Appendix Sovereign Debt Restructuring Mechanism—Timeline
As highlighted in a review of recent country experience, a default or a restructuring in the shadow of default may involve declining real incomes, sharply curtailed private investment, financial sector difficulties, and drainage of external reserves in the attempt to stem pressures from capital outflows. The impact on the domestic economy and the links between sovereign debt restructurings, currency crises and banking crises in recent cases were analyzed in Sovereign Debt Restructurings and the Domestic Economy—Experience in Four Recent Cases, SM/02/67 (2/21/02).
It is worth noting that efforts to resolve collective action difficulties also provide the motivation for contractual approaches to improving sovereign debt restructuring mechanisms.
Recent developments in capital markets have amplified these difficulties. The last 15 years have witnessed a shift away from syndicated commercial bank lending toward a variety of tradable financial instruments issued in a number of legal jurisdictions that are held by a diffuse and broad base of creditors. In many respects, this is a positive development, as it has broadened the investor base for financing emerging market sovereigns, and has facilitated the diversification and management of risk. However, the diversity of claims and interests could generate significant coordination problems across claims and claimants in cases where a sovereign decides to seek the restructuring of its debt. The narrow range of debt instruments containing contractual provisions that could facilitate a restructuring may provide only limited help in achieving rapid agreement in cases in which the member has substantial indebtedness that does not include such provisions. Moreover, the effectiveness of contractual provisions in individual instruments would be limited to the extent that potential holdout creditors are able to acquire controlling interests in individual bond issues.
A number of central banks issue international sovereign bonds, including those of Hungary and the Philippines.
In the event that the debtor wished to exercise this option, it would need to obtain the consent of the central bank if the domestic law of the member so required.
This criterion would be controlling. Accordingly, in circumstances where the public entity is subject to the domestic insolvency law, it would be excluded even if it formed part of the budgetary process.
Perhaps most significantly, the United Nations Commission on International Trade Law (UNCITRAL) has almost completed a legislative guide that would provide guidance as to the design of a domestic insolvency law that would be applicable to both developed and developing countries. The World Bank and the Fund have also done work in this area. The Bank will soon be finalizing its “Principles and Guidelines for Effective Insolvency Systems”. In 1999, the Fund’s Legal Department published “Orderly and Effective Insolvency Procedures: Key Issues.”
An example of such a framework is Chapter 9 of the U.S. Bankruptcy Code, which provides a framework for the restructuring of claims of municipalities and local governments.
This is the approach adopted for the purposes of debt limits in Fund arrangements. For that purpose, the concept of the extension of credit has been broadened to encompass financial and operating leases.
Such techniques could include the use of insurance contracts as well as financial derivatives under which payment obligations could arise from specified events.
By the same token, in order to help ensure that restructurings would be comprehensive, when a guarantee has been called with respect to a specific payment, the guarantee on all other payments associated with the underlying debt instrument would be deemed to have been called.
This is also supplemented by negative pledge clauses in bond contracts and bank loan agreements.
The fact that an otherwise eligible claim benefits from a guarantee extended by an international organization would not, in and of itself, result in an exclusion of the underlying claim from the SDRM. However, to the extent that the guarantee is called by the creditor, the resulting claim of the international organization against the sovereign would be excluded from the SDRM.
As with the notification, the period within which the member would need to provide this information would be specified in procedural rules to be adopted by the SDDRF.
Furthermore, given the commonly-held legal principle that the liabilities of the sovereign are not attributed to separate entities, such as independent central banks, reserves held by the central banks would normally be unavailable for satisfaction of claims against the sovereign. In addition, by depositing assets in jurisdiction or institutions (such as the BIS) that recognize or enjoy enhanced protections from legal process, the sovereign debtor may be able to further limit its vulnerability to creditor litigation.
There would be no advantage to the creditor that has initiated litigation and only obtained (an unsatisfied or uncollateralized) judgment on liability upon activation of the stay. Such a judgment creditor is in the same position as other unsecured creditors in terms of being subject to the stay.
