conferring such powers on the DRF are given full legal effect in their territory.233 While, in some countries, the entry into force of the amendment would automatically have such effect, in others it would require the incorporation of these obligations into domestic law. During the discussion of the SDRM proposal, the question arose—both inside and outside the IMF—whether domestic legal systems of member countries would allow for the framework to apply to claims in existence prior to the effective date of the SDRM.234 Clearly, this is a question for each country to resolve under its own domestic law. However, based on the tolerance that most legal systems have shown to the application of new insolvency laws—or amendments to those laws—to existing claims, it was recognized that it would probably not be a significant problem in the sovereign context. For example, the resolution of the crisis that swept Asia during the late 1990s required a comprehensive restructuring of the debt of the corporate sector, much of which was denominated in foreign exchange.235 A central feature of the corporate restructuring strategy was the strengthening of domestic insolvency laws.236 As in the corporate context, the decisions that would modify existing claims would generally be those taken by a qualified majority of creditors—not by the DRF—who would clearly be motivated by a desire to enhance rather than diminish the value of their claims.
Institutional Features
The efforts by the IMF to design a DRF that was independent, competent, and impartial involved considerable outreach. In addition to consulting closely with members within the legal and juridical community, the staff drew upon the considerable body of precedent in the international law area.237 Of particular relevance were other treaties establishing international organizations that include adjudicative organs that are independent—and perceived as being independent—from the other organs of the organization. A prime example is the International Court of Justice, which is an organ of the United Nations.238 One does not have the perception that, by virtue of it being part of the UN, the decisions of this court are influenced by the Security Council or the General Assembly. In designing the DRF, the challenge was to ensure that its independence was both de jure—that is, through specific provisions in the treaty that insulated the organ from interference from the IMF’s Executive Board and the Board of Governors—and de facto.239 During the discussion, it became increasingly clear that the single most important factor in ensuring de facto independence was the process through which the members of the DRF were selected and appointed.
When approaching the issue of selection and appointment, the IMF was attracted by the approach relied upon by the International Center for the Settlement of Investments Disputes, the World Trade Organization, and the North American Free Trade Agreement. Specifically, while the SDRM would provide that a permanent pool of judges would be selected in advance to serve on the DRF, an adjudicative panel would only be created from this pool once a crisis arose. This approach would avoid the creation of a permanent cadre of judges located in Washington that could be suspected of falling under the influence of the staff or Executive Board of the IMF. Until judges that form part of the pool were impaneled, they would continue to work in their own countries and in their other capacities. At the same time, however, the existence of a permanent pool would mean that a dispute resolution panel could be in place quickly once a crisis arose.
Perhaps more than anything else, the credibility of the DRF as an independent and competent body would be based on the fact that parties outside the IMF would play a role in the selection process. The framework envisages a three-step procedure. The first step involves the appointment of a panel that would, in turn, be responsible for selecting the permanent pool of judges. While the IMF’s Managing Director would formally appoint the selection panel, he or she would do so on the advice of professional associations of corporate insolvency and debt restructuring experts, such as the International Federation of Insolvency Professionals (INSOL), and public or private international organizations that have developed expertise in insolvency and debt restructuring matters, such as the United Nations Commission on International Trade Law (UNCITRAL).240
The second step would involve the selection of the pool of 12–16 candidates that would constitute the pool of judges.241 An open nomination process would be used, thus enabling the selection panel to receive names from member governments of the IMF and from civil society. In making their selection from the nominations, the selection panel would be guided by the selection criteria set forth in the treaty.242 While there was a recognition that the treaty should also require a diversity of legal backgrounds, diversity should not come at the expense of competence. Specifically, when assessing competence, the panel would need to take into consideration whether the nominees had expertise in the laws that govern international sovereign debt instruments. Accordingly, to the extent that the laws of several jurisdictions—New York, England, Japan, and Germany—dominate the existing market, this would need to be taken into consideration. Since it was envisaged that the new pool would be selected every five to six years, adjustments would be made, depending on developments in the sovereign debt market.
The final step would involve the impaneling of four members of the pool once a crisis arose. After considerable consultation with members of the judicial and legal profession, IMF staff recommended that one of the four members of the Dispute Resolution Panel would be the supervisory judge, responsible for overseeing the case and making initial determinations; the remaining three would constitute an appeals panel.243 The method by which the four would be impaneled attracted considerable discussion. Clearly, the notion of allowing the parties to the dispute to select the panel from the available pool—along the lines used for arbitration proceedings—would be unworkable given the fact that one would need to forge a common position among a multitude of creditors. Moreover, since the selection would precede the verification process, one could not even be sure that the creditors involved in selecting the panel would, in fact, be creditors.
The approach that was eventually recommended was to have the president of the DRF—who would be elected for a fixed term by the entire pool of judges—select the panel in a manner that ensured impartiality. One could envisage various ways in which to secure the impartiality of the impaneling process. For example, the president could develop a secret list in consultation with the pool of judges, where a number of panel members would agree to be available for a particular month or calendar quarter. Of course, when applying this system, the president would need to ensure that the judges that are on call when the crisis arises do not have any conflicts of interest in the particular case. It was recognized that this approach would require that the president of the DRF—unlike all other judges—would be permanently located in Washington.
While the independence of the proposed DRF may have gone a long way toward addressing the concerns of academics and members of civil society concerned with the impartiality of the DRF, it may have unsettled those in the official sector who were more concerned with the implications of such independence. While national governments may be able to exercise their influence in decisions made by the IMF’s Executive Board and Board of Governors, this would not be the case with the DRF. Accordingly, as greater clarity emerged as to the independence of the DRF, the pressure grew to ensure that the powers of the DRF were carefully circumscribed.244
Conclusions: Understanding the Resistance
No analysis of the SDRM proposal is complete without some inquiry as to why support from the official sector, while strong, was not sufficient to ensure its adoption. A closely related question is why the private sector remained so virulent in its opposition.
Since an amendment of the IMF’s Articles of Agreement requires the support of three-fifths of its members holding 85 percent of the voting power,245 the support of the United States—which currently holds 17.14 percent of the IMF’s voting power—was a necessary condition. Initially, the signals were positive. In September 2001, then–Secretary of the Treasury Paul O’Neill, in testimony to the Senate Banking Committee, stated, “We need an agreement on an international bankruptcy law, so that we can work with governments that, in effect, need to go through a Chapter 11 reorganization instead of socializing the cost of bad decisions.”246 As time went by, however, it became increasingly clear that the United States was willing to embrace only the “contractual approach” and that further work on the design of the SDRM proposal should be dropped.247
The decision of the United States to turn away from the SDRM proposal may have been motivated by several related factors. First, early consideration of the SDRM proposal was based on the absence of progress in the more incremental contractual approach. Given the breakthrough that occurred with the introduction of collective action clauses in New York law–governed bonds in early 2003, more radical reform may have appeared less necessary.248 Second, and more generally, as the shape of the statutory framework began to emerge, there may have been serious doubts within the U.S. government as to whether there was any realistic chance that it would gain congressional approval.249 No matter how streamlined the SDRM proposal became, its provisions would still interfere with the contractual claims of U.S. investors. Moreover, the jurisdiction of the DRF, although limited, would supersede that of the U.S. courts during the restructuring process. For European countries, which had grown rather accustomed to resolving economic and financial issues through the establishment of treaty obligations and supranational institutions, this type of reform was not particularly novel. For U.S. lawmakers, however, it would have represented a major step.250 The concerns of the U.S. government regarding the SDRM proposal’s reception in Congress may also have been heightened by the fact that the SDRM would be created through an amendment of the IMF’s Articles of Agreement. As a powerful and relatively controversial international financial institution, any amendments to the IMF’s charter were bound to attract considerable scrutiny. Indeed, even if lawmakers supported the SDRM proposal, there may have been a concern that they would want to use the opportunity to press for other reforms to the IMF that may not have been supported by the administration.
But another critical factor behind the U.S. position was most likely the steadfast opposition to the SDRM proposal by the major financial industry associations.251 Not only did such opposition make it much more difficult for the SDRM proposal to be approved in Congress, but there was clearly a reluctance within the U.S. government to forge ahead with such an important reform of the international financial system when a key stakeholder in that system—the private sector—was so resistant. Opposition to the SDRM proposal by financial industry associations was, of course, also an important reason why a number of emerging market countries opposed the SDRM proposal. The private sector consistently warned that the SDRM, if adopted, would adversely affect the volume and price of capital to these countries.252
The source of the private sector’s concern with the SDRM proposal merits some analysis. The issue is complicated by the fact that it did not always speak with a single voice. European and Asian financial institutions were less openly hostile to the SDRM proposal than their U.S. counterparts. Moreover, industry associations made up of investors that actually purchased and held sovereign debt (the “buy-side”) were more willing to engage in discussions regarding the design of the SDRM proposal than those responsible for actually placing new bond issuances for emerging market sovereigns (the “sell-side”).253 Nevertheless, all voiced concern with the fact that the SDRM proposal would limit the rights of individual investors, something they found particularly disturbing given the general view that creditor rights against a sovereign were already very fragile.254 In their view, collective action problems in the sovereign context were not of a sufficient magnitude to merit the degree of official intervention that the SDRM entailed. More generally—and not surprisingly—they expressed a strong preference for resolving such problems through self-regulation rather than official intervention.255 Hence, their belated embrace of collective action clauses.
The evolution in the design of the SDRM proposal did nothing to allay these concerns. On one level, this may seem somewhat surprising since, in its final form, a number of features of the proposal could be described as enhancing rather than reducing creditor leverage; namely, the creditor-approved stay, the introduction of transparency requirements, and the role envisaged for creditors’ committees. While the aggregation of claims across instruments for voting purposes would give rise to interference with contract, it is not clear that this feature, on its own, was the source of all of their anxiety. Indeed, the potential benefits of aggregation have been recognized by the private sector itself, and, as noted above, some elements of an aggregated framework were successfully incorporated into the bonds recently issued by Uruguay, albeit in a limited form.256
In the final analysis, it is possible that the private sector’s opposition was also attributable to suspicions regarding the SDRM’s motivation, not just its design. Indeed, the leading financial industry associations appeared to acknowledge this in a letter signed in December 2003, in which they stated that “no changes in its specifics will alter our serious concerns about the SDRM’s inherent problems.”257 As noted in the economic press, it is possible that they were afraid that the SDRM was simply designed to increase the frequency of restructuring and, thereby, reduce the frequency of large financing packages from the IMF.258 As discussed herein, however, the SDRM proposal was never intended by the IMF to replace large financing packages. Rather, it was intended to provide a framework for the restructuring of unsustainable debt, that is, debt that would have to be restructured no matter how much financing was made available.259
What implications can one draw from the above regarding the prospect of establishing a statutory sovereign debt restructuring framework in the future? To the extent that future experience shows that the restructuring of unsustainable sovereign debt under the existing system is excessively costly, the attitude of creditors toward a statutory framework may evolve. While the private sector would understandably object to any legal framework that it suspects—rightly or wrongly—will make restructurings more likely, it may have a different attitude toward a framework that reduces the costs of a restructuring that the private sector concludes will happen anyway.
In the event that the international community does decide to revisit the concept of a statutory sovereign debt restructuring framework, the considerable progress that was achieved in developing many of the features of the SDRM proposal will provide a useful starting point for discussion and analysis. While not all of the problems relating to the design of the SDRM proposal were resolved, closure was reached on a number of difficult issues. Indeed, provided there is sufficient will to introduce fundamental reform in this area—a significant qualification—there is every reason to believe that a workable and predictable treaty-based restructuring framework (whether created under the IMF’s Articles or elsewhere) could be established.
