Bingham Institute 2013
Global Debt Restructuring: Not What It Used To Be
October 15, 2013
Timothy B. DeSieno [email protected] +1 212 705 7426
Table of Contents
AGENDA ...... Tab 1
BIO: KEYNOTE SPEAKER, ROBERT KAHN ...... Tab 2
REFERENCE MATERIALS OFFICIAL INTERVENTION ...... Tab 3 Necessity Trumps Law: Lessons from Emerging Markets for Stressed Developed Markets? Panel Bios: Tim DeSieno, Moderator, Bingham McCutchen Jacob Steinfeld, JP Morgan Chase Christian Halasz, Bingham McCutchen Roman Popadiuk, Bingham Consulting
SPOTLIGHT: US MUNICIPAL BANKRUPTCY ...... Tab 4 Pension Obligations in Chapter 9 What is Next for the City of Detroit? Report on the Municipal Securities Market, U.S. Securities and Exchange Commission Panel Bios: Chris Cox, Moderator, Bingham Consulting Bill Lockyer, California State Treasurer Hal Horwich, Bingham McCutchen Ed Smith, Bingham McCutchen Soren Reynertson, GLC Governor Pete Wilson, Bingham Consulting
CORPORATE DEBT RESTRUCTURING ...... Tab 5 A Practical Guide to Japanese Insolvency Procedures Overview of People’s Republic of China Reorganization Proceedings European Restructurings and Insolvencies UK (England & Wales) Chapter - PLC Cross Border Restructuring and Insolvency Handbook Update on German Insolvency Law and German Bond Act Panel Bios: Mark Deveno, Moderator, Bingham McCutchen Yuki Sakai, Bingham McCutchen Naomi Moore, Bingham McCutchen James Roome, Bingham McCutchen
Table of Contents (cont’d)
SOVEREIGN DEBT RESTRUCTURING ...... Tab 6 The Role of Markets in Sovereign Debt Crisis Detection, Prevention and Resolution When Bad Things Happen to Good Sovereign Debt Contracts: The Case of Ecuador Sovereign Debt and Debt Restructuring - Behind the 2012 Greek default and Restructuring From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Panel Bios: Tim DeSieno, Moderator, Bingham McCutchen Hung Tran, Institute of International Finance Arturo Porzecanski, American University Bruce Wolfson, Bingham McCutchen
BINGHAM INSTITUTE GLOBAL DEBT RESTRUCTURING: NOT WHAT IT USED TO BE October 15, 2013
AGENDA
1. Registration & Lunch (11:45 ‐ 12:45)
2. Welcome and Introduction (12:30 ‐ 12:45) Tim DeSieno, Bingham McCutchen
3. Keynote Address (12:45 ‐ 1:15) Robert Kahn, Senior Fellow for International Economics, Council on Foreign Relations
4. Official Intervention (1:15 ‐ 2:15) Moderator: Tim DeSieno, Bingham McCutchen
‐‐LatAm policy: Brazil electricity, Venezuelan nationalizations, Vitro law reform Jacob Steinfeld, JP Morgan Chase ‐‐European banking: UK, Germany, and recent history Tim DeSieno and Christian Halasz, Bingham McCutchen ‐‐Ukraine: different approach, risks/benefits for investors Roman Popadiuk, Bingham Consulting
5. Spotlight: US Municipal Bankruptcy (2:15 ‐ 3:45) Moderator: Chris Cox, Bingham Consulting
‐‐California: perspective from the Treasurer’s Office Bill Lockyer, California State Treasurer ‐‐Detroit: ongoing developments and significance for investors Hal Horwich and Ed Smith, Bingham McCutchen ‐‐Jefferson County: proceedings, settlement, implications Soren Reynertson, GLC ‐‐States’ views: objectives, tools, practicalities Gov. Pete Wilson, Bingham Consulting
6. Coffee Break (3:45 ‐ 4:00)
7. Corporate Debt Restructuring (4:00 ‐ 5:00) Moderator: Mark Deveno, Bingham McCutchen
‐‐Japan: restructuring/insolvency hot topics Yuki Sakai, Bingham McCutchen ‐‐China: RTOs and solar industry Naomi Moore, Bingham McCutchen ‐‐Europe: exit consents, consent fees, cross‐border issues James Roome, Bingham McCutchen
8. Sovereign Debt Restructuring (5:00 ‐ 6:00) Moderator: Tim DeSieno, Bingham McCutchen
‐‐IIF Principles: recent deployment and next steps Hung Tran, Institute of International Finance ‐‐Greece: “voluntary” deal and market perception Tim DeSieno, Bingham McCutchen Arturo Porzecanski, American University ‐‐Argentina: equal treatment ruling and implications Bruce Wolfson, Bingham McCutchen Arturo Porzecanski, American University
9. Concluding Remarks (6:00 ‐ 6:15) Tim DeSieno, Bingham McCutchen Jay Zimmerman, Chairman & Chief Executive Officer, Bingham McCutchen
10. Cocktail Reception (6:15)
Keynote Speaker:
Robert Kahn Council on Foreign Relations
Robert Kahn is the Steven A. Tananbaum senior fellow for international economics at the Council on Foreign Relations (CFR) in Washington, D.C. Dr. Kahn has held positions in the public and private sectors, with an expertise in macroeconomic policy, finance and crisis resolution. Prior to joining CFR, Dr. Kahn was a senior strategist with Moore Capital Management, where his portfolio spanned G-7 monetary and fiscal policy, regulatory reform, debt policy and debt workouts, and the crisis in Europe. Prior to that, he was a senior adviser in the financial policy department at the World Bank, where he focused on financial sector assessments for developing economies and was the Bank’s liaison to the secretariat of the Financial Stability Forum.
Dr. Kahn also held staff positions at the International Monetary Fund (IMF), where he worked on public policy and the resolution of debt crises in emerging markets. He was a member of the IMF team that worked closely with Korean authorities in 1997-98 to develop a system for comprehensive monitoring and reporting of external debt and reserves, and subsequently was involved in development of the Fund’s policy for private sector involvement in crisis resolution.
Dr. Kahn has held various senior-level positions at Citigroup and was the managing director and head of the sovereign advisory group. He served as the head of the Office of Industrial Nations at the U.S. Treasury from 1995 to1996. He was also a senior economist at the Council of Economic Advisers from 1990 to 1991, as well as the Federal Reserve Board from 1984 to 1990 and 1991 to1992.
Dr. Kahn received his BA from the University of Chicago and his PhD from the Massachusetts Institute of Technology.
Official Intervention
Presented by: Tim DeSieno, Bingham McCutchen (Moderator) Jacob Steinfeld, JP Morgan Chase Christian Halász, Bingham McCutchen Roman Popadiuk, Bingham Consulting INSOL International
Necessity Trumps Law: Lessons from Emerging Markets for Stressed Developed Markets?