By way of example: a creditor possessing a claim with a face value of $10 million manages to seize assets worth $4 million through judicial enforcement. Under the terms of the eventual restructuring agreement, all unsecured creditors receive a combination of cash and new securities with a secondary market value at the time of issuance of 50 percent of the original face value of their claims. Under the approach suggested, the judgment creditor would receive only $1 million; i.e., the 50 percent of its original claim, as further reduced by the full amount of the recovery. Without such a “hotchpot” provision, the judgment creditor would receive $3 million under the restructuring agreement (i.e., 50 percent of the unsatisfied proportion of the judgment).
For such a feature to be feasible, the amendment would need to provide that neither the debtor nor individual creditors could be made liable in an action brought by the enforcing creditor regarding the damages caused by such an order or the failure to request such an order.
For example, this could be in order to finance the purchase and maintenance of inputs that preserve the productive capacity of public enterprises.
For example, the sovereign could borrow externally and on-lend on a revolving basis to firms that need finance to purchase imports in order to produce exports.
The priority creditor may negotiate a credit that provides for repayment at the time that the restructuring agreement is certified. While the SDDRF would ensure that this credit is not restructured, it would not be expected to ensure that this credit is repaid prior to certification.
The mechanism would probably need to establish some criteria for determining the list; e.g., financial institutions that are in the business of providing credit.
As an exception to this rule, one could limit the advantage that a litigant would otherwise have if, through enforcement action, it obtained a judicial lien on the sovereign’s assets during the period between activation and the restructuring agreement. Such liens would not be treated as privileged claims for voting and distribution purposes and, therefore, could be restructured as an unsecured claim.
Although a menu of options within the same class provides some flexibility, it is limited by the fact that, in terms of their net present value, the options would need to be equivalent in order for their to be any predictability as to the financial implications of the restructuring.
For example, the debtor would be precluded from creating two different classes of unsecured creditors where certain inter-bank 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.
Creditors could, of course, also design their own penalties. For example, the terms of the eventual restructuring agreement could provide that, in the event that evidence comes to light that the information provided to the SDDRF and creditors was materially inaccurate, their original claims could be reinstated. Disputes relating to the implementation of this clause (or other clauses in the restructuring agreement) would be subject to the jurisdiction of the national or arbitral court designated in the agreement.
A “former” judge or practitioner would not necessarily mean one that is retired. For example, one could imagine a former insolvency judge who has left the judiciary to pursue other interests, but maintains his or her expertise in insolvency matters.
The rules for the panel’s operations, including rules on the selection of its chairman and on its decision-making process, would have to be addressed. Some of these rules may have to be specified in the amendment, but others could be established by the panel itself.
International professional associations that could be consulted include the International Federation of Insolvency Professionals (INSOL International), the International Bar Association’s Committee J, and the International Insolvency Institute (III). In addition to direct consultation between the selection panel and these and other groups, a website could also be established for comments on the list of nominees by any person who would like to comment.
Private sector creditors consulted by the staff have suggested that SDDRF members should be judges that are highly qualified in insolvency and debt restructuring rather than academics or practitioners. These creditors feel that only trained judges would have the expertise to deal with the complex disputes that would inevitably arise. However, they are also concerned that the pool of such judges that may be willing and able to serve is probably quite small. Thus, they have expressed support for opening up the positions to retired or other former insolvency judges.
The amendment to the Articles would also need to establish the procedures and standards for dismissal in case of improper behavior by an SDDRF member impaneled for a particular case. One option could be that SDDRF members would be subject to dismissal only upon the unanimous decision of all other SDDRF members.
This is a common procedure in other international organizations (See ICJ Statute, Art. 21(1); WTO Appellate Body Working Procedures, Article 5(1)).
The rules of procedure would address issues such as communications with the SDDRF; filing, registration, notifications, administration of voting; dispute resolution, including on evidentiary standards, written and oral proceedings, verification of claims, integrity of the voting process, and creditor classification; the SDDRF’s powers of interpretation (its own decisions, the SDRM Amendment, including the SDDRF’s jurisdictional powers), procedural rule-making, and the appeals process; conflicts of laws and recognition of rulings of other courts; the internal workings of the SDDRF, including its relationship with its secretariat, internal discipline, impaneling, and conflicts of interest.