Notes
The text of this chapter has been reprinted with permission of the publisher, Georgetown Journal of International Law © 2005.
Adam Smith, Wealth of Nations, Book V, Ch. III, at 416 (1776).
Indeed, the IMF’s initiative has been described as being “radical” by a number of commentators. See, e.g., Richard N. Cooper, “Chapter 11 for Countries?” 81 Foreign Affairs 90, at 90 (2002); Marcus Miller, “Sovereign Debt Restructuring: New Articles, New Contract—or No Change,” International Economy Policy Briefs, No. PB02-3, at 1 (April 2002), http://www.iie.com/publications/pb/pb02-3.pdf; Nouriel Roubini and Brad Setser, “Improving the Sovereign Debt Restructuring Process: Problems in Restructuring, Proposed Solutions and a Roadmap for Reform,” at 12–13 (February 2003), http://www.worldbank.org/wbi/banking/finsecpolicy/restructuring2004/pdf/roubini-setser.pdf.
The proposal was publicly launched by Anne Krueger, First Deputy Managing Director of the IMF. Anne Krueger, Speech at the American Enterprise Institute: “International Financial Architecture for 2002: New Approach to Sovereign Debt Restructuring” (November 26, 2001) [hereinafter “New Approach”], http://www.imf.org.org/external/np/speeches/external/np/speeches/2001112601.htm. Additional speeches and publications of Ms. Krueger on this topic include: Anne Krueger, “Address to the Indian Council for Research on International Economic Relations: A New Approach to Sovereign Debt Restructuring” (December 20, 2001), http://www.imf.org./external/np/speeches/2001/122001.htm; Anne Krueger, Address to the Economics Society Dinner: “The Evolution of Emerging Market Capital Flows: Why We Need to Look Again at Sovereign Debt Restructuring” (January 21, 2002), http://www.imf.org/external/np/speeches/2002/012102.htm; Anne Krueger, Address to the Conference on Sovereign Debt Workouts: “Hopes and Hazards, New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking” (April 1, 2002), http://www.imf.org/external/np/speeches/2002/04102.htm; Anne Krueger, Address at the Bretton Woods Committee Annual Meeting: “Sovereign Debt Restructuring and Dispute Resolution” (June 6, 2002), http://www.imf.org/external/np/speeches/2002/060602.htm; Anne Krueger, Address at the Latin American Meeting of the Econometric Society: “Preventing and Resolving Financial Crises: The Role of Sovereign Debt Restructuring” (July 26, 2002), http://www.imf.org/external/np/speeches/2002/072602.htm; Anne Krueger, Address at the Banco de Mexico’s Conference on Macroeconomic Stability, Financial Markets and Economic Development: “Sovereign Debt Restructuring Mechanism: One Year Later” (November 12, 2002), http://www/imf.org/external/np/speeches/2002/111202.htm; Anne Krueger, Address at the Annual Meeting of the American Economic Association: “Sovereign Debt Restructuring, Messy or Messier?” (January 4, 2003), http://www.imf.org/external/np/speeches/2003/010403.htm; Anne Krueger, Address at the Harvard University Business School’s Finance Club: “The Need to Improve the Resolution of Financial Crises: An Emerging Consensus?” (March 27, 2003), http://www.imf.org/external/np/speeches/2003/032703.htm.
Report of the Managing Director to the International Monetary and Financial Committee on a Statutory Sovereign Debt Restructuring Mechanism (April 2003) [hereinafter “IMF Managing Director’s Report”], http://www.imf.org/external/np/omd/2003/040803.htm.
Articles of Agreement of the International Monetary Fund, as amended, Article XXVIII(a) [hereinafter IMF Articles], http://www.imf.org/external/pubs/ft/aa/aa28.htm. A member’s voting power in the IMF is determined by the size of its quota, which also determines the amount of its financial subscription in the organization and the level of its access to the IMF’s financial resources. A member’s quota is based on the economic size of the member and takes into account the quotas of similar countries.
In his statement at the International Monetary and Financial Committee (IMFC) on April 12, 2003, U.S. Secretary of the Treasury John Snow stated that it is “neither necessary nor feasible to continue working on SDRM.” John W. Snow, U.S. Secretary of the Treasury, Statement at the Meeting of the International Monetary and Financial Committee (April 12, 2003), http://www.imf.org/external/spring/2003/imfc/state/eng/usa.htm. For further discussion of the position of the United States on the SDRM, see infra the section entitled “Conclusions: Understanding the Resistance.”
For a comprehensive overview of proposals made during the 1980s and 1990s to establish new sovereign debt restructuring frameworks, see Kenneth Rogoff and Jeromin Zettelmeyer, “Bankruptcy Procedures for Sovereigns: A History of Ideas, 1976–2001,” IMF Working Paper No. 02/133 (2002), http://www.imf.org/external/pubs/ft/wp/2002/wp02133.pdf.
Alan Beattie, “Bankruptcy Plan Leaves IMF to Fill in the Detail,” Financial Times (November 29, 2001), at 15.
In 1995, the IMF’s Legal Department prepared an internal paper entitled “Note on International Adjustment Facility,” which discussed the scope and design of a legal and institutional framework that could be established to restructure the debt of sovereign debtors. For further discussion of this report, see Rogoff and Zettelmeyer, supra note 7, at 485–86.
See discussion of Group of Ten (G-10) Deputies Report infra note 59 and accompanying text.
See discussion of collective action clauses infra text accompanying notes 51–71. At the end of 2001, 59 percent of the value of all outstanding international sovereign bonds was governed by New York law. See IMF, “Collective Action Clauses in Sovereign Bond Contracts—Encouraging Greater Use,” at 5 tbl.1 (June 6, 2002) [hereinafter “Encouraging Greater Use”], http://www.imf.org/external/np/psi/2002/eng/060602a.pdf. At that time, only one such bond issuance included the type of “majority restructuring” provision that is generally found in international sovereign bonds governed by English law. See IMF, “The Design and Effectiveness of Collective Action Clauses,” at 7 n.8 (June 6, 2002) [hereinafter “CAC Design”].
Clearly, assessments of sustainability are easier to make with the benefit of hindsight. In an internal study that was completed in October 2003, IMF staff concluded that, by the end of July, “barring some extraordinarily favorable shock, the debt dynamics were clearly unsustainable.” IMF, “Lessons from the Crisis in Argentina,” para. 58 (October 8, 2003), http://www.imf.org/external/np/pdr/lessons/100803.htm.
Shortly after the SDRM was launched, Domingo Cavallo, Argentina’s Minister of Economy, acknowledged that a system for sovereign bankruptcy would “undoubtedly be useful.” “When Countries Go Bust,” The Economist, (December 6, 2001), at 68.
Based on the information provided by the Argentine authorities, the total value of eligible debt that still remained to be restructured as of December 31, 2003, was US$82.1 billion. This includes 152 bonds, issued under eight different governing laws and issued in seven currencies. Because much of this debt is held in the retail sector, the number of bondholders is unprecedented. According to Argentina’s secretary of finance, “there are more than 400,000 holders in Italy, around 40,000 in Germany, about 30,000 in Japan, and about 9 million indirectly throughout the Pension funds in Argentina.” See Argentina Secretary of Finance, Ministry of Economy and Production, Investor’s Information Service, http://www.infoarg.org.
Michael M. Philips, “Support Builds for Plan to Ease Debt Loads of Developing Nations,” Wall Street Journal (September 17, 2002), at A16. As stated by Ms. Krueger in the November 2001 speech that launched the SDRM: “[W]e lack incentives to help countries with unsustainable debts resolve them promptly and in an orderly way. At present, the only available mechanism requires the international community to bail out the private creditors.” “New Approach,” supra note 3.
The relevant IMF staff papers and related Executive Board documents included the following: IMF, “A New Approach to Sovereign Debt Restructuring: Preliminary Considerations” (November 2001) [hereinafter “Preliminary Considerations”], http://www.imf.org/external/np/pdr/sdrm/2001/113001.pdf; Anne Krueger, “Statement by the First Deputy Managing Director on Sovereign Debt Restructuring Mechanism,” IMF Executive Board Seminar (March 2003), http://www.imf.org/external/np/pdr/sdrm/2002/030602.pdf; “Concluding Remarks by the Acting Chair on Sovereign Debt Restructuring Mechanism—Further Reflections and Future Work” (March 2002, BUFF/02/39 EDM 02/3 and 02/4); IMF, “Fund Policy on Lending into Arrears to Private Creditors—Further Considerations of the Good Faith Criterion” (July 30, 2002), http://www.imf.org./external/pubs/ft/privcred/073002.pdf; IMF, “Access Policy in Capital Account Crises” (July 29, 2002), http://www.imf.org/externalexternal/np/treaccess/2003/pdf/072902.pdf; IMF, “Communiqué of the International Monetary and Financial Committee of the Board of Governors of the IMF” (September 28, 2002), http://www.imf.org/externalexternal/np/sec/pr/2002/pr/0245.htm; Concluding Remarks by the Chairman: “Sovereign Debt Restructuring Mechanism—Further Considerations” (September 2002, BUFF/02/140, EBM/02/92); IMF, “The Design of the Sovereign Debt Restructuring Mechanism—Further Considerations” (November 2002) [hereinafter “SDRM Design”]; Concluding Remarks by the Acting Chair: “The Design of the Sovereign Debt Restructuring Mechanism—Further Considerations” (January 2003, BUFF/03/1, EBM 02/126); “Sovereign Debt Restructuring Mechanism—Summary of January Workshop” (February 2003, SM/03/67) (unpublished); Note by Staff on Official Bilateral Creditor Claims and SDRM (February 2003) (unpublished); IMF, “Crisis Resolution in the Context of Sovereign Debt Restructuring: A Summary of Considerations” (January 28, 2003); IMF, “Proposed Features of a Sovereign Debt Restructuring Mechanism” (February 12, 2003); “The Acting Chair’s Concluding Remarks—Proposed Features of an SDRM” (March 2003, BUFF/03/1, EBM/03/23); IMF, “Sovereign Debt Restructuring Mechanism—Further Considerations” (August 1, 2002) [hereinafter “SDRM Considerations”]; IMF, “Report of the Managing Director to the International Monetary and Financial Committee on the IMF’s Policy Agenda” (April 11, 2003), http://www.imf.org/external/np/omd/2003/041103.pdf; IMF Managing Director’s Report, supra note 4.
See, e.g., “A Better Way to Go Bust,” The Economist (January 30, 2003), at 64; “Battling over the Bankrupt,” The Economist (October 5, 2002), at 70; Martin Wolf, “Debt to the World,” Financial Times (April 24, 2002), at 16; “A Better Way to Go Bust,” The Economist (April 6, 2002), at 14; Editorial, “Mr. O’Neill Climbs Down,” Washington Post (April 4, 2002), at A16; Alan Beattie, “Co-operate or Bust,” Financial Times (April 2, 2002), at 13; “Bankrupt U.S. Veto,” Financial Times (April 2, 2002); Editorial, “A Question from Argentina,” Washington Post (December 11, 2001), at A32, http://www.washingtonpost.com/wp-dyn/articles/A22945-2001/Dec10.html; “When Countries Go Bust,” supra note 13, at 88; “Ending Bail-Outs,” Financial Times (November 29, 2001), at 22.