January 2013
Technical Series Issue No. 25 INSOL International Technical Series Issue No 25
Necessity Trumps Law: Lessons from Emerging Markets for Stressed Developed Markets?
Contents i
Acknowledgement ii
Introduction 1
Crises in the 1990s and early 2000s: Governments’ Behavior and Global Responses 1
A. The East Asian Financial Crisis 1
B. The Argentine Case 4
C. Best Practices 5
Global Financial Crisis of 2008: Governments’ Behavior and Investor Responses 5
A. Ireland 6
B. Greece 7
C. Spain 9
D. Iceland 10
Patterns, Lessons, and Next Steps 11
Annex A 12
Annex B 20
INSOL International 6-7 Queen Street, London, EC4N 1SP Tel: +44 (0) 20 7248 3333 Fax: +44 (0) 20 7248 3384
Copyright © No part of this document may be reproduced or transmitted in any form or by any means without the prior permission of INSOL International. The publishers and authors accept no responsibility for any loss occasioned to any person acting or refraining from acting as a result of any view expressed herein.
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Acknowledgement
INSOL is delighted to present the 25th Technical Paper under our Technical Paper Series titled “Necessity Trumps Law: Lessons from Emerging Markets for Stressed Developed Markets? written by Tim DeSieno and Katherine Dobson of Bingham McCutchen LLP, USA.
In this paper the authors examine the financial crisis experienced by the East Asian countries in the 1990s and also the sovereign debt crisis faced by Argentina in early 2000s and how the respective governments responded. On a more global scale - leading International Organisations responded to these crises by developing best practices for debt restructuring which were widely adopted by many countries and these are highlighted in this paper.
Several years later the world saw another financial crisis in 2008 and the paper covers the struggles in Europe among over-leveraged sovereign debtors and the cases of Ireland, Greece, Spain and Iceland are discussed. In the concluding part, the authors look at the short and long term policy ramifications including lessons from solutions previously deployed in stressed emerging markets.
INSOL would like to sincerely thank Tim DeSieno and Katherine Dobson for taking the time to write this excellent paper.
January 2013
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Necessity Trumps Law: Lessons from Emerging Markets for Stressed Developed Markets?
By Timothy B. DeSieno and Katherine Dobson* Bingham McCutchen LLP
Introduction1
Since the Asian currency crisis of 1997-1998 and the Argentina crisis of 2001-2002, global institutions have been very focused on international best practices in debt restructuring exercises. For example, the International Monetary Fund (IMF),2 the World Bank,3 United Nations Commission on International Trade Law (UNCITRAL),4 INSOL International (INSOL),5 and the Institute of International Finance (IIF)6 each have published principles and guidelines that policy makers and professionals alike agree should be adhered to in times of financial stress, for companies, countries, and financial institutions. These principles include transparency, creditor engagement, and fairness of treatment among creditors. Notwithstanding the “Western” or “OECD”7 roots of these best practices, which were launched in earnest in response to the behavior of a number of stressed emerging markets, the period of global financial stress that started in 2008 has engendered a curious trend. Since 2008, “developed” markets –– in the United States and Western Europe –– have resorted to debt restructuring techniques that suffer from some of the same alleged infirmities that were the subject of much criticism in the East Asian and Latin American financial crises. During the 2008 financial crises, where “developed” governments intervened intending to resolve problems, they often did so without providing transparency, meaningful communication, or fairness among creditors. Arguably, these actions have lacked a thorough respect even for the rule of law, and creditors’ rights have been impaired ex post facto, through official behavior that many investors see as purely expropriatory.
In this paper, we examine some significant cases from the emerging markets precedents and standards, as well as some of the key official sector and other recommendations. We then examine what has happened in the current global financial crisis, and what responsive and preventative actions governments have taken. In that context, we consider how investors have been reflecting and reacting. We conclude with some thinking about what we have learned, including about official and investor behavior in the wake of a crisis, and about what systems and steps may be worth consideration in light of the candid learning.
Crises in the 1990s and Early 2000s: Governments’ Behavior and Global Responses
A. The East Asian Financial Crisis
The history of sovereign financial crises is a very long one indeed.8 It is easy to think of each financial crisis, or each period affected by crises, as unprecedented. But students of the subject do well to remind themselves that lessons from each previous crisis are useful in following crises. That statement is not meant to diminish the distinguishing features of each crisis –– each one occurs in a given place and against the background of a particular cultural history –– and it is important to understand these dynamics when seeking to understand, to navigate, or to manage a crisis. We aim here to reflect on recent financial crises in the spirit of both of these lines of thought.
The views expressed in this article are the views of the authors and not of INSOL International, London. * The authors are in the Financial Restructuring Group of Bingham McCutchen LLP. They gratefully acknowledge the organizational and “sounding board” support of Spencer H. Wan, Columbia Law School, J.D. expected 2013. 1 Please note that facts are current through November 2012, though developments in Europe continue. 2 Orderly & Effective Insolvency Procedures (International Monetary Fund Legal Department, Washington, D.C.), 1999. 3 The World Bank Principles for Effective Insolvency and Creditor Rights Systems (The Worldbank, Washington, D.C.), December 21, 2005. 4 UNCITRAL Model Law on Cross-Border Insolvency with Guide to Enactment (UNCITRAL), 1997. 5 Statement of Principles for a Global Approach to Multi-Creditor Workouts (London: INSOL International), 2000 (hereafter, “INSOL 2000 Principles”). 6 Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets (Institute of International Finance, Washington, D.C.), October 10, 2010. 7 Organisation for the Economic Co-operation and Development. 8 Carmen Reinhart & Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009).
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We begin with the Asian currency crisis of 1997–1999. This crisis started with a significant depreciation of the currencies in Thailand, Indonesia, and South Korea. Up to the time of the crisis, these countries had been seen as among the “Asian Tigers,” who were testing the previously accepted wisdom that Western-style democracy and capitalism provide the best way to advance the interests of any nation’s populations. These Tigers had been deploying their own forms of democracy that many saw as a variant of oligarchy or even benign dictatorship, and their own form of capitalism that many saw as much more state-influenced and/or relationship-based than the U.S. or U.K. “ideals” of democracy and rule of law, that emphasize the free, private markets and de- regulation. Many an expert and many a journalist were then writing about how the Asian model might have been showing the world a new way to prosperity.
When currencies crashed throughout Asia, investors were unsure what was happening or how to perceive it. Many observers speedily reached the conclusion that the Asian model was not so powerful after all, as it had been unable to prevent the crisis. Indeed, as the crisis unfolded, and regional companies and financial institutions became stressed, it became apparent that the region’s legal systems were not capable of fostering efficient restructurings –– financial or operational. These shortcomings added to the region’s stresses.
