Author: Mark Weidemaier

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

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    Mark Weidemaier

    Mark Weidemaier and Mitu Gulati

    In 2016, the Maduro government bought some time through a debt exchange in which holders of maturing bonds issued by state oil company PDVSA swapped them for new bonds due in 2020. The new bonds were collateralized by a 50.1% interest in the U.S. parent company of Citgo. Now that the U.S. no longer recognizes the Maduro administration, the new Venezuelan government sued in the Southern District of New York asking to invalidate the bonds and the collateral pledge. It points to Venezuelan law requiring legislative approval for contracts in the “national public interest,” which didn’t happen here. For background, see our posts from last October, here and here.

    The initial briefs have been filed, and not surprisingly the parties disagree about the relevance of Venezuelan law. The PDVSA 2020 bonds are governed by New York law. Venezuela argues that this does not matter, that Venezuelan law determines whether the bonds are valid. The indenture trustee argues that Venezuelan law is irrelevant, that New York law is all that matters, and that under New York law the bonds are enforceable. We’ve seen similar disputes a lot of late, including in connection with debt issued by Ukraine, Mozambique, and Puerto Rico. A government issues foreign-law debt that it later claims was unlawful under its own law. What law governs the dispute?

    We have been mulling this question for some time now. At first, we thought it was straightforward, and we suspect many market participants feel the same way. But it is more complicated than a simple foreign versus domestic binary. The end result is this paper, Unlawfully-Issued Sovereign Debt.

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  • Selling CITGO–Timing and Process

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    Mark Weidemaier

    Yesterday was the deadline for opening briefs regarding the writ of attachment and potential execution sale of PDVSA’s shares in PDVH, the parent company of US oil refiner CITGO. As expected, Venezuela has asked the court to set aside the writ of attachment. Other briefs argue about what an execution sale should look like, if a sale goes forward. An execution sale is typically an informal, auction-on-the-courthouse-steps kind of thing. That’s not the usual way to sell a multi-billion dollar oil company.

    Here’s a very quick summary of the filings, with links to the briefs. And here’s a bit more background, focusing on the timing and process of any execution sale.

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

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    Mark Weidemaier

    By Mitu Gulati and Mark Weidemaier

    In 2014, after much fanfare, a shiny new set of collective action clauses was released by ICMA (the International Capital Markets Association), with the endorsement of the IMF, the US Treasury, and others. The inspiration for these clauses? The fact that Argentina, after its 2001 default, got taken to the cleaners by hedge funds who found ways to exploit ambiguities (pari passu) and oddities (FRANs) in the terms of its debt contracts. The new ICMA CACs were supposed to protect against the risk of holdouts (by letting a super-majority of bondholders quash minority holdouts) while constraining opportunistic behavior by sovereigns (by limiting the sovereign’s ability to coerce creditors into supporting a restructuring). But for all of the good intentions behind these 2014 ICMA CACs, they are long, complicated, and leave gaps for clever parties to exploit. And Argentina’s 2020 restructuring proposal may just illustrate the problem.

    Many creditors are irate about Argentina’s exchange offer, so much so that some of them say they no longer want the 2014 ICMA CACs. We have been struggling to understand why the offer got them so upset. Fortunately, Anna Szymanski of Reuters Breaking Views put out a piece titled “Argentina Gets Cheeky With its Creditors” earlier today that makes the basics of the drama clear (here). Cribbing from Anna’s research, here is how we understand what is going on and why creditors are irate.

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  • How Are So Many EM Sovereigns Issuing New Debt?

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    Mark Weidemaier

    Mitu Gulati and Mark Weidemaier

    We have been working on building a dataset of sovereign bonds and their contract terms. Given the economic fallout of the Covid-19 pandemic–close to 100 countries have approached the IMF for assistance–we would not have been surprised if few low- to mid-income countries had issued sovereign bonds in recent months. Instead, there have been large issuances by Guatemala, Paraguay, Peru, Chile, Philippines, Hungary, Mexico and others. 

    Take Mexico, one of the biggest players in the sovereign debt market. The country has been badly hit not only by Covid-19 but by brutal drops in oil prices, tourism, and remittances. These developments surely increased the need to borrow in dollar/euro bond markets, but we would have expected investors to balk, or at least to demand punitive coupons. But that doesn’t seem to have happened.

    What explains investors’ continued willingness to lend? Might they have drunk the bleach-flavored Kool-Aid and decided that there will be no deep and sustained economic downturn? Possible, we suppose, but unlikely. More plausible explanations include (i) that financial markets are so awash with QE money that investors have few places to go for yield and (ii) that investors may be betting that countries will be bailed out by an official sector desperate to prevent widespread defaults on sovereign debt.