For example, from January 22 to 23, the IMF hosted a workshop and conference on the SDRM that attracted a broad array of market participants, academics, workout specialists, and judges. See “IMF Consults Widely as It Redefines Proposed Sovereign Debt Plan,” 32 IMF Survey 33, at 37 (February 17, 2003) [hereinafter “IMF Consults Widely”], http://www.imf.org/external/pubs/ft/survey/2003/021703.pdf. Throughout 2002, IMF staff had consulted informally with many of these participants regarding a number of the SDRM’s design features. Id.
A review of the IMF staff papers and the various speeches delivered by Ms. Krueger reveals that the difficulty of securing collective action among creditors with diverse interests was perceived as representing the key weakness in the existing system. However, as the IMF analyzed the nature of collective action problems, it placed increasing emphasis on the problems that arise in the pre-default context. See, e.g., id.
Concerns regarding the absence of a transparent and collaborative debt restructuring process are a primary motivation behind the formation of the Emerging Market Creditors Association. See infra note 88.
See discussion of IMF financing infra notes 72–85 and accompanying text; see also Andy Haldane and Mark Kruger, “The Resolution of International Financial Crises: Private Finance and Public Funds,” Bank of Canada Working Paper 2001–20 (November 2001), at 1. (“[T]he lack of ex-ante clarity about the scale of official assistance represents an additional source of risk for borrowers and lenders operating in these markets. It may also serve to delay negotiations between debtors and creditors should repayment problems arise.”)
For a detailed discussion of concerns regarding creditor moral hazard, see discussion infra notes 81–82 and accompanying text.
A number of commentators have noted the difficulty of determining when indebtedness is unsustainable in the sovereign context. See Cooper, supra note 2, at 92–93; see also Nouriel Roubini, “Do We Need a New Bankruptcy Regime?” 2002(1) Brookings Papers on Economic Activity, at 321, 322; Hal S. Scott, “A Bankruptcy Procedure for Sovereign Debtors,” 37 International Law 103, at 111 (2003).
Interestingly, in his discussion of the need for some form of sovereign insolvency framework, Jeffrey Sachs has distinguished between two different motivations for a bankruptcy law in the nonsovereign context. While the first motivation is to overcome collective action problems, the second—which only applies to individuals and municipalities—is to provide the debtor with a “fresh start.” Jeffrey D. Sachs, “Resolving the Debt Crisis of Low Income Countries,” 2002(1) Brookings Papers on Economic Activity, at 257, http://www.jubileeusa.org/learn_more/BPEA_Sachs.pdf.
There is a considerable amount of literature regarding the history of the debt crisis in the 1980s. See Lex Rieffel, Restructuring Sovereign Debt: The Case for Ad Hoc Machinery (Washington: Brookings Institution, 2003); William Cline, International Debt: Systemic Risk and Policy Response (Washington: Institute for International Economics, 1984); C.M. Watson and K.P. Riegling, “History of the Debt Crisis,” in Current Legal Issues Affecting Central Banks, Vol. 1, at 67 (Washington: IMF, 1992). With respect to the IMF’s role during the crisis, see James Boughton, Silent Revolution: The International Monetary Fund 1979–1989 (Washington: IMF, 2001), http://www.imf.org/external/pubs/ft/history/2001/chapter1.pdf; see also Sean Hagan, “Sovereign Debtors, Private Creditors, and the IMF,” in Joseph J. Norton, ed., International Monetary and Financial Law Upon Entering the New Millennium, at 327–53 (London: BIICL, 2002) [hereinafter Hagan, “Sovereign Debtors”].
For a discussion of the role of bank steering committees during the debt crisis of the 1980s, see Lee C. Buchheit, “Advisory Committee: What’s in a Name,” International Finance Law Review (January 1991), at 9; see also Rieffel, supra note 25, at 95–132.
It was largely due to this reluctance that the IMF established, in 1989, its policy of “lending-into-arrears,” which enables it to provide financing to countries implementing strong adjustment plans, even in circumstances where they have not yet normalized their relations with private creditors. See Hagan, “Sovereign Debtors,” supra note 25, at 338–42; see also infra text accompanying notes 89–90.
The most notable example was when Fidelity Union Trust of New Jersey refused to participate in a restructuring agreement that had been reached between Costa Rica and all other members of the syndicate. It sued Costa Rica through the agent, Allied Bank. The ensuing litigation had important implications regarding the development of the doctrine of “comity,” which refers to the deference that the U.S. courts afford to the acts of a foreign sovereign to the extent that they are consistent with the law and policy of the United States. Allied Bank v. Banco Credito Agricola de Cartago, 757 F.2d 516 (2d Cir. 1985) (en banc), cert. dismissed, 473 U.S. 934 (1985). For an analysis of these cases, see Christopher C. Wheeler and Amir Attaran, “Declawing the Vulture Funds: Rehabilitation of a Comity Defense in Sovereign Debt Litigation,” 39 Stanford Journal of International Law 253, at 268–70 (2003).
The distressed debt purchasers that specialize in holding out and enforcing their claims through litigation have gained considerable notoriety over the past 10 years. For a discussion of their tactics and success rate, see Wheeler and Attaran, supra note 28. See also Samuel E. Goldman, “Mavericks in the Market: The Emerging Problem of Hold-Outs in Sovereign Debt Restructuring,” 5 UCLA Journal of International Law and Foreign Affairs 159, at 169–171 (2000–2001); G. Mitu Gulati and Kenneth N. Klee, “Sovereign Piracy,” 56 Business Law 635 (2001).
A restrictive theory of sovereign immunity has been adopted under both the U.S. Foreign Sovereign Immunities Act of 1976, 28 U.S.C. §§ 1330, 1602–1611 (FSIA), and the U.K. State Immunity Act of 1978, 10 Halsbury’s Statutes, §§ 1–23, at 829–46 (4th ed. 2001 reissue).
28 U.S.C. § 1605(a)(1).
28 U.S.C. § 1605(a)(2).
See Republic of Argentina v. Weltover, 504 U.S. 607 (1992). The court concluded that “when a Foreign government acts, not as a regulator but in the manner of a private player within it, the Foreign sovereign’s actions are ‘commercial’ within the meaning of the FSIA.” Id. at 614.
In the United States, for example, the “act of state” doctrine precludes a court from passing judgment on the legality or validity of public acts of a foreign sovereign to the extent that the sovereign acts within its own territory. However, where bonds issued by the sovereign provide for payment in the United States, the sovereign is considered to have engaged in an activity outside its territory and the act of state doctrine does not apply. See Allied Bank International v. Banco Credito Agricola de Cartago, 757 F.2d 516 (2d Cir. 1985). Another defense that has become increasingly unavailable is that of champerty, which prohibits litigating a claim that was acquired for the exclusive purpose of filing a lawsuit. While this doctrine is recognized in both the United States and England, recent decisions in both jurisdictions demonstrate the desire of the courts to interpret this doctrine very narrowly. See Elliott Associates, L.P. v. Banco de la Nacion, 194 F.3d. 363 (2d Cir. 1999); Camdex International Limited v. Bank of Zambia [1996] QB 22.
For a discussion of the difficulties encountered in executing judgments under the FSIA, see Richard W. Cutler, “Executing Judgments Under FSIA: Winning Isn’t Everything,” New York Law Journal (August 17, 1995), at 1.
See Philip R. Wood, Project Finance, Subordinated Debt, and State Loans, at 104 (Sweet & Maxwell, 1995). Moreover, to the extent that a statute allows seizure of the sovereign’s property in aid of executive, it would be possible for the government—with the assistance of the legislature—to repeal such legislation.
28 U.S.C. § 1610(a).
See, e.g., Connecticut Bank of Commerce v. Republic of Congo, 309 F.3d 240 (5th Cir. 2002).
See, e.g., National City Bank v. Banco Para El Commercio Exterior de Cuba, 462 U.S. 611 (1983).
LNC Investments, Inc. v. Republic of Nicaragua, 115 F. Supp. 2d 358 (S.D.N.Y. 2000). For a comprehensive analysis of the treatment of central banks under the FSIA, see Paul L. Lee, “Central Banks and Sovereign Immunity,” 41 Columbia Journal of Transnational Law 327 (2003); E.T. Patrikis, “Foreign Central Bank Property: Immunity from Attachment in the United States,” 1982 University of Illinois Law Review 265 (1982).
See Elliott Assoc. No. 2000QR92 (Court of Appeals of Brussels, 8th Chamber, September 26, 2000). Elliott had acquired in the secondary market US$20.7 million face amount of commercial bank loans that had been guaranteed by the Republic of Peru. Unlike most other creditors, Elliott did not participate in the restructuring of Peru’s debt, which involved an exchange of bank loans for Brady bonds. Instead, Elliott filed suit in New York for a recovery of the full face amount of the debt, plus accumulated interest, and obtained a judgment against Peru in the amount of US$56 million. Armed with this judgment, it then sought injunctive relief in several jurisdictions designed to prevent Peru from making a scheduled interest payment to the holders of the Brady bonds unless a payment was made to Elliott at least proportionate to the payments being made to the Brady bondholders. In addition to obtaining an ex parte temporary restraining order preventing Peru’s fiscal agent from making the interest payment, it obtained an ex parte order from a Brussels court preventing Euroclear from accepting payments from Peru that were intended to be distributed to the holders of its Brady bonds. Before the ex parte restraining order could be challenged by Peru or by Euroclear, Peru settled with Elliot, perhaps in part in order to avoid risking a payment default on its Brady bonds.
For a discussion of the reasons why the pari passu provision cannot be reasonably interpreted as limiting payments, see Lee Buchheit and Jeremiah Pam, “The Pari Passu Clause in Sovereign Debt Instruments,” 53 Emory Law Journal 763 (2004); see also Gulati and Klee, supra note 29; Phillip R. Wood, “Pari Passu Clauses—What Do They Mean?” 18 Butterworths Journal of International Banking and Finance Law 371 (2003).
A pari passu provision typically provides as follows: “The notes rank, and will rank, pari passu in right of payment with all other present and future unsecured and unsubordinated External Indebtedness of the Issuer.”
See generally Buchheit and Pam, supra note 42.
Memorandum of Law of Amicus Curiae The New York Clearing House Associations L.L.C. in Support of Motion Pursuant to CPLR Section 5340 to Preclude Plaintiff Judgment Creditors from Interfering with Payments to Other Creditors, January 12, 2004; Statement of Interest of the United States, January 12, 2004; Memorandum of Law of Amicus Curiae Federal Reserve Bank of New York in Support of Motion Pursuant to CPLR Section 5340 to Preclude Plaintiff Judgment Creditors from Interfering with Payments to Other Creditors, January 12, 2004.
See, e.g., Memorandum of Law of the Republic of Argentina in Support of Its Motion Pursuant to CPLR 5240 to Preclude Plaintiff Judgment Creditors from Interfering with Payments to Other Creditors, EM Ltd v. The Republic of Argentina, No. CV 2507 (TPG). Among the authorities cited in the brief is Section 18 of the Restatement (Second) of Judgments (1982), which reads, in part: “When a valid and final judgment is rendered in favor of the plaintiff … the plaintiff cannot therefore maintain an action on the original claim or any part thereof, although he may be able to maintain an action upon the judgment.”
Court of Appeals of Brussels, No. 2003KR334, at 13. The decision of the Court of Appeals is presently on appeal to Belgium’s Supreme Court of Justice. Belgium recently amended Article 9 of the law that implements European Directive 9826EC for the purpose of ensuring that future court orders do not prevent Euroclear from receiving and channeling payments on account of bondholders. See Belgian Law 1119204, art. 15.
See Red Mountain Finance Inc. v. Democratic Republic of Congo and National Bank of Congo, Case No. CV 00-0164 (C.D. Cal. May 21, 2001).