Although the restructuring mechanics for companies had previously fallen outside of the focus of the IMF, when it was called on for financial and technical assistance, in the case of Indonesia and Thailand, the IMF quickly observed their importance to the recovery of sovereigns and their currencies. The basic idea, mostly unappreciated before that time, was that sovereigns are heavily dependent on the smooth and efficient operation of the financial institutions in their territory (this much was not new), but also that the health of these financial institutions is fundamentally dependent on the health of their assets –– the loans to companies in the so-called “real sector.” If financial institutions’ portfolios become full of non-performing assets quickly in the wake of a currency or other financial crisis, then the banks’ liquidity, their ability to lend to healthy businesses, and their ability to remain adequately capitalized and remain current on their tax obligations can each be profoundly threatened. The result can be additional and material stress on the sovereign itself, as the sovereign seeks resources to replace the lost tax revenue and resources to recapitalize the distressed banks.9 Regardless of whether the Asian “model” had been better or not in good economic times, officials seemed to agree that, in order to be prepared for bad economic times, it is important for all countries to pay close attention to the connections among the sovereign’s health and the health of its financial sector and its companies.
With this realization, the IMF began to include corporate debt restructuring in its policy recommendations to countries that sought IMF financial support. For example, in the policy conditionality for Indonesia, the IMF required that the country implement a focused corporate debt restructuring regime as a means to address the perceived linkages. The out-of-court debt restructuring program that the Indonesian Government and the IMF designed in 1998/1999 was called the “Jakarta Initiative”, and it was based loosely on the principles that are known as the London Approach. The London Approach involves an out-of-court debt restructuring exercise that includes creditor organization, debtor information sharing, a basic standstill, and a transparent negotiation of restructured debt terms based on a respect for contracts and a common perception of sustainable debt levels.
The London Approach has been documented –– effectively –– by INSOL International.10 INSOL’s Global Principles for Cross-border Debt Restructuring (the “INSOL Principles”) embody the core features that have gained the widest acceptance as “best practice” in this field. These features include creditor organization and standstill; debtor information sharing and independent creditors’ verification; good faith discussion designed to lead to an agreed restructuring that is sustainable and that respects stakeholders’ legal rights; and debtor responsibility for the costs of the exercise.
9 We credit our former partner, Richard Gitlin, with having planted the seed with the IMF, initially in the business class lounge of the Grand Hyatt Hotel in Jakarta, Indonesia. 10 See INSOL 2000 Principles, supra note 5. These principles were designed by a global team, but the product has clear roots in the London Approach, as it was outlined in Pen Kent’s seminal paper on the subject. Kent, Pen, The London Approach (Journal of International Banking Law 8:81-84, 1993).
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The IMF viewed these rules as demonstrably helpful in maximizing efficiency and fairness, though earlier they had not been included in the Indonesian approach to debt restructuring. So the Jakarta Initiative was born to add these features to Indonesia’s approach to debt restructuring with the full imprimatur of the Government. The Jakarta Initiative appeared to be reasonably well-received, and it appeared to help a number of companies restructure a significant amount of debt. While debt restructuring in Indonesia today remains a far cry from the London Approach, there is little doubt the Jakarta Initiative introduced the basic principles, structures, and ideas into the debt restructuring culture, and it has been possible to observe some progress since 1998.
In addition to the Jakarta Initiative, the Indonesian Government and the IMF also decided to revamp the Indonesian insolvency law. At the time, these officials felt the law was overly focused on liquidating financially stressed companies, and that it did not contain adequate tools for rehabilitating companies that would enable these companies to continue and to preserve asset value and employment. For example, the law did not include practical or useful means for organizing the creditors, providing creditors financial and commercial information, negotiating restructured debt terms, or obtaining creditor voting/approval. Certainly, the law contained nothing speedy in this regard –– no practically useful pre-packaged plan possibility. So the authorities introduced a new law to enhance utility in these areas.
The law included many features that the authorities found to be important in the laws of the U.S. and other countries. Such features included clear case commencement standards, a moratorium during a reorganization effort, specified deadlines, debtor-in-possession financing, specified creditor treatment and voting rules, and even a pre-packaged plan mechanic.
As resolution of the regional crisis continued, rescue packages and other governmental programs began to include similar items. Specifically, out-of-court debt restructuring and insolvency law was bolstered in Thailand and South Korea, as part of IMF programs. Malaysia also introduced a specific out-of-court procedure.11 All this work was heavily influenced by the INSOL Principles that INSOL had prepared as a representation of how effective and efficient debt restructuring exercises work in practice.12 Even China –– where debt finance and debt restructuring had long been perceived fundamentally differently from these “best practices” –– has participated in this kind of work. For decades, China had wrestled with a law on bankruptcy of enterprises, though the effort had languished due to the nature of China’s largely state-controlled economy. Stressed enterprises were more a matter of policy than of fixing an enterprise’s finances or operations. But since China started fostering more capitalism, it seemed right that a law addressing financially stressed companies be introduced. In 2006, such a law was finally passed, and it too included many of the “best practices.”13
Over the period 1998 – 2004 and even since, officials at the IMF and the World Bank spent quite a bit of time studying these issues and building expertise. Indeed, this work spawned even broader focus, which led to co-operation with efforts underway at UNCITRAL on establishing a model insolvency law. The IMF prepared a policy paper on the subject of best practices in insolvency laws, and the World Bank did the same.14 A mini-industry developed to study and to build a collection of “best practices,” and even to assess how countries’ systems stacked up against the models. As a result, the fundamentals of these best practices –– in or out of court –– converged quickly, and there has almost always been agreement on what the principles are and why they are useful.
11 The Republic of Korea established the Corporate Debt Restructuring Committee; Malaysia, the Corporate Debt Restructuring Committee; and Thailand, the Corporate Debt Restructuring Advisory Committee. See also Mako, William, Maximising Value of Non-Performing Assets – Facilitating Out-of-Court Workouts in a Crisis: Lessons from East Asia, 1998-2001 (Forum for Asian Insolvency Reform (FAIR), Seoul, Korea, November 10-11, 2003); Peh Lee Kheng, Khoo Kay Ping and Effendy bin Othman, Malaysia (Zaid Ibrahim & Co., 2012); Approaches to Corporate Debt Restructuring in the Wake of Financial Crises (IMF Staff Position Note, January 26, 2010). 12 See INSOL 2000 Principles, supra note 5. 13 The 2006 Law of the People’s Republic of China on Enterprise Bankruptcy Law, adopted at the 23rd meeting of the Standing Committee of the Tenth National People’s Congress on 27 August 2006, and promulgated on that date, and effective as of 1 June 2007 (reprinted by the China Legal Publishing House) (“2006 PRC Enterprise Bankruptcy Law”). A translation by the Bankruptcy Law and Restructuring Research Center of China University of Politics and Law under the supervision of Professor Li Shuguang may also be found at (2008) 17(1) International Insolvency Review 33. 14 The World Bank Principles for Effective Insolvency and Creditor Rights Systems (The Worldbank, Washington, D.C.), December 21, 2005; Orderly & Effective Insolvency Procedures (International Monetary Fund Legal Department, Washington, D.C.), 1999.