The grant of such rule-making authority is common in the dispute resolution fora of other international organizations. The International Court of Justice, for example, has been granted the authority to establish its rules of procedure and rules for its internal workings. Article 30(1) of the ICJ Statute provides: “The Court shall frame rules for carrying out its functions. In particular, it shall lay down rules of procedure.” In the Fund, members of the Administrative Tribunal, by majority vote, establish the rules of procedure for the Tribunal (Statute of the Administrative Tribunal, Article X.2). For certain other fora, the grant of rule-making authority is more limited. The WTO Appellate Body, for example, has authority to establish its rules of procedure, but only if this is done in consultation with the Chairman of the Dispute Settlement Body (a body composed of member states of the WTO that oversees the WTO’s dispute settlement system) and the Director-General of the WTO Secretariat (See Article 17(9) of the WTO Understanding).
Other members not impaneled would continue to work in their other capacities. As described above in the section on Appointments to the SDDRF, creditors and debtors would not be able to choose members for a panel.
Similar systems are common in a number of civil law countries in Europe (The Netherlands, France, for example). The appellate process would not preclude the SDDRF from establishing rules for the review by a supervisory judge of his or her decisions before the appeals process is engaged.
In most dispute resolution fora in international organizations, there is no recourse to an appeals process. Prominent exceptions include the WTO Appellate Body and the European Court of Justice (consisting of the Court of Justice and the Court of First instance). The Court of First Instance has jurisdiction to hear and determine at first instance certain classes of action subject to an appeal to the Court of Justice on points of law (TEEC, Art. 225.1).
The Fund has two recent precedents for establishing the secretariat/staffing of an independent organ of the Fund. The secretariat of the Fund’s Administrative Tribunal performs similar functions to those envisaged for the secretariat of the SDDRF (Rules of Procedure, Rule IV). The administrative arrangements necessary for the Administrative Tribunal, including designation of personnel, are made by the Managing Director of the Fund, although the personnel assigned to the Tribunal are independent from the Fund and work under the authority of the President of the Tribunal (Statute of Administrative Tribunal, Article IX and Commentary to Report of the Executive Board to the Board of Governors on the Establishment of an Administrative Tribunal for the IMF.) In contrast, the Director of the Independent Evaluation Office (IEO) is solely responsible for the selection of IEO personnel (including external consultants) on terms and conditions set by the Executive Board with a view to ensuring that IEO is staffed with independent and highly qualified personnel. When the office is fully staffed, a majority of its personnel will come from outside the IMF. In addition, IEO staff report exclusively to the Director of IEO, not to IMF management. (See Terms of Reference of IEO).
The ICJ chooses its Registrar and Deputy Registrar (ICJ Rules of Court, Articles 22 and 23). Staff of the registry are appointed by the Court on the proposal of the Registrar. Certain staff appointments may require the approval of the President of the ICJ (ICJ Rules of Court, Article 25). The Registrar and Deputy Registrar can be dismissed only by Court (ICJ Rules of Court, Article 29).
The administrative expenses of international dispute resolution bodies are typically borne by the international organization under whose auspices they are established. However, parties to a dispute bear their own costs. Expenses of the ICJ are borne by the UN “in such a manner as shall be decided by the General Assembly.” (Article 33 of ICJ Statute.) WTO panelists expenses and the expenses of the Appellate Body are met from the WTO budget (WTO Understanding, Articles 8(11) and 17(8)), in accordance with criteria adopted by the General Council of the WTO, on the recommendation of the committee on budget, finance and administration. In contrast, the NAFTA Commission decides on the level of remuneration and expenses to be paid to Chapter 20 panelists and others, but the actual payments are made by the parties to the dispute (Chapter 20, Article 2002.2 b) ii and Annex 2002.2(1) and (2)). ICSID operations are financed from the charges for use of its facilities and other receipts. Any shortfalls are paid for by the contracting states. (ICSID Convention, Article 17).
Under the normal budgetary procedures of the Fund, the expenses of the Fund’s Administrative Tribunal are borne by the Fund (Statute of Administrative Tribunal, Article IX.3). The parties, with certain exceptions (Statute of Administrative Tribunal, Article XIV.4 and XV.1), are responsible for their own expenses.