Id. Transcript of May 29 hearing at 6–7. Indeed, the judge apparently deleted by hand the introductory language requested by Red Mountain that stated that “plaintiff’s motion … for Specific Performance of Covenants in Aid of Execution is granted.” Id.
One of the striking features of the order is that it does not appear to have any geographical limitation. Under the terms of the injunction, even payments made by the Democratic Republic of the Congo to creditors outside the United States from funds not subject to execution would have violated the order unless proportionate payments were made to Red Mountain. The extraterritorial reach of the order raises the question of whether it is consistent with the provisions of the FSIA, which only allows for execution with respect to “property in the United States of a Foreign state … used for a commercial activity in the United States.” 28 U.S.C. § 1610(a); see, e.g., Fidelity Partners, Inc. v. First Trust Co. of New York, 58 F. Supp. 2d 52, 54 (S.D.N.Y. 1997), remanded for consideration of mootness, 142 F.3d 560 (2d Cir. 1998), prior decision adhered to on remand, 58 F. Supp. 2d 55 (S.D.N.Y. 1999), aff’d, 216 F.3d 1072 (2d Cir. 2000); Fidelity Partners, Inc. v. Philippine Export and Foreign Loan Guarantee Corp., 921 F. Supp. 1113 (S.D.N.Y. 1996); Philippine Export and Foreign Loan Guarantee Corp. v. Chuidian, 267 Cal. Rptr. 457 (California Court of Appeals 1990).
See Encouraging Greater Use, supra note 11. As of late December 2001, bonds governed by New York law and English law represented 59 percent and 24 percent, respectively, of the total value of international sovereign bonds outstanding. For a comprehensive analysis of the origins of collective action clauses, see Lee Buchheit and G. Mitu Gulati, “Sovereign Bonds and the Collective Will,” 51 Emory Law Journal 1317 (2002). For analysis of the various features of collective action clauses, see “CAC Design,” supra note 11.
See “CAC Design,” supra note 11, at 5–10; G-10 Working Group, Report of the G-10 Working Group on Contractual Clauses 3–4 (September 26, 2002) [hereinafter “G-10 Working Group Report”], http://www.bis.org/publ/gten08.pdf; Buchheit and Gulati, supra note 51, at 1324–26.
Their absence from bonds governed by New York law does not arise from a legal constraint. The U.S. Trust Indenture Act (TIA), enacted in 1939, prohibits any impairment of a bondholder’s right to receive payments due (or to recover the missed payments) without its consent, except that it allows a majority of bondholders with 75 percent of outstanding principal to postpone interest payments for up to three years. This limitation does not apply to sovereign bonds. For a general discussion of the motivations of the TIA, see Buchheit and Gulati, supra note 51, at 1326–30.
On February 14, 2000, the German federal government issued a statement on the acceptability of including collective action clauses in sovereign bond issues subject to German law. However, this statement did not affect market practice, and German law firms have generally been reluctant to issue legal opinions confirming the validity of such provisions. As a means of further promoting the inclusion of the clauses in sovereign bonds, legislation is being considered that would confirm the consistency of these provisions with German law. See “CAC Design,” supra note 11, at 8; G-10 Working Group Report, supra note 52, at 4 n.3; see also, IMF, “Progress Report to the International Monetary and Financial Committee on Crisis Resolution,” at 5 n.9 (April 20, 2004), http://www.imf.org/external/np/pdr/cr2004/eng/042004.pdf.
While bonds governed by New York law contain a special de-acceleration provision, bonds governed by English law normally achieve deceleration by using the majority restructuring provision to amend the maturity date. See “CAC Design,” supra note 11, at 11–12.
While a trustee may also initiate proceedings at its own discretion, it will normally not do so because of the costs and the risks involved. For a further discussion of the trust deed structure, see id. at 12–13.
For a further discussion of the use of the majority restructuring provisions in the case of Ukraine, see IMF, “Involving the Private Sector in the Resolution of Financial Crises—Restructuring International Sovereign Bonds,” at 6 box 2.3 (February 5, 2001) [hereinafter “Involving the Private Sector”], http://www.imf.org/external/pubs/ft/series/03IPS/pdf. Interestingly, although Pakistan had collective action clauses in its bonds, it decided not to use them when it restructured its debt in 2000. See id. at 5 box 2.2.
For a discussion of the successful Uruguay exchange, see Ben Maiden, “Uruguay Faces Up to Challenges of Emerging Market Debt,” International Financial Law Review (2003).
The call for the inclusion of collective action clauses in international sovereign bonds was contained in a report of the G-10 Deputies Working Group. G-10 Deputies Working Group, “The Resolution of Sovereign Liquidity Crises” (May 1996) [hereinafter “G-10 Deputies Report”], http://www.bis.org/pub/lgten/03.htm. The G-10 Deputies Report notes that certain contractual provisions, if broadly contained in international debt contracts, could help to facilitate debt holders’ decision making and hence the resolution of a sovereign liquidity crisis. Other benefits include the fostering of dialogue and consultation between the sovereign debtor and its creditors and the reduction of the ability of a small number of dissident creditors to disrupt, delay, or prevent arrangements supporting a credible adjustment program that are acceptable to the vast majority of the interested parties. Id. at 15. But the G-10 Deputies Report emphasized that the cooperation between sovereign borrowers and their creditors needs to be a market-led process if it is to be successful. Id. at 1.
At the end of 2001, 59 percent of the value of all outstanding international sovereign bonds were governed by New York law. See “Encouraging Greater Use,” supra note 11, at 5 tbl.1. At that time one such bond issuance included the type of “majority restructuring” provision that is generally found in international sovereign bonds governed by English law. See “CAC Design,” supra note 11, at 7 n.8.
The process started with Mexico, which included majority restructuring provisions in the bonds that it issued in early 2003. Since then, the following additional countries have issued bonds governed by New York law that include majority restructuring provisions: Belize, Brazil, Colombia, Costa Rica, Guatemala, Indonesia, Italy, Korea, Lebanon, Panama, Peru, Philippines, Poland, South Africa, Turkey, Uruguay, and Venezuela (as of June 30, 2004).
The relationship between collective action clauses and the SDRM, at least from the perspective of market participants, was clearly outlined by Adam Lerrick and Allan H. Meltzer, “Sovereign Default: The Private Sector Can Resolve Bankruptcy Without a Formal Court,” Quarterly International Economic Report (April 2002), at 2 (“With bailouts ruled out, the private sector is confronted with a choice: accept regulation or find its own solution to make restructuring work.”). See also Barry Eichengreen et al., “Crisis Resolution: Next Steps,” IMF Working Paper No. 03/196 (October 2003) (pointing out that the Institute of International Finance’s embrace of collective action clauses would never have happened in the absence of the SDRM initiative), http://www.imf.org/external/pubs/ft/wp2003/wp/03196.pdf.
While this limitation was identified by the IMF in its work on the SDRM, it has also been specifically recognized as a critical issue by others. See Patrick Bolton and David A. Skeel, Jr., “Inside the Black Box: How Should a Sovereign Bankruptcy Framework Be Structured?” in this volume of Current Developments in Monetary and Financial Law, pp. 307. See also Scott, supra note 23, at 122; Patrick Bolton, “Toward a Statutory Approach to Sovereign Debt Restructuring: Lessons from Corporate Bankruptcy Practice Around the World,” 50 IMF Staff Papers 41 (2003), http://www.imf.org/External/Pubs/FT/staffp/2002/00-00/pdf/bolton.pdf. In one academic study, empirical evidence was presented to suggest that, where there are a large number of different issuances, the problem that this creates may affect the price of the bonds, at least with respect to sovereigns with poor credit and limited market access. See Eichengreen et al., supra note 62, at 27–31.
See “CAC Design,” supra note 11, at 13.
“Involving the Private Sector,” supra note 57, at 6.
See, e.g., John B. Taylor, “Sovereign Debt Restructuring: A U.S. Perspective,” Remarks at the Institute for International Economics (April 2, 2002), http://www.ustreas.gov/press/releases/po/2056.htm. “There is no reason to restrict the scope of these clauses to bonded debt. It would be appropriate, for example, to include such clauses in bank debt along with bonded debt.” Id.
To be truly effective, [majority action] clauses should not be applied issue by issue but across all debt of the same priority rank. Otherwise, a maverick investor, who accumulates a blocking minority position in a single small issue, can attempt to hold hostage the entire restructuring process. The voting provisions should be based upon a super-majority of all creditors of the same priority, regardless of the instrument held—bond, loan or trade credit—as long as the treatment of all individual groups of claims is non-discriminatory.
See B. Maiden, supra note 58.
See, e.g., Director General of Fair Trading v. First National Bank plc. [2001] 3 W.L.R. 1297 (“It is trite law in England that once a judgment is obtained under a loan agreement for a principal sum and judgment is entered, the contract merges in the judgment and the principal becomes owed under the judgment and not under the contract”).
See supra text accompanying note 11.
Even among those that have argued that the doctrine of merger precludes the invocation of the pari passu provision, there is a recognition that certain provisions relating to enforcement survive the entry of judgment. See, e.g., Memorandum of Law of the Republic of Argentina in Support of Its Motion Pursuant to CPLR 5240 to Preclude Plaintiff Judgment Creditors from Interfering with Payments to Other Creditors, EM Ltd. v. The Republic of Argentina, No. CV 2507 (TPG).
For emerging market economies that wish to access the capital markets, it has also been emphasized that the reputational costs arising from a restructuring will also weigh heavily on the decision maker. See Bolton and Skeel, supra note 63, at 309.
While some have focused exclusively on the problems arising from the availability of IMF financing, others have recognized that improvements in the system also require reform of the legal framework—whether through contract or otherwise—that guides the restructuring process. See generally Eichengreen et al., supra note 62, at 5; Scott, supra note 23; Hal S. Scott, “How Would a New Bankruptcy Regime Help?” 2002(1) Brookings Papers on Economic Activity, at 334 [hereinafter Scott, “Bankruptcy Regime”]. See Bolton, supra note 63; Bolton and Skeel, supra note 63; Lerrick and Meltzer, supra note 62. The need for reform on both fronts was also recognized by the United States relatively early during the reform discussions. See Taylor, supra note 66.
IMF Articles, supra note 5, Article I.
Id. Article V, Section 3(a).
Id. Although the maturity structure for IMF obligations varies, the standard period is three to five years. Id. Article V, Section 7(d).
The Guidelines on Conditionality set forth the general principles that the IMF applies when considering both (a) the type of economic reform programs it will support with its resources and (b) the types of conditions it will formulate for purposes of ensuring that its resources actually support the effective implementation of these programs. IMF, Selected Decisions and Selected Documents of the International Monetary Fund, 29th Issue (IMF, 2004), at 223–31 [hereinafter Selected Decisions], http://www.imf.org/external/pubs/ft/sd/index.asp.
Exceptional access is defined as access by a member to the IMF’s general resources, under any type of financing, in excess of an annual limit of 100 percent of quota or a cumulative limit (net of scheduled repurchases) of 300 percent of a member’s quota. The existing criteria used for purposes of determining whether a member qualifies for exceptional access are discussed infra note 101.
In the event that the overindebtedness is in the banking or enterprise sector, the objective will be to avoid the imposition of capital controls.
Too much discretion regarding official actions leads to confusion among debtors and creditors and time-consistency problems among policymakers. Greater clarity about the scale of official financing would help to condition the actions and expectations of debtors and creditors about the roles they are expected to play in resolving crises.