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B. The Argentine Case
Only shortly after this policy work in East Asia, similar topics became relevant in connection with sovereign debt itself –– in the case of Argentina, for example. Argentina experienced a financial crisis at roughly the same time as the East Asian crisis. It was soon apparent that Argentina would struggle to meets its obligations to external creditors, as would its banks. Notwithstanding some early efforts, rather than seek to resolve these issues consensually with the creditors, Argentina resorted to unilateral solutions, some of which the investment universe saw as aggressive and unfair. One example was the law that converted obligations of Argentine banks that had previously been denominated in U.S. dollars into Argentine pesos.15
In addition, as its crisis unfolded, Argentina notoriously took an aggressive approach with the holders of its external sovereign debt. Rather than engage its external creditors in a good faith dialog, Argentina designed and launched an exchange offer for its external bond debt. This offer asked creditors to take new debt instruments that included a material reduction in the face amount of their claim amounts and that included a GDP warrant that enabled further payments to creditors in the event the Argentine economy performed better than expected. The market’s consensus of the Argentine package of exchange securities is viewed as imposing a Net Present Value (“NPV”) reduction on the holders of the bonds of approximately 75%.
Rather than design its proposed terms after a good faith negotiation with a representative creditors’ committee and based on an agreed vision of debt sustainability and fairness of treatment, Argentina effectively made its offer unilaterally in 2005. In order to coerce bondholders into agreeing to this haircut, Argentina made clear statements that it had no intention of paying anything to bondholders who did not agree to the exchange.16 In order to make this commitment concrete, Argentina also passed a law (called the “lock law”) that made it illegal for Argentina to settle with the holdouts.17 Argentina took all these steps notwithstanding numerous efforts to organize the bondholders into a committee and numerous offers of good faith dialog.
Due to the strong-arm tactics Argentina openly deployed, these steps have been subject to much investor criticism, even though they led to a reasonably high degree of bondholder acceptance. Indeed, the Argentine case sparked adjustment of the IMF policy on lending to countries that are in arrears with their creditors. The IMF’s 2002 policy recited that Argentina was a relevant case study, and the paper went on to outline the means for countries to engage their bondholders, especially in the wake of a default. The paper outlines details of information sharing and creditors’ committee discussions.18
In addition to the IMF’s policy on lending into arrears, Argentina’s behavior played no small role in the IIF decision to build a set of principles for fair debt restructuring, which was initially targeted on the external sovereign debt of emerging markets countries,19 but which the IIF has later extended to include all countries and all obligations in which the sovereign plays a major role in influencing the restructuring (e.g., in the case of systemically important banks). In the wake of the Argentine exchange, the IIF designed its principles to include requirements of (a) transparency and information flow to creditors, (b) debtor-creditor dialog, in order to seek to avoid restructuring, (c) good faith processes in any restructuring (e.g., respect for contracts and coordination with creditor organization), and (d) fair treatment among creditors –– avoiding unfair discrimination.
15 Law No. 25.466, Sep. 25, 2001, B.O. 29739 (Arg.). 16 The Republic of Argentina, Prospectus Supplement to Prospectus Dated Dec. 27, 2004 (Jan. 10, 2005); H.R. Res. 586, 112th Cong. (2012); The Republic of Argentina, Prospectus Supplement to Prospectus Dated Apr. 27, 2010. 17 Law No. 26,017, June 2005, A.L.J.A. 436. In 2010, Argentina effectively reopened the exchange, and it had to suspend the lock law in order to do so. See also Hornbeck, J.F., Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts” (Congressional Research Service Report For Congress, July 2, 2010). 18 Fund Policy on Lending into Arrears to Private Creditors – Further Consideration of the Good Faith Criterion (International Monetary Fund), July 30, 2002, available at http://www.imf.org/external/pubs/ft/privcred/073002.pdf; IMF Policy on Lending into Arrears to Private Creditors (International Monetary Fund, Washington, D.C.), June 14, 1999, available at http://www.imf.org/external/pubs/ft/privcred/lending.pdf. 19 Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets (Institute of International Finance, Washington, D.C.), October 10, 2010.
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C. Best Practices
The result of all of the professional activity of the 1990s and the 2000s was the formation of a fairly widely adopted set of best practices for debt restructurings. Concepts of transparency, creditor engagement, information sharing, respect for contracts, and nondiscrimination among creditors were widely agreed to be best-suited to maximizing (a) the efficiency of the debt restructuring process and (b) the value of the enterprise for the benefit of all stakeholders. It seems fair to assert that these practices enjoyed approbation from restructuring professionals, from multilateral bodies such as the IMF and the World Bank, and from governments who had been involved in their design or who had received technical assistance in their implementation. These principles, while born in part of the U.S. bankruptcy code and the London Approach to out-of-court restructurings, had specifically been applied and extended to sovereigns who were wrestling with financial crises in their country or region. Between 2002 and 2007, it likely would have been difficult to find a globally credible professional organization advocating a materially different approach to debt restructuring.
Against this backdrop, global developments in debt restructuring practice since 2008 have been somewhat surprising, especially in their deviation from the widely accepted principles. We describe some of these developments below, and we then turn to an assessment of possible motivations and improvements.
Global Financial Crisis of 2008: Governments’ Behavior and Investor Responses
From 2002 onwards, many commentators predicted that leverage (debt levels) throughout the world were becoming increasingly unsustainable and that the resulting credit bubble would burst sooner or later. For years, these predictions seemed to be wrong, as credit expanded ever more. Finally in 2007, some signs of stress in the credit markets started to appear, with erosion of confidence in what was known as the “sub-prime lending” market. This market consisted of lenders with exposure, most often “structured” exposure, to individual borrowers who had been granted credit –– on their credit cards or in the form of (second) mortgages or other lines of credit –– without a demonstrably sufficient cash flow to service all of the debt. During the time when sub-prime lending grew the fastest, U.S. housing prices were climbing steadily, and there was a perception that home equity would be sufficient in most cases to secure repayment of the debts. So credit grew and grew. But in 2007, investors’ perceptions changed, and this sub-prime market began to tighten dramatically.
While the market’s concerns were initially isolated on sub-prime lending, it did not take long before questions arose around the structured nature of the investments, and questions then began to spread to other kinds of structured investments. Structured Investment Vehicles (“SIVs”) of all kinds came under stress, as investors began to scratch below the surface of many of the complex investment products they had been sold. These included a wide variety of instruments, including CDSs, TRSs, CDOs, synthetic CDOs, etc. As confidence continued to drain from the investment marketplace, institutional exposure to these vehicles came into question, as did institutional capability to meet all related obligations in connection with these vehicles, especially since there was no clarity on the extent to which any institution was exposed.