    But, because we are interested in the terms of sovereign bonds, we also wondered if investors were demanding extra contractual protections against the risk of non-payment. That would be a sensible precaution given the likelihood that many countries will be unable to make payments. Indeed, colleagues working on M&A contracts have documented a trend towards including risk-shifting clauses that explicitly address pandemic-related events (for a recent paper by Jennejohn, Talley & Nyarko, see here). With superb research assistance from Amanda Dixon, Hadar Tanne, and Madison Whalen, we wondered whether we would find a similar trend in the sovereign bond markets.

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

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    Mark Weidemaier

    Mark Weidemaier & Mitu Gulati

    The sovereign debt world has been debating how to design an emergency debt standstill for the poorest nations, so that they can devote scarce resources to public health rather than debt service. As we’ve discussed on this blog, the question has come up as to whether countries might be able to use the customary international law doctrine of necessity to defend against creditor lawsuits.

    Our discussion hasn’t focused on any particular jurisdiction, although we have implicitly assumed that much of the litigation would take place in New York. Now, let us switch gears to assume (plausibly, we think) that Italy is one of the countries that might need a debt standstill. It has been among the worst hit by COVID-19 and will likely soon have a debt/GDP ratio upwards of 150%. To quote a scary new report out from Schroders (here): “Italy is the prime candidate for being the first [Eurozone] casualty [from the Covid-19 crisis]. Its high indebtedness and lack of economic growth require policies that are either illegal in the eurozone, or politically unpalatable domestically.” 

    Our work on the mechanics of an Italian debt restructuring—see here (Mark) and here (Theresa Arnold, Ugo Panizza, and Mitu)—has not discussed necessity or other defenses to enforcement. That’s because most of Italy’s debt is subject to Italian law, and our focus was on how Italy might change this law to enable a restructuring. But let us say that Italy does not take this approach. Perhaps it continues to pretend that a debt restructuring is simply inconceivable. It does not lay any legal groundwork for a restructuring. Instead, Italian politicians simply pray for some magical combination of high growth (unprecedented) and a no-strings-attached bailout package from European authorities. In that event, it is conceivable that a sudden spike in interest rates might prevent Italy from making payments. Assuming no immediate European bailout (Italy’s politicians have demonstrated a distaste for any of the conditionality that would come with ESM funding), that means some risk of having to defend the non-payment against creditor lawsuits.

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

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    Mark Weidemaier

    Mitu and I posted some preliminary thoughts about the defense of necessity, which might be raised as a basis for allowing sovereign borrowers to defer debt service during the crisis. I wanted to follow up on some of the open issues. A few are technical, addressing some potential objections to the defense. I’ll deal with these first and close with a more fundamental question: What good does this potential defense really do for a sovereign? In thinking through that question, my premise is that many sovereigns will need a temporary standstill on debt service during the crisis. For proposals to this effect, see here, here, and here. (Others will eventually need a debt restructuring, but that’s a topic for another day.) But of course private creditors must agree to a standstill on payments. Those who don’t might sue or file arbitration claims, which will potentially put the sovereign's assets at risk and will certainly consume time and resources to defend. [Last sentence edited for clarity.]

    Some background

    Necessity is a rule of customary international law. As expressed in Article 25 of the International Law Commission’s draft Articles on Responsibility of States for Internationally Wrongful Acts, a state can invoke necessity to excuse its non-performance of an “international obligation” if non-performance is the only way to address “a grave and imminent peril,” as long as non-performance does not seriously impair an essential interest of the “State or States towards which the obligation exists.” Even if these conditions are satisfied, the state cannot invoke necessity to excuse the violation of an international obligation that “excludes the possibility of invoking necessity.” (Put differently, the doctrine purports to treat necessity as a default rule.) Nor can a state invoke the defense if it has contributed to the state of necessity. Finally, even if the defense is available, non-performance is excused only while the threat persists. The state must resume performance when the crisis ends, and it may have to pay compensation for any loss caused by its non-compliance.

    It may not be obvious, but this is a remarkably crabbed conception of “necessity.”

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  • Necessity in the Time of COVID-19

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    Mark Weidemaier

    Mark Weidemaier and Mitu Gulati

    COVID-19 has wrought an unprecedented economic crisis, which will most severely impact the poorest countries. Anna has written insightfully (here and here) about the G-20’s agreement to a temporary debt standstill for a subset of poor countries. And there have been numerous proposals (e.g., here and here) for a broader standstill to allow all countries the ability to devote necessary financial resources to the crisis. The basic idea behind these proposals is that countries should have the option to defer debt payments to both official and private creditors during the time of the crisis. A limitation of these proposals is that their efficacy depends on high levels of voluntary participation by private creditors. What is to stop less public-spirited creditors from insisting on full payment, even filing lawsuits or arbitration claims to enforce their debts? One answer to this question is that borrower governments could invoke the defense of necessity—long recognized as a rule of customary international law—as a defense to such lawsuits. We want to address that defense here briefly, recognizing that the topic deserves a lengthier treatment than we can give it here.