Id. at 3. It has also been observed that the expectation of future IMF financing was a key reason the proposed exchange offer made by Russia in 1998 was unsuccessful. See Bolton, supra note 63, at 31.
The existence of creditor moral hazard is cited by a variety of legal and economic commentators as a principal motivation for either stricter limits on IMF financing or a more robust legal framework for the restructuring of sovereign debt. See generally Rogoff and Zettelmeyer, supra note 7. See Steven L. Schwarcz, “Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach,” 85 Cornell Law Review 956, at 962 (2001); Jeremy Bulow and Kenneth Rogoff, “Sovereign Debt: Is to Forgive to Forget?” 79 American Economic Review 43 (1989), http://ideas.repec.org/a/aea/aecrev/v79y1989i1p43-50.html; Adam Lerrick and Allan H. Meltzer, “Blueprint for an International Lender of Last Resort,” 50 Journal of Monetary Economy, at 289–308 (2003); Scott, “Bankruptcy Regime,” supra note 73; Miller, supra note 2, at 7; Bolton and Skeel, supra note 63. Some have gone so far as to argue that the moral hazard problems created by IMF financing can only be remedied by the abolition of the IMF itself. See Anna Schwartz, “Time to Terminate the ESF and the IMF,” Foreign Policy Briefing No. 48, Cato Institute (1998), http://www.cato.org/pubs/fpbriefs/fpb-048.pdf.
Among those that have identified creditor moral hazard as a major consequence of large IMF financing packages, there are those who also point out that such financing also reduces the discipline on a sovereign debtor’s own economic policies. See, e.g., Scott, supra note 23, at 113.
[T]he issue is not whether creditors have paid a price for making bad loans, but whether the price has been commensurate with the risk. IMF and official support have sheltered creditors from paying the full price of the risks they have assumed. The result has been that they have been more willing to make loans than they would have otherwise have been, and that debtor countries have incurred more debt or engaged in less prudent fiscal and monetary policies than they otherwise would have had they known no official support was forthcoming.
Id. at 114–15.
See Steven L. Schwarcz, “Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach,” 85 Cornell Law Review 956, at 962 (2001) (“Notwithstanding the lack of empirical evidence of the extent, if any, to which the moral hazard risk actually influences the behavior of States or their creditors, the potential for moral hazard figures prominently in the media debate. …”).
Because the IMF’s resources are limited, the notion that the IMF can perform a true lender of last resort function is an inaccurate one. Indeed, the problems arising from the growing demands on the IMF’s finite resources have been identified by a number of commentators as an important motivation for reform. See, e.g., Cooper, supra note 2, at 92–93; Hagan, “Sovereign Debtors,” supra note 25, at 337–42; Bolton, supra note 63, at 3.
Stanley Fischer, “The International Financial System: Crises and Reform” (October 29–31, 2001), http://www.iie.com/fischer/pdf/Fischer178.pdf.
The approach relied upon by Ecuador to restructure its Brady bonds and Eurobonds from 1999 to 2000 was the first case that generated considerable criticism in that regard. After Ecuador defaulted on its external bonds, the authorities refused to engage in negotiations with bondholders. Although the authorities established a so-called Consultative Group of eight institutional investors with large exposure, the authorities did not provide them with any confidential information or, more generally, engage in the type of dialogue that had generally been commonplace during the restructurings of the 1980s, where the debtor was engaged in a relatively structured negotiating process through the bank steering committees. For a discussion of investors’ concerns regarding the process that was relied upon by Ecuador to restructure its bonds, see F. Salmon and J. Gallardo, “The Buy Side Starts to Bite Back,” Euromoney (April 2001), at 46.
For a discussion of the broader implications of the strategy relied upon by Ecuador, see “Involving the Private Sector,” supra note 57.
This is fundamental: That private sector willingness to provide capital in the future will depend on the character of interaction between official actors, debtors and bondholders, as well as the specific outcome. Players who believe themselves to have been “hard done by” tend not to stay in the game, they tend to leave the field after extracting whatever near term justice they can. Players who lose, but believe in the game, tend to return to the field.
Bond Holders Working Group, “Bondholder Roles in Sovereign Crisis Management and Prevention,” at 7–8, http://emcreditors.com/pdf/bondholder_management_prevention.pdf.
See IMF, supra note 77, at 305–11. For a discussion of the origins and recent application of the IMF’s lending into arrears policy, see Hagan, “Sovereign Debtors,” supra note 25, at 338–42.
See “Involving the Private Sector,” supra note 57, at 9–10.
For a description of the Paris Club process, see Eichengreen et al., supra note 62, annex 4; see also Rieffel, supra note 25, at 56–95.
The “Proposed Features” are attached to the “IMF Managing Director’s Report,” supra note 4.
The fundamental question for participants in this debate is whether new procedures for resolving sovereign debt crises will significantly enhance the efficiency and stability of international financial markets and the growth and stability of the developing countries that depend on those markets. Our view is that while these provisions will make a difference, they are only one among many needed improvements. The case for them is strongest if their addition to loan agreements is viewed as one of a number of interdependent changes in the international financial architecture, none of which is feasible in the absence of the others but which together promise to make the world a significantly safer place.
Eichengreen et al., supra note 62, at 37.
See IMF, “Proposed Features of a Sovereign Debt Restructuring Mechanism,” para. 11 (February 12, 2003) [hereinafter “Proposed Features”], http://www.imf.org/external/np/omd/2003/040803.htm.
Id.
Id.
Id. para. 3(b).
Id. para. 5.
Id. para. 8.
Id. para. 3(d)(vi).
In parallel with the development of the SDRM, the IMF has also sought to provide further clarity to its access policy. While an assessment of debt sustainability remains central to the determination as to whether exceptional access will be provided, greater efforts have been made to strengthen the methodology that is used when making these assessments. Moreover, when determining whether a member should be granted exceptional access, the IMF has decided to pay greater attention to the implications of such access on the liquidity position of the IMF. In 2002, the IMF adopted a policy that provides guidance as to the circumstances when it will grant exceptional access in capital account crises. The policy requires that the following criteria be met:
(i) The member is experiencing exceptional balance of payments pressures on the capital account resulting in a need for Fund financing that cannot be met within normal limits;
(ii) A rigorous and systemic analysis indicates that there is a high probability that debt will remain sustainable;
(iii) The member has good prospects of regaining access to private capital markets within the time Fund resources would be outstanding, so that the Fund’s financing would provide a bridge; and
(iv) The policy program of the member country provides a reasonably strong prospect of success, including not only a member’s adjustment plans but also its institutional and political capacity to deliver that adjustment.
IMF, supra note 77, at 322–23. When considering exceptional access, it has also been agreed that the relevant staff paper would include an assessment of the risks to the IMF arising from the exposure and its effect on liquidity. Id. at 324.
The notion that a more orderly and less costly restructuring framework would reduce the pressure on the IMF to continue financing in marginal situations has been recognized by a number of economic and legal commentators. See, e.g., “G-30 Working Group Report, Key Issues in Sovereign Debt Restructuring” (2002) [hereinafter “G-30 Working Group Report”]; Eichengreen et al., supra note 62, at 5; Scott, “Bankruptcy Regime,” supra note 73, at 335. Scott appropriately recognized that the relationship between the SDRM and IMF financing was “indirect”: “The idea is that pressure for IMF lending would be lessened if the SDRM offered a mechanism by which a troubled sovereign debtor and its creditors could reach an agreement to reduce the sovereign’s debt.” Id.; see also Eichengreen et al., supra note 62, at 1. Kenneth Rogoff, the IMF’s former Chief Economist, noted that the strengthened ability of the IMF to resist pressure for financing unsustainable debt would be one of the “by-products of the SDRM.” Kenneth Rogoff, “Emerging Market Debt: What Is the Problem?” Speech at the IMF Sovereign Debt Restructuring Conference (January 22, 2003), http://www.imf.org/external/np/speeches/2003/012203a.htm.
Under U.S. bankruptcy law, the votes for a plan may be solicited and obtained prior to the commencement of reorganization proceedings. 11 U.S.C. § 1126. For a discussion of prepackaged and prenegotiated plans under Chapter 11, see Stephen H. Case and Mitchell A. Harwood, “Current Issues in Prepackaged Chapter 11 Plans of Reorganization and Using the Federal Declaratory Judgment Act for Instant Reorganizations,” 1991 Annual Survey of American Law 75 (1991).
The idea that a more predictable framework would enhance the quality of emerging market debt as an asset class is recognized in G-30 Working Group Report, supra note 102, at 1–2, 4. There are others, however, who took the view that the SDRM would have reduced the flows to emerging market economies and that this reduction would have been beneficial to the overall system. See, e.g., Cooper, supra note 2, at 94.
As noted by a number of commentators, the goal was to reduce the cost of restructuring for all involved while not actually encouraging defaults. See, e.g., Roubini, supra note 23, at 323. Some observers have argued that a key element that reduces the risk of debtor moral hazard in the sovereign context—particularly for emerging market sovereigns wishing to regain or maintain access to the capital markets—is the reputational cost of default. See, e.g., Bolton and Skeel, supra note 63, at 309.
Article XXVIII of the IMF’s Articles provide that an amendment will enter into force for all members once it has been accepted by three-fifths of the members, holding 85 percent of the total voting power, IMF Articles, supra note 5, Article XXVIII(a).
IMF Articles, supra note 5, Article XXXI, Section 2(a).
See Editorial, “A Question from Argentina,” Washington Post (December 11, 2001), at A32 (“Mr. O’Neill needs to decide whether Congress can be talked into ceding sovereignty to an international bankruptcy court. If that looks impossible, it would be better to bury the whole subject quickly.”); “Battling over the Bankrupt,” supra note 17, at 70.
For a comprehensive discussion of the relevance of corporate reorganization legislation to the restructuring of sovereign debt, see Bolton, supra note 63; Bolton and Skeel, supra note 63; Schwarcz, supra note 83; Scott, supra note 23; Michelle J. White, “Sovereigns in Distress: Do They Need Bankruptcy?” 2002(1) Brookings Papers on Economic Activity, at 287–319, http://econ.ucsd.edu/~miwhite/BPEA_White.pdf.
While some of the proposals were designed by economists, others were formulated by the legal profession. The various proposals are reviewed in Rogoff and Zettelmeyer, supra note 7. Perhaps the most comprehensive and detailed proposal, which was published shortly before the SDRM was launched in November 2001, is that of Professor Steven Schwarcz. See Schwarcz, supra note 83.
While insolvency laws vary considerably among countries, over the past several years it has become increasingly possible to identify emerging “standards” and best practices in this area. Most important, the United Nations Commission on International Trade Law (UNCITRAL) recently adopted the Legislative Guide on Insolvency Law, which provides detailed analysis and recommendations on all aspects of the design of an insolvency law. UNCITRAL Legislative Guide on Domestic Insolvency Law (October 5, 2004) [hereinafter UNCITRAL Legislative Guide], at http://www.uncitral.org/english/texts/insolven/provisfinal.pdf. This work builds upon work that has been done by a variety of international organizations, including that of the IMF and the World Bank. See IMF, Orderly and Effective Insolvency Procedures—Key Issues (Washington: IMF, 1999); World Bank, Principles and Guidelines for Effective Insolvency and Creditor Rights Systems (April 2001), http://siteresources.worldbank.org/GILD/PrinciplesAndGuidelines/20162797/Principles%20and%20Guidelines%20for%20Effective%20Insolvency%20and%20Creditor%20Rights%20Systems.pdf.