Among the growing lack of confidence, large U.S. banks came under stress, as the inter-bank lending markets dried up. The U.S. Government organized rescues for a number of these banks. But in the case of Lehman, there was no rescue, and Lehman was forced to resort to chapter 11 bankruptcy protection. This development fatally deflated confidence around the world. If such a venerable U.S. financial institution was in such trouble, which institutions could investors rely on as being healthy? Global credit markets froze, as did much of the world’s commercial activity that was materially dependent on credit. Below we describe the impact of these developments in a few places that have produced some of the most surprising results, in light of the previous work on global best practices in debt restructuring.20
20 These introductory paragraphs are a truncated (a kind of layperson’s) explanation of a series of developments that we contend remains beyond the capability of anybody to explain fully. Time will likely teach us more, and of course there will be multiple legitimate perspectives. But these paragraphs help set the stage for the rest of the theme of this paper.
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A. Ireland
Perhaps the most interesting impact on Ireland of the global crisis is its effect on the large Irish banks and the related Irish policy response. As in many other places, at the start of the global financial crisis, Irish banks were immediately hit by the global illiquidity. The banks encountered operational difficulties as well as related threats to their capital adequacy. The Irish Government observed these weaknesses and designed a program in 2008 that was intended to re-instill confidence in the Irish banks. Specifically, the Government passed a law that provided a state guarantee in respect of the banks’ obligations (not just deposits, but funded debt obligations as well). In addition, the Government recapitalized the Irish banks by injecting liquidity in exchange for equity instruments in the banks.21 These steps were designed to overshoot the perceived need, and thereby comfortably to assure investors that the banks were safe again.
For a time, these steps seemed to have their intended effects. The banks did not fall precipitously further or suffer massive depositor flight or need to be wound up. On the other hand, neither did the Irish banks fly and return to robust health. As time dragged on, investors realized that the Government’s programs had not fixed a central issue in each of these banks: heavy over-exposure to the Irish property market, which, much like the U.S., had seen a significant bubble effect in the years leading to 2008. As the Irish property bubble deflated, market confidence in the Irish banks again waned. By 2010, it was clear that the Irish needed to take further action.
As things then stood, the Irish Government was heavily exposed to the banks. The State owned junior securities in the banks, and the State was on the hook for a wide variety of bank liabilities. The position was politically awkward: the Government had sought to rescue the banks with bold action in 2008, only to see the solution prove to be inadequate, such that further resources were needed. It was going to be difficult for the Irish “to pour good taxpayer money after bad,” so the authorities began to reflect on where else the needed resources could be found.
At the time, Ireland turned to the so-called “Troika” of the IMF, the European Commission (“EC”), and the European Central Bank (“ECB”) for a rescue package. Among the programs that Ireland launched in connection with that process was a means for addressing the illiquidity and undercapitalization of the banks. Among the tools that Ireland decided to implement was a new law focused on the banks’ subordinated liabilities, and it created an unusual tool: it bestowed upon the Irish Minister for Finance (the “Minister”) the power to sign a subordinated liabilities order (“SLO”) for a given bank. An SLO could do a wide variety of things, all of which were targeted at diminishing (or even eliminating) a bank’s subordinated liabilities as part of recapitalizing the bank, if the Minister concluded that doing so was needed in the interests of Ireland, such as to avert systemic crisis.22
The SLO mechanic was the clearest form of “bailing-in” the banks’ subordinated creditors, as opposed to bailing them out, consistent with evolving IMF policy. Notably, however, the exercise of the SLO power did not require (a) any good-faith negotiation with creditors or (b) the impairment of interests in the bank that are junior to the subordinated liabilities in question. Instead, such junior securities –– such as the preference shares that the Irish Government owned in the banks from the 2008 re-capitalization exercises –– could remain outstanding. Many commentators concluded that the SLO power was therefore a fairly direct violation of the usual rule of priority that pertains under most laws: debt is senior to equity. Further, the SLO did not require good faith (or any) engagement with creditors, whether through information sharing or commercial dialog/negotiation.
The Minister actually deployed the SLO in the case of Allied Irish Banks. But the more important use of the SLO was as a kind of threat, providing the backdrop to liability management exercises that the major banks implemented, offering to purchase their subordinated liabilities at material discounts to par (between 20 and 30 cents on the Euro). Knowing the Minister might deploy an
21 Credit Institutions (Financial Support) Act 2008 (Act No. 18/2008 (Ir.), available at http://www.irishstatutebook.ie/2008/en/act/pub/0018/index.html. 22 Credit Institutions (Stabilisation) Act 2010 (Act No. 36/2010) (the “Stabilisation Act”), available at http://www.irishstatutebook.ie/2010/en/act/pub/0036/index.html. Under the Stabilisation Act, the Minister has the power, after consulting with the Governor to make several important orders, including an SLO. The Minister may issue an SLO with regard to an institution that has received financial support from the State if the Minister deems such SLO necessary for preserving or restoring the financial position of the institution. The SLO may include modifying rights to interest and the repayment of principal, events of default, timing of obligations or may facilitate a debt for equity swap. See New Banking Stabilisation Act, McCann FitzGerald (December 2010).
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SLO, many holders felt compelled to agree to the discounted pricing. Many investors were openly disturbed that Ireland would pursue this path, and perhaps even more disturbed that the path seemed to have the full blessing of the Troika. According to these investors, the Irish approach was demonstrably inconsistent with the principle of creditor engagement as well as the principle that requires a respect for contract and similar treatment for similarly situated creditors. Indeed, in connection with the EC’s consultation on the subject of unifying European law on bank restructuring and resolution,23 one group of investors submitted a comment focusing on the Irish case and the pitfalls Europe should avoid.24
B. Greece
The global financial crisis’ impact on Greece came in a somewhat different form. The sovereign itself was perceptibly overindebted, and global investors became concerned about the State’s ability to continue to finance itself. There have been revenue issues in Greece, with apparent widespread tax evasion, and the resulting cash flow did not appear to be sufficient to repay significant liability maturities between 2012 and 2016. Greece seemingly needed debt relief, and it too ultimately approached the Troika for assistance. Initially, the policy position of the Troika members was that Greece’s debt was sustainable, and that no restructuring would be needed. As time marched on, however, the Troika came to admit that a restructuring would be necessary, although initially only with minor NPV impairment for the creditors. In time, the Troika admitted that Greece’s finances were worse and worse, and in the end the NPV “haircut” suffered by Greek creditors was on the order of 75%, akin to what Argentina had imposed.
From an early stage of the discussions, the preference of the Troika and the Greek authorities was to bail in the private sector creditors as well. One early concern with such a bail-in, though, was the possibility that, if it was handled the wrong way, it could lead to contagion –– possibly even mass debt defaults across the financially stressed countries in so-called “peripheral Europe.”25 One of the biggest stated concerns was that the Credit Default Swap (“CDS”) market would become a major transmission vehicle for financial stress. The concern was that so many European banks had sold so much CDS protection that large-scale financial sector stress would result from a Greek default, after which CDS protection sellers might be unable to make good on their protection promises.