    To clarify, here is how we understand the necessity defense: If successfully invoked, a sovereign could defer payment of any principal and interest that came due during the crisis, although it would have to make the payments once the crisis ended. It might also (although this is less clear) have to pay some compensation, likely in the form of interest on the delayed payments. But any compensation would reflect a below-market interest rate. In this sense, investors would suffer a real loss. They would be subsidizing the crisis response, although this does not make them unique. So is every other person with a claim on the sovereign’s resources, including the citizens and residents for whose welfare the state is responsible.

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  • Lebanon’s Vexing Modification Clause

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    Mark Weidemaier

    Mark Weidemaier and Mitu Gulati

    We posted earlier about Lebanon’s befuddling fiscal agency agreement. Understanding what exactly the modification provision in this contract means to say is key because Lebanon is in the process of trying to restructure its obligations to bondholders. 

    To recap, the chief oddity is that the agreement seems to have only one voting threshold for modifying the bonds (75%).  That makes it relatively easy for dissident investors to block a restructuring. A typical sovereign bond has two voting thresholds, a higher one for payment-related and other “core” terms and a lower one for non-core terms (usually 50%, but sometimes 66.67%). If Lebanon’s bonds lack a lower voting threshold for non-core terms, this would negate the government’s most feasible restructuring strategy, which would involve the use of exit consents to discourage holdouts.  Now, in theory, it is possible that Lebanon and its creditors consciously negotiated a special type of sovereign debt contract totally precluding the use of exit consents. But if that were the case, we’d think that everyone involved (creditors, debtors, rating agencies and so on) would have been aware and this matter would have been prominently flagged on the front pages of the offering document.  Best we can tell, none of that happened.

    So, assuming there is no evidence that this was a specially designed anti-exit consent vehicle, the next question to ask is what arguments can be made for enabling the use of the technique. We see two arguments—closely related but distinct—for allowing the government to modify non-core terms at a voting threshold lower than 75%. Apologies; this will be a bit technical.

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  • Subordinating Holdouts in a Lebanese Restructuring

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    Mark Weidemaier

    Mark Weidemaier & Mitu Gulati

    Our prior post expressed frustration with the drafting of Lebanon’s fiscal agency agreement, and particularly the collective action clause. The CAC both lacks the aggregation features that are now standard in the market and potentially blocks the use of exit consents. Creditors with a 25% stake in a Lebanese bond issuance would therefore have the whip hand in restructuring negotiations. We noted that this was not the necessary reading of the FAA, but it was certainly plausible given the contract’s idiosyncratic drafting.

    But there are other unusual attributes of the FAA that work in the government’s favor, including one that seems to give the government power to subordinate holdout creditors to restructuring participants and other favored creditors.

    The oddity appears in the pari passu clause in the Lebanese FAA. This is the same clause, of course, that gave Argentina so much trouble between 2012-2016. Oversimplified, the clause is a relatively ambiguous promise that creditors will be treated equally with other similarly-situated creditors. In Argentina’s case, federal courts in New York interpreted the clause to prohibit the government from legally subordinating one set of bondholders (holdouts) to another (restructuring participants). Argentina violated that prohibition by, among other things, enacting a law in 2005 that forbade the government to pay or negotiate with holdouts. Six years later, the courts ruled that Argentina had violated the clause and issued an injunction that forbade the country to service its restructured debt unless it also paid holdouts in full. (More details here and here.)

    Lebanon’s pari passu clause is pretty much the polar opposite of Argentina’s.

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  • Making (Non)Sense of The Lebanese Fiscal Agency Agreement

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    Mark Weidemaier

    Mark Weidemaier & Mitu Gulati

    After trying but failing to locate the fiscal agency agreements underlying Lebanese bond issues, we finally managed to get our hands on this one. We had hoped that the FAA would clarify the respective legal positions of the Lebanese government and its investors. Nope. Our review of the FAA leaves us scratching our heads. The original contract dates from 1999—this is the 3d amended version from 2010—and was one of the first post-Brady-era bonds issued under New York law to include a collective action clause. We were eager to see it and had even heard it had been carefully designed to minimize the risk of holdouts in the event of a restructuring. Certainly the government has reason to fear holdouts, such as London-based hedge fund Ashmore.

    This may be the weirdest CAC ever. Taken as a whole, the FAA also includes just about the weakest set of anti-holdout tools we have seen. The Lebanese government may have to get creative to restructure.

    Let’s start with the CAC. For background, Ashmore is rumored to hold over 25% in aggregate principal amount of multiple Lebanese bond issues (here). That’s enough to block a restructuring vote in most first-generation CACs (i.e., those that first took hold in the NY market around 2003). Lebanon’s CACs are even older; it adopted them at a time when CACs virtually never appeared in NY-law bonds.

    For reasons not obvious to us, Lebanon’s lawyers were New York specialists but operated out of London. For reasons that are also not entirely clear, they designated New York law to govern but then bolted on modification provisions (the CAC) derived from the template then in use in the English law market. The end result is confounding.

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