See UNCITRAL Legislative Guide, supra note 111, at 213, 218; IMF, supra note 111, at 59–60.
See UNCITRAL Legislative Guide, supra note 111, at 197–212, 216; IMF, supra note 111, at 64–69. Some commentators have argued, however, that it could be feasible to construct the equivalent of a liquidation benchmark for a sovereign state. See Scott, supra note 23, at 130.
In recognition of these limitations, a number of commentators have pointed to the potential relevance of Chapter 9 of the U.S. Bankruptcy law, which governs the debts of municipal governments, to sovereign states. See 11 U.S.C. § 900 et seq. Commentators who have advocated the use of Chapter 9 in this context include Kunibert Raffer, “Applying Chapter 9 Insolvency to International Debts: An Economically Efficient Solution with a Human Face,” 18 World Development 301 (1990). See also John Chun, “Post-Modern Sovereign Debt Crisis: Did Mexico Need an International Bankruptcy Forum?” 64 Fordham Law Review 2647 (1996). A number of the features of Chapter 9 that are of potential relevance to the sovereign context are (i) only the debtor can initiate proceedings; (ii) the bankruptcy court may not interfere with any of the debtor’s political or governmental powers; and (iii) a Chapter 9 proceeding may not be converted into a liquidation. At the same time, however, an important limitation to the Chapter 9 analogy is that municipalities are not sovereign. Indeed, Chapter 9 acknowledges the power of the state within which the municipality exists to continue to control the exercise of the municipality’s powers, including expenditures. For this reason and others, a number of commentators and scholars have been somewhat skeptical of the Chapter 9 analogy. See White, supra note 109, at 9–11; Schwarcz, supra note 83, at 980–81.
See, e.g., Andrei Shleifer, “Will the Sovereign Debt Market Survive?” 3–4, National Bureau of Economic Research Working Paper No. 9493 (2003); Sergio Galvis, “Sovereign Debt Restructurings—The Market Knows Best,” 6 International Finance 145, at 150 (2003). Indeed, these differences were part of the reason why the official sector declined to seriously consider a statutory framework on earlier occasions. See G-10 Working Group Report, supra note 52, at 4; Eichengreen et al., supra note 62, at 15; White, supra note 109, at 24.
In his proposal to establish a statutory framework for sovereign debtors, Professor Schwarcz is also sensitive to the need to design a framework that takes into consideration the unique features of the sovereign state and, in that context, does not create debtor moral hazard. See Schwarcz, supra note 83. Others have also taken issue with the assumption that a statutory framework will necessarily create moral hazard. See Celeste Boeri, “How to Solve Argentina’s Debt Crisis: Will the IMF’s Plan Work?” 4 Chicago Journal of International Law 245 (2003).
See relevant discussion of stay on creditor enforcement infra in the section entitled “The Stay on Creditor Enforcement.”
IMF Articles, supra note 5, Article XXVIII(a).
The potential conflicts that would arise if the IMF’s Executive Board were to perform a dispute resolution function were recognized at the outset. See Preliminary Considerations, supra note 16, at 16–17. Commentators have reached similar conclusions. See, e.g., Eichengreen et al., supra note 62 at 44; Michael T. Hilgers, “Debtor-States and an International Bankruptcy Court: The IMF Creditor Problem,” 4 Chicago Journal of International Law 257, at 263 (2003).
“The IMF is so politicized in its decision making that it is impossible that administrating a bankruptcy procedure would be any less politicized than administering general funds.” Suara Merdeka, “Wall Street Gives IMF Bankruptcy Plan Cool Reception,” Reuters (December 1, 2001) (quoting Kasper Bartholdy of Credit Suisse First Boston), at http://www.suaramerdeka.com/harian/0112/01eng7.htm; see Bolton, supra note 63, at 38; Bolton and Skeel, supra note 63, at 351; see also Eichengreen et al., supra note 62, at 44.
See discussion of Dispute Resolution Forum infra in the section entitled “Dispute Resolution Forum.”
“Proposed Features,” supra note 94, para. 2.
See discussion of Dispute Resolution Forum infra in the section entitled “Dispute Resolution Forum.”
See UNCITRAL Legislative Guide, supra note 111, at 199–212, 215–16; IMF, supra note 111, at 64–69.
In some countries, including the United States, a plan can be approved over the objections of a class that is affected by the plan. See, e.g, 11 U.S.C. § 1129(b). The authority of the court to approve a plan in these circumstances is often referred to as “cram-down” authority. Where the court exercises such authority, the law will often require that certain protections be provided to the dissenting class to avoid discrimination between different classes of creditors, taking into account their relative priority in liquidation. In the United States, for example, the court will apply what is referred to as the “absolute priority rule.” This standard of relative protection among different classes of creditors should be distinguished from the absolute protection that is afforded to individual dissenting creditors within a class that has approved a plan. The latter standard often requires that the dissenting creditor receive at least what it would have received in liquidation. See UNCITRAL Legislative Guide, supra note 111, at 216–17 (Recommendation 151); see also IMF, supra note 111, at 64–69. Of course, one of the difficulties of applying “cram down” in the sovereign context is that there is no liquidation law that provides a basis for determining the relative priority of claims. This is a key reason why it was not pursued under the SDRM. Another reason, stated above, is that would require greater reliance on the Dispute Resolution Forum. A number of commentators have also pointed to the difficulty of introducing a cram-down rule in the sovereign context. See Schwarcz, supra note 83, at 1006–1008; Scott, “Bankruptcy Regime,” supra note 73, at 339.
See UNCITRAL Legislative Guide, supra note 111, at 199–212; IMF, supra note 111, at 64–69.
The absence of a clear priority structure for sovereign debt and the implications that this absence has on the restructuring process is analyzed by Anna Gelpern, “Building a Better Seating Chart for Sovereign Debt Restructurings,” 53 Emory Law Journal 1115 (2004).
See discussion of Dispute Resolution Forum infra in the section entitled “Dispute Resolution Forum.”
Indeed, debt that is denominated in foreign currency will normally be converted into domestic currency, often at the time of commencement, with all distributions being made in domestic currency. In the United States, the applicable rule is set forth in 11 U.S.C. § 502(b). See also UNCITRAL Legislative Guide, supra note 111, Part Two, Chapter V(A), Section 2(c), Recommendation 175; IMF, supra note 111, at 45–46. However, the Proposed Features do not provide for such a conversion. Rather, claims would continue to be denominated and payable in their original currencies after commencement. Moreover, unlike the approach followed in most insolvency laws (at least for unsecured creditors), interest would continue to accrue at the contractual rate. The decision not to follow the corporate insolvency model in these areas was, in large part, motivated by a desire to limit the degree to which the SDRM would interfere with contractual relations. See SDRM Design, supra note 16, at 33–36.
See supra note 34 for a discussion of the difficulty of enforcing claims against a sovereign when the action is brought within the sovereign’s territory.
Professor Schwarcz reaches a similar conclusion regarding the seniority of external law claims for purposes of the design of his proposed Convention. See Schwarcz, supra note 83, at 1006.
For a further discussion of these options, see “Sovereign Debt Restructuring Mechanism—Further Considerations,” supra note 16, at 9–12.
See discussion infra in the section entitled “Improving the Dialogue.”
Of course, they have greater political leverage than external creditors, thereby enabling them to press for preferential treatment. In these circumstances, the question would be whether external creditors would be willing to tolerate such discrimination when deciding to accept the terms of any offer.
“Proposed Features,” supra note 94, para. 3(b).
The political implications of including debt governed by domestic law under the SDRM were identified by Charles Dallara, Managing Director of the International Institute for Finance, who is an outspoken critic of the SDRM: “Are the U.S. and U.K. governments really going to allow the IMF to intervene in private contracts undertaken by their own citizens under their own laws?” Alan Beattie, “Bankruptcy Plan Leaves IMF to Fill in the Detail,” Financial Times (November 29, 2001), at 15.
For a description of the rescheduling procedures relied upon by the Paris Club, see Eichengreen et al., supra note 62, at 23–25; see also Rieffel, supra note 25, at 56–95.
See discussion supra in the section entitled “Policies, Process, and Equity.” Interestingly, Professor Schwarcz also alludes to the inclusion of official bilateral claims as a separate class under his proposed Convention. See Schwarcz, supra note 83, at 1006. Unlike the Proposed Features, however, he also contemplates the inclusion of multilateral claims within the framework. See id. See supra note 129 for a discussion of the treatment of multilateral debt under the SDRM.
For a discussion of the IMF staff’s own consideration of the relative advantages and disadvantages of including official bilateral claims within the SDRM, see “SDRM Considerations,” supra note 16, at 19–25.
See “Proposed Features,” supra note 94, para. 3(d)(vi) n.2.
Id. para. 3(d)(v).
The United States opposes any attempt by the judgment creditors to force Argentina to depart from well-established, internationally-accepted payment practices. Both policy and equity require that sovereigns be permitted to service their [International Financial Institution (IFI)] obligations. An interruption of the financial transactions between the IFIs, especially the IMF, and their members would substantially undermine the ability of the IFIs to fulfill their vital systematic public policy functions in promoting international economic and financial stability.
Statement of Interest of the United States, supra note 45, at 17–18.
See UNCITRAL Legislative Guide, supra note 111, Part Two, Chapter II(D), Recommendations 63–68.
IMF staff do not believe that the institution itself, a major creditor, should be included in the “debt standstill” agreement. In other words they are asking the sovereign debtor make [sic] an exception of the IMF, and to therefore treat “some creditors more favourably than others.” This preferential treatment of creditors, like the IMF, that have made major errors in lending and policy advice, is clearly unacceptable.
Ann Pettifor, “Resolving International Debt Crises—The Jubilee Framework for International Insolvency,” 12 (2002), http://www.jubileeplus.org/analysis/reports/jubilee_framework.pdf.
While state-owned enterprises often borrow on a secured basis, it was decided that the debt of such enterprises would not be included under the SDRM to the extent that they were already subject to a statutory debt restructuring framework. In addition to the government, the central bank or similar monetary authority of the member would be eligible to restructure their claims under the SDRM. See “SDRM Design,” supra note 16, at 14–17.
As noted by one commentator, this is one of the biggest differences between the structure of sovereign and nonsovereign debt. See Jeremy Bulow, “First World Governments and Third World Debt,” 2002(1) Brookings Papers on Economic Activity, at 229.
[Sovereign Debtor] has agreed that as long as any of its debt securities remain outstanding, it will not create or permit to exist any security interest on its revenues or assets to secure its public indebtedness, unless the debt securities are given an equivalent security interest.
See UNCITRAL Legislative Guide, supra note 111, at 197–212, 216; IMF, supra note 111, at 64–65.
In particular, a holder of a secured claim will often be able to foreclose on its collateral without the need for a judgment or any other form of judicial intervention.
See UNCITRAL Legislative Guide, supra note 111, at 88–91; IMF, supra note 111, at 70.
Negative pledge clauses can be found in the loans extended by the World Bank, the European Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, and the African Development Bank.
The claims that were excluded under the Proposed Features included any claims that benefit from a statutory, judicial, or contractual privilege, to the extent of the value of such a privilege. “Proposed Features,” supra note 94, para. 3(d)(i). Two important exceptions were made to this carve-out. However, in the event that the judicial lien was created after commencement, the exclusion would not apply, thereby creating an additional disincentive against creditor litigation during the restructuring process. Id.
For a discussion of the Asian financial crisis, see The Asian Financial Crisis: Origins, Implications and Solutions (William C. Hunter et al., eds., 1999); see also Timothy Lane et al., “IMF-Supported Programs in Indonesia, Korea, and Thailand—A Preliminary Assessment,” IMF Occasional Paper 178 (1999), http://www.imf.org/external/pubs/ft/op/op178/op178.pdf.