So an early idea was that Greece should restructure its external debt on a purely voluntary basis, through a process where creditors volunteered additional credit or concessions, as a means of preventing CDS from triggering.26 The idea was to follow in the pathway of the “Vienna Initiative” wherein European lenders had voluntarily agreed to continue credit lines to borrowers in Central Europe so as prevent significant defaults and afford the borrowers time to address their policy and restructuring needs.27 This suggestion, however, entailed two rather material issues: (a) the Greek external debt was largely in the form of notes and bonds as opposed to the form of readily extendible bank loans and (b) much of the bond debt was held by the European Central Bank (“ECB”) in connection with its Securities Market Program (“SMP”), in an effort to prevent spikes in
23 Technical Details of a Possible EU Framework for Bank Recovery and Resolution (DG Internal Market and Services, 2011), available at http://ec.europa.eu/internal_market/consultations/docs/2011/crisis_management/consultation_paper_en.pdf, which outlines an agenda in the EU for bank recoveries and resolution, including a legislative proposal for a harmonized EU regime for crisis prevention and bank recovery and resolution, aims of resolving and liquidating harmonized bank insolvency regimes under the same substantive and procedural rules, and creation of an integrated resolution regime. 24 Memorandum from Tim DeSieno, partner at Bingham McCutchen, to the European Commission, DG Internal Market and Services on Technical Details of a Possible EU Framework for Bank Recovery and Resolution (March 3, 2011) (attached as Annex A). 25 Specifically, Portugal, Italy, Ireland, Greece, and Spain (i.e., P.I.I.G.S). See Allen, Franklin, Caletti, Elena and Corsetti, Giancarlo, Politics, Economics and Global Governance: The European Dimensions (PEGGED) Contract No. 217559 (FIC Press, Wharton Financial Institutions Center, 2011). 26 CDS triggers for sovereigns typically occur in the case of (1) a failure by the sovereign state to pay any relevant debt, (2) a moratorium or repudiation declared by the sovereign state with regards to any relevant debt, (3) a restructuring of any relevant debt, or (4) in the case of emerging market sovereigns, an obligation acceleration, where one or more obligations of the reference entity become due and payable before they would otherwise have become due and payable as a result of the occurrence of a default, event of default, or other similar condition or event other than a failure to make any required payment. See International Swaps and Derivatives Association, Inc., 2003 ISDA Credit Derivatives Definitions (May 2003), as supplemented by the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement to the 2003 ISDA Credit Derivatives Definitions (July 2009). 27 The “Vienna Initiative” was launched at the height of the first wave of the global financial crisis in January 2009 by creating a working group on nonperforming loans in Central, Eastern and South-Eastern Europe (CESEE), established under the European Bank Coordination Initiative (EBCI). The group was jointly chaired by Sophie Sirtaine (World Bank) and Christoph Rosenberg (IMF). More information is available at www.vienna- initiative.org.
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the pricing of the sovereign debt of “peripheral” European countries.28 The ECB holdings meant that creditor concessions would lead to the need for the members of the Eurosystem to recapitalize the ECB, which would have been the opposite of the “bail-in” objective.
So the Greek authorities considered what steps they might take to navigate these facts. Fortunately for Greece, leading legal advisor to sovereign borrowers Lee Buchheit of Cleary Gottlieb had earlier posited a key possibility for Greece. Mr. Buchheit identified that the vast majority of Greek sovereign debt had been issued under Greek law, and only a small percentage had been issued under the law of other countries (of that percentage, most was under English law). As a consequence, it was open to Greece to amend its law so as to make adjustments to its external sovereign debt obligations. Though one could imagine numerous kinds of law reform that could reduce Greece’s debt burden –– especially in light of the Irish SLO law, for example –– Mr. Buchheit suggested Greece deploy a more limited reform. Specifically, Mr. Buchheit suggested that Greece pass a law that made collective action mechanics applicable to the Greek law debt. These mechanics would enable holders of a specified majority of the Greek law notes to bind a dissenting (or nonvoting) minority of such holders to any given restructuring.
Here, Mr. Buchheit was drawing on years of policy work that had demonstrated the benefit to debt issuers of collective action mechanics.29 The authors would argue that Mt. Buchheit was also keenly aware of the holdership of the Greek law bonds, much of which was in the hands of European banks, making them susceptible to suggestions and guidance from their national regulators. And indeed, Mr. Buchheit’s foresight was keen. But the way the Greek restructuring story played out was both interesting and thought-provoking.
By the time the Troika started to acknowledge that a Greek restructuring was going to be necessary, the IIF’s principles were at the center of focus among European lenders, in no small part in connection with the Icelandic bank restructuring discussions.30 The principles require information sharing and good faith creditor engagement, and when Greece decided to commence work on a restructuring proposal, the holders of the Greek debt began to request that these principles govern any discussions. The major creditors enlisted the assistance of the IIF in the formation of a creditors’ committee and a proposed forum for the Private-Sector Involvement (“PSI”) exchange/discussion with the Greek authorities and the other official sector bodies. From external appearances, this effort bore fruit. The IIF became a kind of secretariat for the creditors’ committee, and the authorities dealt with the creditors in the common IIF forum. It appeared as if information was exchanged, and terms were negotiated over a period of months. These steps and appearances were well-received among investors; there was an appearance of progress and respect for the principles at a certain level.
On the other hand, reports from committee members indicate there was much room for improvement. Two major dynamics detracted from investors’ favorable perception of the Greek PSI committee process. First, many were concerned that the leading members of the committee’s steering group were themselves European banks. In a vacuum, that would have been acceptable, but in the event, these banks’ national regulators were keen to resolve the Greek crisis in the manner that the Troika felt was necessary. There was at least the perceived possibility that the steering group –– the leading creditor spokespersons –– were susceptible to influence from “the other side of the table.” Second, even if the first concern may have been unfounded, all reports indicate that the exchange with the Greek authorities and the Troika was more one-directional than in the nature of a give-and-take dialog. Of course, the steering group made a significant impact on the outcome in creditors’ interests. But the prevalent view was that positions and limits were
28 The SMP was a monetary policy tool allowing the ECB to purchase distressed government bonds of the European periphery (Portugal, Italy, Ireland, Greece, and Spain). On August 2, 2012, the Governing Counsel of the ECB announced that it would replace the SMP and undertake Outright Monetary Transactions (“OMT”) in secondary, sovereign bond markets, aimed “at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy.” On September 6, 2012, the SMP was terminated. See Technical Features of Outright Monetary Transactions (ECB Press Release, September 6, 2012). 29 See International Monetary Fund, A New Approach to Sovereign Debt Restructuring (April, 2002) (in which the IMF discusses its rejection of the corporate restructuring model for use in a sovereign restructuring, and the adoption of the view that collective action clauses should be included in sovereign debt obligations); see also European Commission, European Financial Stability and Integration Report 2011 (April, 2012) (stating that collective action clauses should be included in all EU sovereign debt obligations from June 2013 onward). 30 See infra Part D.