The Director of IEO, in consultation with Executive Directors, prepares a budget proposal for IEO for consideration and approval by the Executive Board. Its preparation is independent of the budgetary process over which management and the Office of Budget and Planning have authority, but its implementation is subject to the Fund’s budgeting and expenditure control procedures. IEO’s budget is appended to that of the Executive Board within the Fund’s Administrative Budget (IEO Terms of Reference).
Members of the Fund’s Administrative Tribunal are considered as “officers of the Fund” for purposes of the immunities and privileges in Article IX, Section 8 of the Articles of Agreement (Statute, Article VIII). Article 19 of the ICJ Statute provides diplomatic privileges and immunities to members of the Administrative Tribunal of the ICJ. ICSID property, assets, officers, employees, and panelists have similar immunities and privileges to those in the Fund’s Article IX (ICSID Convention, Articles 19-23). ICSID Convention, Article 22 extends immunities, in the course of travel to and from proceedings and during stay at proceedings, to parties, agents, counsel, advocates, witnesses and experts.
The administrative process of sending notices, processing filings, record-keeping, vote-tallying, etc., could be quite considerable, depending on the number of claims and creditors. The SDDRF would need a registry capable of performing such functions. The registry would be part of the secretariat discussed above.
With respect to the statute of limitations, which may be seen by some as a substantive matter and by others as a procedural matter, it would be useful to clarify that the lex contractus will apply, in order to avoid having to adopt special rules for the SDDRF. This approach seems consistent with the evolution of international rules on conflicts of laws and has been accepted also in countries that previously applied the lex fori in such cases. For instance, Article 10 of the Rome Convention on the Choice of Law for Contracts, provides that the law applicable to a contract “shall govern … prescription and limitation of actions.” Article 10 of the Rome Convention has been given effect in the United Kingdom by the Contracts (Applicable Law) Act of 1990.
Example: Creditor asserts a claim of 100, but SDDRF finds claims is only 50. Later, restructuring plan discounts all claims by 50%, so creditor’s claim is now only 25. Certification would encompass both the value of the claim as 25 and the previous ruling on the value of the creditor’s original claim.
Decisions of dispute resolution bodies in other international organizations are not subject to challenge in domestic courts or any other fora. Article 53(1) of the ICSID Convention, for example, provides: “The award … shall not be subject to any appeal or to any other remedy except those provided for in this Convention.” Article 23(1) and (2)(a) of the WTO Understanding establishes that WTO members shall not resolve disputes under the WTO agreements other than “through recourse to dispute settlement in accordance with the rules and procedures of this Understanding.” Article 60 of the ICJ Statute states: “The judgment is final and without appeal.”
Additionally, Article 54(1) of the ICSID Convention is explicit in establishing arbitral awards under the auspices of ICSID as equivalent to the decisions of a domestic court and, thus, directly binding, with no need for any further procedure to make the decision binding: “Each Contracting State shall recognize an award rendered pursuant to this Convention as binding and enforce the pecuniary obligations imposed by that award within its territories as if it were a final judgment of a court in that State.”
Article 54 (2) of the ICSID Convention provides: “A party seeking recognition or enforcement in the territories of a Contracting State shall furnish to a competent court or other authority which such State shall have designated for this purpose a copy of the award certified by the Secretary-General. Each Contracting State shall notify the Secretary-General of the designation of the competent court or other authority for this purpose and of any subsequent change in such designation.”
Article 15 of the UN Charter requires the ICJ to submit annual and special reports to the General Assembly. The Registrar is required to notify all members of the UN and others entitled to appear before the court of cases filed (ICJ Statute, Article 40). Hearings “shall be in public” unless the Court decides otherwise, or the parties demand so (ICJ Statute, Article 46). Judgments shall be read in open court, stating reasons on which they are based and names of the judges partaking in decision (ICJ statute, Articles 56 and 58). Of course, deliberations of the court take place in, and remain, secret, unless the court agrees to waive secrecy (ICJ Rules of Court, Article 21(1)).
See Dames & Moore vs. Regan, 453 U.S. 654 (1981).