Over the years, the question has arisen as to whether the existing text of Article VIII, Section 2(b) of the IMF’s Articles could be relied upon to provide debtors with protection against litigation in circumstances where the arrears arise exclusively from the imposition of exchange controls. The provision reads as follows: “Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territories of any member.” Articles of Agreement of the International Monetary Fund, Article VIII, Section 2(b), http://www.imf.org/external/pubs/ft/aa/aa.pdf. This provision has not been interpreted uniformly by the courts of the IMF’s various members. Under the narrow interpretation—which prevails in the United States and the United Kingdom—exchange contracts have been interpreted in such a way that Article VIII, Section 2(b) is not applicable to credit agreements. Under a broader interpretation that prevails in a number of other jurisdictions, the IMF’s temporary approval of restrictions that fall within its jurisdiction on current payments (interest payments and moderate amortization of loan principal) will result in an automatic stay on creditor actions relating to the arrears that arise from the restrictions in question. The stay would lapse on the expiration of the IMF’s approval. While the IMF could adopt an authoritative interpretation along the above lines, it would not help with respect to other arrears relating to capital payments (e.g., nonpayment of bullet payments of principal). There are only two ways in which such arrears could be treated. Under one scenario, controls that give rise to such arrears would be treated as always being consistent with the IMF Articles. Alternatively, the term “consistent” could be interpreted more narrowly, as only including restrictions on current payments and transfers. Under this interpretation, therefore, controls on capital payments would never be “consistent” with the IMF’s Articles. In any event, neither of these interpretations would enable arrears on capital payments to be temporarily protected on a conditional basis, i.e., only in situations where the IMF judged the arrears in question were justified. Accordingly, to achieve symmetry between the treatment of arrears arising from current and capital payments, it was recognized that an amendment of the IMF’s Articles would be required.
For a further discussion of exchange controls under the SDRM, see “Preliminary Considerations,” supra note 16, at 15.
As discussed earlier, this limitation represents an important departure from the approach taken in the nonsovereign context, where creditors are often given the right to initiate proceedings under the reorganization law. See UNCITRAL Legislative Guide, supra note 111, at 50–52; IMF, Orderly and Effective Insolvency Procedures—Key Issues (Washington: IMF, 1999), at 53–54.
See “Preliminary Considerations,” supra note 16, at 12.
The initial proposal also envisaged the IMF playing a similar role at the time of the mechanism’s termination. Specifically, once a debtor and a qualified majority of its creditors had agreed upon a debt restructuring agreement, IMF endorsement would be a necessary condition for the effectiveness of this agreement. Absent such an endorsement, there was a fear that the debtor and creditors may agree upon debt restructuring terms that were not sustainable—thereby placing an undue burden on the member’s adjustment program or future financing from the IMF. However, the Proposed Features did not provide such a role for the IMF.
See discussion of automatic stay infra in the section entitled “The Stay on Creditor Enforcement.”
“Proposed Features,” supra note 94, para. 6.
As noted by Patrick Bolton, one of the concerns expressed by governments of emerging market economies was that the ability of a sovereign to initiate the mechanism on a purely voluntary basis would increase the domestic political pressure on these governments to default on their external debt. See Bolton, supra note 63, at 15.
See discussion supra in the section entitled “Overview” regarding economic costs of restructuring and the impact such costs have on the incentives of economic policymakers.
See “Preliminary Considerations,” supra note 16, at 12–13.
“Proposed Features,” supra note 94, para. 7(b).
See discussion of the design of majority enforcement provisions supra in the section entitled “The Existing Tools: Collective Action Clauses.”
Professor Schwarcz’s decision not to provide for any form of stay on enforcement under his own proposal is motivated, in part, by the view that such a stay would not be necessary, given the absence of strong creditor enforcement mechanisms in the sovereign context. See Schwarcz, supra note 83, at 984–85.
In the United States, for example, a debtor may not pay pre-petition claims after commencement unless the court determines that, under the “doctrine of necessity,” such payments are necessary for the continuation of the debtor’s business. 11 U.S.C. § 105(a).
See discussion infra note 184 and accompanying text.
See discussion of information provided by the sovereign to its creditors infra in the section entitled “Improving the Dialogue.”
As is discussed in the UNCITRAL Legislative Guide, laws vary as to the degree to which incumbent management is displaced from control. While some laws provide for complete displacement, others allow for a form of power sharing between management and a court-appointed administrator. The ability of management to retain completed control, as provided under Chapter 11, does not represent the approach relied upon by most countries. UNCITRAL Legislative Guide, Part Two, Chapter III(A), Section 2. Even under Chapter 11, however, in the event that management takes actions that adversely affects the interests of creditors, the court can remove it from power. 11 U.S.C. § 1142.
See Bolton and Skeel, supra note 63, at 325.
See discussion of credit enforcement supra in the section entitled “The Stay on Creditor Enforcement.” To the extent that a creditor’s claim is secured, it may have the ability to foreclose on its collateral through self-help remedies, i.e., without the need for judicial intervention.
See discussion regarding the type of claims that would be subject to the SDRM supra in the section entitled “The Scope of Debt.”
Moreover, to the extent that the creditor had received a judicial lien after the commencement of proceedings, this claim, unlike other secured claims, would not be excluded from the SDRM. See supra note 152 and accompanying text.
See Ian E. Fletcher, The Law of Insolvency, at 29–38 (3rd ed. 2002).
See “Proposed Features,” supra note 94, para. 7(a). Let us say, for example, that a creditor possessing a claim with a face value of US$10 million uses judicial enforcement measures to seize assets worth US$4 million. When a restructuring agreement is finally reached, creditors receive a distribution equivalent to 50 percent of their original claims. Applying the hotchpot rule, the judgment creditor would only receive US$1 million, i.e., 50 percent of its original claim (US$5 million) as further reduced by the full amount recovered through the court system. In the absence of such a rule, the creditor would have received US$3 million under the restructuring agreement.
Professors Bolton and Skeel have also suggested the inclusion of a targeted stay, but as an alternative rather than a supplement to a general stay. See Bolton and Skeel, supra note 63, at 325–27.
Litigation would be particularly disruptive if, for example, there was sufficient evidence that the creditor seeking enforcement could attach sufficient assets to circumvent the operation of the hotchpot rule described above.
See “Proposed Features,” supra note 94, para. 7.
Id. para. 5.
Id. para. 8.
See IMF, supra note 77, at 626–32. Under the IMF’s existing publication policy, the publication of both the member’s letter of intent (which sets forth the economic adjustment program) and the relevant staff report (which assesses this program and explains why it justifies IMF financial support) are subject to the consent of the member concerned. However, the policy provides that such consent will be presumed. Accordingly, where a member does not wish to consent to IMF publication of a document, the member would need to notify the IMF of this decision and provide an explanation. Id. at 626.
See “Proposed Features,” supra note 94, para. 5.
This list would also include claims of multilateral organizations. Moreover, the list would also include claims of official bilateral creditors in the event that a decision was made to exclude such claims from the coverage of the SDRM. See discussion supra in the section entitled “Overview.”
Because of concerns regarding state sovereignty, the provisions of the SDRM regarding the provision of information would not constitute legal obligations of the sovereign. Instead, adherence to these provisions would constitute a condition for the availability of the mechanism’s restructuring provisions.
For a discussion of the role of steering committees during the debt crisis, see Reiffel, supra note 25, at 95–132; Buchheit, supra note 26.
Although the existence of a trustee for each bond issuance provides, in theory, some framework of representation, trustees have traditionally been very cautious about speaking on behalf of bondholders during a restructuring process, largely because of concerns regarding their own liability. See, e.g., L. Buchheit, “The Representation Clause,” 17 International Finance Law Review 9 (September 1998).
In the case of Ecuador, the stated reluctance by the debtor to deal with a creditors’ committee was based on a concern that sensitive information disclosed during the negotiations would either be leaked or be traded on. See “Involving the Private Sector,” supra note 57, at 7.
Perhaps the most notable effort in this area is the “Statement of Principles for a Global Approach to Multi-Creditor Workouts,” prepared by the International Association of Restructuring, Insolvency, and Bankruptcy Practitioners (INSOL) in 2000. See http://www.insol.org. Among other things, the Statement of Principles establishes a framework that accommodates the trading of claims during the restructuring process and, more generally, the diversity and multiplicity of creditor interests through the establishment of different subcommittees.
See Council on Foreign Relations, Roundtable on Country Risk in the Post-Asia Crisis Era: Key Recommnedations, http://www.cfr.org/publication/8693/roundtable_on_country_risk_in_the_postasia_crisis_era.html. Consistent with the approach followed in the INSOL Statement of Principles, the Council on Foreign Relations principles provide guidance with respect to (i) the modalities of creditor organization (including the establishment of subcommittees), (ii) expectations regarding the debtor behavior (including the provision of information), (iii) retention of financial advisors (and the expectation that the debtor will bear the reasonable expenses of these advisors), and (iv) standstill on litigation during the negotiation period.
See IMF, supra note 77, at 309.
See discussion of possible role of a creditors’ committee in the context of a targeted stay supra note 177 and accompanying text.
See discussion of stay on enforcement actions supra in the section entitled “The Stay on Creditor Enforcement.”
See IMF, supra note 77, at 309.
First, the committee would need to include those creditors with the greatest exposure to the sovereign. Second, it should be sufficiently representative of the diverse financial and economic interests of the claims being restructured. Thus, for example, it may be necessary to include claims held by both institutional and retail investors. Third, the size would need to be sufficiently small to enable it to operate in an efficient manner. See “SDRM Design,” supra note 16, at 43.
See UNCITRAL Legislative Guide, supra note 111, at 182–86; IMF, supra note 111, at 75–76. In the United States, for example, the expenses of the committee are treated as an administrative expense of the estate. See 11 U.S.C. § 503(b)(4).
See Reiffel, supra note 25, at 129.
“Proposed Features,” supra note 94, para. 8.
For a detailed discussion of how regulatory issues shaped the strategy that was relied upon during the 1980s debt crisis, see generally Lee Buchheit, “Alternative Techniques in Sovereign Debt Restructuring,” 1988 University of Illinois Law Review 371 (1988). See also Reiffel, supra note 25, at 127.
See Reiffel, supra note 25, at 126. See generally Buchheit, supra note 199.
For Professor Schwarcz, the creation of a priority structure that would shift financing away from the IMF and toward the private sector would serve to address not only moral hazard problems but would “eliminate the need for taxpayers to pay for the funding and would avoid politicizing the decisions of when and to whom the IMF should make funding available.” See Schwarcz, supra note 83, at 987.
It is very likely, however, that trade creditors—because of the short-term nature of their claims—would be willing to provide financing even in the absence of any formal assurances regarding the priority of their claims.
“Proposed Features,” supra note 94, para. 10.
For the law of the United States, see 11 U.S.C. 364 (a), (b); UNCITRAL Legislative Guide, supra note 111, at 105–10.
See discussion of negative pledge clauses supra in the section entitled “The Scope of Debt.”
For an exploration of the feasibility of using a contractual framework to provide for a priority structure, see Buchheit and Gulati, supra note 51, at 1348–50. Of course, one of the limitations of this approach is that the framework would not aggregate claims across instruments.
See discussion of negative pledge clauses supra in the section entitled “The Scope of Debt.”
For issues relating to the classification of claims and voting procedures, see UNCITRAL Legislative Guide, supra note 111, at 197–210, 235–39.