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effectively dictated by the official sector, especially as debt sustainability analysis allegedly worsened and proposed PSI haircuts steepened.
Perhaps the culmination of these dynamics was the outright carve-out from the PSI treatment of the notes held by the ECB, which were exactly the same as the notes held by private sector participants. Even though the ECB-held notes enjoyed exactly the same legal rights and priority as all other similar notes, the terms of the PSI expressly excluded the ECB-held notes from the proposed haircut that was offered to private note holders. This aspect of the Greek PSI was quite similar in spirit to the effects of the Irish SLO, which had elevated the Irish State’s bank preference share holdings over the subordinated debt holdings of private creditors.
In these respects, many investors consider that the Greek process also deviated markedly from the principles requiring creditor engagement and similar treatment for creditors with similar legal rights.
C. Spain
Investors have been watching the rest of peripheral Europe carefully, wondering what lessons governments may have learned from the Irish and Greek cases and what similar steps countries may take that are at odds with global best practices. At the time of this writing, Spain’s efforts are new, but investors can already observe the contagious deviation from the principles. Many have hoped that Spain would escape the crisis without the need for extraordinary action or bailout. Indeed, until quite recently, Spain’s national level debt was seen as relatively low and Banco de España was widely praised as being a more realistic regulator than many others in Europe.31 But as the crisis has continued to unfold, and it has become clearer how over exposed the Spanish financial institutions are to the Spanish property bubble, the Spanish banks and “cajas” have come under scrutiny and increasing stress. The Government has enacted new laws designed to aid in the consolidation and revitalization of these institutions.32
While many of these laws were in process, a number of investors were assessing what Spain could do as well as what Spain might do, and what it might be unable to do. A common investor comment during the early stages of 2012 was that the subordinated debt instruments issued by Spanish banks had been widely sold to Spanish retail investors, as a kind of higher-yielding substitute for simple bank deposits. The conclusion was that it would be difficult for the Spanish authorities to implement an Irish-style SLO since so many Spanish retail investors would suffer impairments to their retirement savings as a result.33 Over time, the Spanish also created a body that was designed to aid in the recapitalization of banks and “cajas,” as needed, known as the FROB34 (Fund for Orderly Bank Restructuring). The FROB had also purchased subordinated debt instruments of several of the Spanish institutions, bolstering investors’ perception of protection.
But these dynamics proved to be false protection. The latest law Spain has enacted35 adds procedures for bank reorganization and resolution, in an effort to harmonize Spanish law with the trends within Europe, including at the EC level. This law rather predictably (in light of the Irish and Greek experiences) provides for “bail-ins” of at least the subordinated debt instruments of the
31 Our experience of the behavior of Spanish financial institutions in the insolvency proceeding of Martinsa Fadesa S.A. caused us to disagree with this latter view starting in 2008. 32 See, e.g., Ley 22/2003, de 9 de julio, Concursal (BOE de 10); Real Decreto Ley 5/2005, de 11 de marzo, de reformas urgentes para el impulso a la productividad y para la mejora de la contratación pública (BOE de 14) Tit. I Cap. II; Ley 6/2005, de 22 de abril, sobre saneamiento y liquidación de las entidades de crédito (BOE de 23); Ley 5/2005, de 22 de abril, de supervisión de los conglomerados financieros y por la que se modifican otras leyes del sector financiero (BOE de 23); Real Decreto 1332/2005, de 11 de noviembre, por el que se desarrolla la Ley 5/2005, de 22 de abril, de supervisión de los conglomerados financieros y por la que se modifican otras leyes del sector financiero (BOE de 23); Ley 36/2007, de 16 de noviembre, por la que se modifica la Ley 13/1985, de 25 de mayo, de coeficientes de inversión, recursos propios y obligaciones de información de los intermediarios financieros y otras normas del sistema financiero (BOE de 17); Real Decreto 216/2008, de 15 de febrero, de recursos propios de las entidades financieras (BOE de 16) (corrección de errores BOE 1 de marzo); Real Decreto-ley 2/2012, de 3 de febrero, de saneamiento del sector financiero (BOE de 4); Real Decreto-ley 10/2012, de 23 de marzo, por el que se modifican determinadas normas financieras en relación con las facultades de las Autoridades Europeas de Supervisión (BOE de 24). 33 Our response to these comments was to predict that Spain would have to consider enacting a combination of the Irish SLO with something like Greece’s ECB exclusion. And that is what Spain has done. See Ashurst Madrid, Law Reform for Bank Restructurings in Spain (Nov. 2012) (discussing price valuation criteria for the execution of SLEs and the case of HSCDs held by Spanish retail investors; mentioning that FROB-owned HCSDs are excluded from SLEs and that FROB can buy retail holders’ positions; description of potential solutions to mitigate losses for retail investors in respect of HSCDs issuances), available at www.ashurst.com/page.aspx?id_content=8549. 34 Id. (describing the Spanish Parliament’s approval of Law 9/2012 and Royal Decree Law 24/2012, setting out a new Spanish regime for restructuring and resolution of credit entities). www.ashurst.com/page.aspx?id_content=8549. 35 Reyal Decreto-Ley 24/2012.
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Spanish institutions. But it also provides mechanics to carve out from “bail-in” instruments held by the Fund for Orderly Bank Restructuring (“FROB”), and it includes regulations to protect retail investors who acquire financial products that are not covered by the depositor protection scheme.36 Like the Irish pathway, the law makes no requirement for good-faith negotiation with creditors.
In these ways, Spain has followed in the pathway Ireland and Greece carved in a rather patent deviation from the principles, including the principle that requires similar treatment for creditors with similar legal rights. By now, this deviation may be achieving greater acceptance than it should, if investors are seriously supportive of the principles.
D. Iceland
Much of the Icelandic chapter of the financial crisis story played out before the other countries’ chapters described above. But because Iceland is such a small country that was so dwarfed by its banking sector,37 it may be difficult to draw many firm lessons from its case. Still, Iceland’s case included some important developments –– happy and otherwise, from the standpoint of the principles –– so it is worth a brief mention.
The Icelandic banks failed quickly in the wake of Lehman’s chapter 11 filings. Within days of the failure, Iceland took the legislative and administrative steps required (a) to split the banks, in each case into (i) a new bank, with continued domestic assets and operations and (ii) an old bank, with foreign assets and obligations and (b) to introduce a priority for depositors over other senior unsecured bank creditors.38 Both of these steps had the effect of removing assets from the legal reach of the banks’ creditors and of subordinating their claims to the protection of depositors of all types. These steps led the banks’ creditors to organize quickly and to pursue engagement with the banks and the Icelandic authorities on the consequences and the best next steps.