“Proposed Features,” supra note 94, para. 6.
Id.
The rule that a claim is presumptively valid unless challenged by the debtor or a creditor is one that is relied upon in the United States in the nonsovereign context. See 11 U.S.C. § 502(a). This approach is efficient since it avoids the need for each claim to be subject to a verification procedure.
One of the challenges that arise when designing any registration and verification framework relates to the disclosure of the end-investor. Under existing practice in the sovereign market, private settlement companies and their depositories are the lenders of record for voting purposes and hold the sovereign securities in global form. The beneficial owners of these securities normally have accounts with large financial institutions that, in turn, have accounts with these settlement companies. In these circumstances, would a creditor be in a position to meaningfully challenge a claim—either for distribution or voting purposes—unless it knew the identity of the end-investor? While there is considerable attraction to requiring such disclosure, it would not necessarily resolve the problem since, for example, the sovereign could always establish a special purpose vehicle as the end-investor. An alternative approach that was recently used in the context of the restructuring of Uruguay’s external bonds would be to require the sovereign to certify that none of the bonds being voted on are owned or controlled by the sovereign.
“Proposed Features,” supra note 94, para. 11. This 75 percent threshold is the same that was advocated for collective action clauses by the G-10 Deputies Working Group, and which has become the emerging standard for bonds governed by New York law. See “G-10 Deputies Report,” supra note 59; “Progress Report,” supra note 54, at 7 n.11. The decision to calculate this percentage on the basis of all registered and verified claims—rather than on the basis of those registered and verified claims attending a duly convened meeting—also took into account concerns that U.S. institutional investors had expressed during discussions of the design of majority restructuring provisions. “G-10 Working Group Report,” supra note 52, at 4–5.
“G-10 Working Group Report,” supra note 52.
See discussion of scope of claims under Part III of Appendix III.
International sovereign bonds typically provide that, upon the occurrence of an event of default, the holders of the bonds may declare that the entire amount outstanding under the bond becomes due and payable. As has been discussed, above, the activation of acceleration provisions may require the support of bondholders representing at least 25 percent of outstanding principal. See discussion supra text accompanying note 55.
See discussion of prepackaged bankruptcy procedures supra note 103 and accompanying text; UNCITRAL Legislative Guide, supra note 111, at 218–23.
See UNCITRAL Legislative Guide, supra note 111, at 203; IMF, supra note 111, at 66–67.
As another example, a sovereign may need to restructure claims that were originally interbank claims or trade credit but have become claims on the sovereign because a guarantee had been called. In these cases, the sovereign may need to provide these creditors with terms that are preferable to those offered to bondholders because of the need to resume normal interbank and trade financing after the crisis subsides. Since these preferential terms could only be offered to bank creditors they would be placed in a separate class from bondholders. Bondholders may be willing to accept being treated less favorably because of the recognized need to resume trade credit.
“Proposed Features,” supra note 94, para. 11(d).
In the corporate context, this risk can be particularly problematic where the law allows for “cram down,” i.e., where a restructuring plan can become effective notwithstanding the fact that the plan did not receive adequate support from a number of creditor classes. As discussed earlier, however, the Proposed Features would require the support of each class for a restructuring to go forward. See discussion supra in the section entitled “The Scope of Debt.”
For example, a debtor would presumably be precluded from creating two different classes of unsecured creditors where certain interbank claims creditors are placed in their own class and given short-term instruments while other inter-bank creditors are placed in another class with bondholders and are given long-term instruments.
See “Proposed Features,” supra note 94, para. 13.
For a discussion of registration and verification, see Part VIII of Appendix III.
For issues relating to creditors’ committees, see Part VIII of Appendix III.
For example, under U.S. bankruptcy law, a reorganization plan must be approved by the court on the basis of the criteria set forth in the law. 11 U.S.C § 1129. In particular, the court must determine that “confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor of the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.” Id. at § 1129(11); see also UNCITRAL Legislative Guide, supra note at 111, at 201–10.
As discussed earlier, the imperative of creating a dispute resolution forum with limited powers and discretion was also advanced by Professor Schwarcz. See Schwarcz, supra note 83, at 980.
It has been noted that making an assessment as to whether a country’s debt is unsustainable involves difficult judgments regarding the feasibility of the member’s adjustment capacity. See supra in the section entitled “Collective Action Problems.” Such an assessment is relevant not only for purposes of determining whether a country should activate the SDRM but also for whether it is ready to exit the mechanism, i.e., does the agreement that it has reached with its creditors provide for true debt sustainability? To the extent that it does not, there is a risk that the restructuring exercise would need to be repeated or that further pressure would be placed on the IMF to provide additional financing.
For information regarding composition of the DRF, see infra text accompanying notes 237–44.
See “Proposed Features,” supra note 94, para. 13.
Other international dispute resolution bodies also have some rule-making authority. Under Article 30(1) of the Statute of the International Court of Justice (ICJ), the ICJ has been granted the authority to establish rules of procedure and rules for its internal workings. The Appellate Body of the World Trade Organization has authority to establish its rules of procedures if it is done in consultation with the Chairman of the Dispute Settlement Body. See General Agreement on Tariffs and Trade—Multilateral Trade Negotiations (The Uruguay Round): Understanding on Rules and Procedures Governing the Settlement of Disputes, December 15, 1993, art. 17(9), 33 I.L.M. 112 (1994).
Thus, while the Board of Governors could veto the rules adopted by the DRF, it could not take the initiative and adopt its own rules. This balance of authority was designed to address the risk of excessive interference by the IMF’s other organs in the operation of the SDRM.
Under Article XXXI, Section 2 of the IMF Articles, members have the obligation to ensure that they have taken all steps necessary to enable it to carry out all of its obligations under the Agreement. IMF Articles, supra note 5, Article XXXI, Section 2.
Critics of the SDRM identified this feature as being problematic from both a policy and a legal perspective: “This ex poste facto modification through legislative fiat of contractual rights is troubling not only out of abstract concerns about fairness, but also because it strikes at the very heart of the market’s confidence in the sanctity of private contracts and, thus, the rule of law.” Galvis, supra note 115, at 149.
For a discussion of the insolvency reforms introduced during the Asian crisis, see Sean Hagan, “Insolvency Reform and Economic Policy,” 17 Connecticut Journal of International Law 63, at 63–73 (2001).
Similarly, Professor Schwarcz concludes that his proposed Convention could apply to claims in existence at the time of ratification. See Schwarcz, supra note 83, at 1012–14.
See discussion of IMF workshop and conference supra note 18. Among those providing advice on the design of the SDRM was the Honorable Burton Lifland, Chief Judge of the U.S. Bankruptcy Court. See “IMF Consults Widely,” supra note 18.
See U.N. Charter art. 92–96.
The de jure independence of the DRF would be established in the text of the treaty provisions themselves. Specifically, the amendment to the IMF’s Articles would provide that the decisions of the DRF would not be subject to the review of any of the IMF’s other organs (other than the DRF’s rule-making authority, see supra the section entitled “Dispute Resolution Forum”) and that the members of the DRF would not be subject to any influence of these organs or the management or staff of the IMF. As a means of ensuring security of tenure for DRF members, the text of the amendment would also specify the grounds for their dismissal.
See “Proposed Features,” supra note 94, para. 13(a)(i).
Id. para. 13(a)(ii).
Based on consultation with the private sector, there was a view that the candidates should be limited to judges that have demonstrated experience in insolvency, but not academics or practitioners. However, because the available pool of such judges could be relatively small, there was a recognition that retired judges should also be eligible.
See “Proposed Features,” supra note 94, para. 13(a)(iii).
Notwithstanding these safeguards, some continue to believe that the very fact that the legal instrument establishing the DRF would be the IMF’s Articles would effectively preclude independence from the IMF. See, e.g., Boeri, supra note 116, at 250.
IMF Articles, supra note 5, Article. XXVIII(a).
Paul O’Neill, U.S. Secretary of the Treasury, “The Condition of the Financial Markets, Testimony Before the Senate Committee on Banking, Housing and Urban Affairs,” 107th Cong., S. Hrg 107–606, at 33 (2001).
The IMF’s exploration of a sovereign debt restructuring mechanism has raised important issues. But clearly, given the reactions of markets and emerging-market countries, we should move forward with collective action clauses. These clauses, and not a centralized mechanism, are the vehicle to resolve the issues connected with sovereign debt restructuring. There can at times be “collective action” problems that prevent a prompt, orderly resolution of a sovereign debt crisis. The source of these problems lies in the relationships and agreements of debtors and creditors. It is these parties, not an international organization, that must assume responsibility for the solution. Therefore, it is neither necessary nor feasible to continue working on SDRM.
Meeting of the International Monetary and Financial Committee, IMF (April 12, 2003) (statement by Sec. John W. Snow, U.S. Treasury), http://www.imf.org/external/spring/2003/imfc/state/eng/usa.htm.
See discussion of developments with collective action clauses in New York law–governed bonds supra in the section entitled “The Legal Environment.”
Cf. “Battling over the Bankrupt,” The Economist (October 5, 2002), at 71 (“The chances of America’s Congress agreeing to such a change in the Fund’s rules are slim. That is why America’s Treasury insisted on pushing a second market-based approach.”).
It has been observed that the reluctance of the United States to surrender any national sovereignty in this context is consistent with its hesitancy to do so in other areas. See, e.g., Wheeler and Attaran, supra note 28, at 264 (“From a U.S. perspective, it is difficult to imagine a Congress that has been unwilling to sign away sovereignty to an international criminal court doing so in an area that implicates property interests.”).
A number of leading financial industry associations joined forces to lobby against the SDRM proposal. The associations consisted of the Institute for International Finance, the Emerging Market Traders Association, the International Primary Market Association, the Bond Market Association, the Securities Industry Association, the International Securities Market Association, and the Emerging Market Creditors Association.
See Michael M. Philips, “Support Plan Builds for Plan to Ease Debt Loads of Developing Nations,” Wall Street Journal (September 17, 2002), at A16.
For a discussion of differences of view between “buy-side” and “sell-side” creditor groups on the SDRM, see Melvyn Westlake, “Battle of the Heavyweights,” Emerging Markets (September 27, 2002), at 16.
The various stated and unstated concerns of the private sector are well summarized in “A Better Way to Go Bust,” The Economist (February 1, 2003), at 64.
See Galvis, supra note 115.
See discussion supra text accompanying note 68.
Letter from Charles H. Dallara, Managing Director, IIF et al. to Dr. A.H.E.M. Wellink, Governor, De Nederlandsche Bank NV (December 6, 2002).
The underlying problem is suspicion: bankers, bondholders, and many emerging-market borrowers worry that the IMF has a hidden agenda. The IMF could use the SDRM, once it is in place, as an excuse to trim official bail-outs, by demanding that the private sector take more of the strain when governments run into trouble.
“A Better Way to Go Bust,” The Economist (February 1, 2003), at 64.
The principled objection to sovereign bankruptcy is the risk that an SDRM will make it too easy for sovereign debtors to default. Much as bailouts create moral hazard on the part of creditors, sovereign bankruptcy could have a similar effect on debtors. Limiting sovereign debtors’ ability to restructure, on this view, encourages sovereigns to repay what they owe. The less principled explanation for the underwriters’ and investors’ opposition is simply that the existing bailout approach usually assures that bondholders will be made whole. If an SDRM replaced bailouts as the strategy of choice, sovereign debt holders could no longer count on a handout when sovereigns encountered financial distress.
Bolton and Skeel, supra note 63, at 308.