Despite firm initial resistance to recognizing and dealing with creditors’ committees, the Icelandic banks rather quickly conceded and agreed to work with the committees. Indeed, from a reasonably early stage (after Iceland’s initial steps described above), a rather familiar and frequent process of information exchange and discussion commenced, at least with respect to the bank splits. As a key example, over the course of the ensuing year and a half, the parties reached agreement on the old banks’ obtaining stakes in the new banks, a mechanic that creditors wanted so as to ensure that creditors benefitted from any future improvement in the fortunes of the new banks. Despite initial resistance from the Icelandic authorities, this structure was ultimately agreed, and on the basis of a good degree of information sharing and creditor discussion. In getting to this result, a number of the creditors had enlisted the support of the IIF in explaining and promoting the principles. Arguably, the outcome is reasonably consistent with the principles that require creditor engagement, respect for contracts, and similar treatment for creditors with similar legal rights.39
Patterns, Lessons, and Next Steps
The astute observer has identified that since 2008 countries in Europe, the cradle of “the rule of law,”40 have appeared to be willing to deviate from what many of Europe’s institutions would have claimed was
36 “The new regulation is based on the public interest in (i) the financial system continuing to work normally regardless of the crisis of a particular bank, (ii) protecting deposit-holders, and (iii) minimizing public financial support: shareholders and creditors have to bear losses (bail-in mechanism) before the tax payers takes the strain (bail-out).” The Spanish Bail-In Tool: Restructuring of Certain Bank Liabilities in Royal Decree-Law (Linklaters, September 12, 2012). 37 It was widely reported that Iceland’s three main banks had assets at the commencement of the crisis that were close to ten times the size of Iceland’s GDP. 38 See, e.g., Act No 125/2008 (the “Emergency Act”), which was brought in almost overnight in October 2008 to safeguard three Icelandic banks; Article 6 of this Act brought in depositor priority. This act also empowered the FME (the Icelandic regulator) to dispose of or transfer assets out of the banks, which was used to create the new banks); Act No 44/2009 (which made some of the temporary powers laid out in the Emergency Act permanent); Act No 98/1991 (the Bankruptcy Act, which was amended by the Emergency Act in relation to depositor priority). 39 The issue of creditor damage as a result of depositor priority has not been resolved. In fact, that issue has been litigated to the Icelandic Supreme Court, which has ruled that the measure was consistent with applicable principles of the Icelandic Constitution. The measure was seen as necessary to the preservation of the Icelandic economy, and notwithstanding vigorous arguments to the contrary, as having been proportionate to the circumstances. 40 The United States could be included as well, especially given many investors’ perceptions of U.S. Government intervention in cases such as Chrysler Motors and AIG. See Andrew P. Atkins, The AIG Bailout: Constraining the Fed’s Discretion, 14 N.C. BANKING INST. 335 (2010); Katalina Bianco, A Retrospective of the Troubled Asset Relief Program, WOLTERS KLUWER LAW & BUS. (Mar. 2011), http://business.cch.com/bankingFinance/focus/News/TARPwhitepaper.pdf.
10 INSOL International Technical Series Issue No 25 the rule of law in connection with stressed credits in Latin America in the 1990s or East Asia around the turn of the century. Agreed procedural norms of creditor engagement have been de-emphasized during the European financial crisis. And respect for the principle of similar treatment for creditors with similar rights has also been disregarded. One might form the view that European nations have been less guided by the rule of law in these circumstances than by political expediency, or more charitably, by the perceived need to go to extremes to preserve national economies. Certainly the ex post law reform and administrative action seems to have been driven more by the limits of what governments can get away with in cases of expropriation than by a grounded support for the international “best practice” principles. For some observers, this outcome may be no surprise. For others, who have been listening to officials’ statements and advice to emerging markets governments over the years, the recent pattern may be somewhat surprising.
As usual representatives of private creditors, the authors contend that policy makers could do more to adhere to the principles, even in times of financial crisis, and, in fact, as a means of restoring confidence in a financial sector sooner than would otherwise result.
Annex A
This is a comment paper that Bingham prepared on behalf of certain clients in response to the EC consultation on bank resolution, in which we outlined the key issues in the Irish case, and we urged that EC law harmonization take heed. This document focuses on both creditor engagement as well as similar treatment for creditors with similar legal rights (ordinary rules of priority).
Annex B
This is a proposed amendment to the IMF’s rules against lending into arrears that Bingham assembled in 2005. This document addresses the proposed consistent use of creditors’ committees in cases of sovereign debt restructurings.
11 Annex A Memorandum
Direct Phone: +1.212.705.7426 Direct Fax: +1.212.508.1458 [email protected]
DATE: 3 March 2011 TO: European Commission, DG Internal Market and Services FROM: Timothy B. DeSieno RE: Working Document - Technical Details of a Possible EU Framework for Bank Recovery and Resolution (the "EC Working Document")
INTRODUCTION
Bingham McCutchen LLP ("Bingham") is legal advisor to an Ad Hoc Group (the "AIB/BKIR Ad Hoc Group") of holders of senior and subordinated debt securities issued by Allied Irish Banks ("MB") and Bank of Ireland ("BKIR"). The AIB/BKIR Ad Hoc Group's members include a wide variety of institutional investors (insurance companies, pension funds, banks, asset managers, etc.) from around the world, and at formation, the holdings of the AIB/BKIR Ad Hoc Group exceeded €1.8 billion in face amount of these debt securities.
The AIB/BKIR Ad Hoc Group formed in response to a series of recent developments in Ireland that has caused them material concern about their investments in AIB and BKIR, as well as about the bank capital/obligation asset class in general, in Ireland and beyond. Central among these concerning developments is Ireland's recent Credit Institutions (Stabilisation) Law 2010 (the "Irish 2010 Law") and as of 28 February, also the Central Bank and Credit Institutions (Resolution) Bill 2011 (the "Irish 2011 Bill"). In the view of the AIB/BKIR Ad Hoc Group's Working Group (the "AIB/BKIR Investor Working Group"), I the Irish 2010 Law contains features that are unprecedented, and these features are enabling or encouraging behavior by Irish banks that is setting harmful precedents. In addition, the Irish 2011 Bill is similarly deficient in significant ways, which will also engender harmful behavior.
So the AIB/BKIR Investor Working Group is encouraged by the work of the DG Internal Market and Services in seeking to advance and to harmonize a sensible European approach to the subject of bank recovery and resolution. And the AIB/BKIR Investor Working Group considers that the ongoing developments and processes in Ireland are worth reporting and discussing in the context of the DG's work, so the Irish case may be factored into the design and implementation of the proposed European framework.
I Bingham submits this paper on behalf of the AIB/BKIR Investor Working Group, and we gratefully acknowledge the assistance of AIB/BKIR Investor Working Group member Abaci Investment Management. In this paper, we address a collection of points included in the EC Working Document that appear to the AIB/BKIR Investor Working Group to be implicated (positively or negatively) by the Irish case. In each instance, we offer a description of the relevant aspect of the Irish case, and we include a brief response to relevant questions that the DG included in the EC Working Document. The AIB/BKIR Investor Working Group would welcome the opportunity to discuss these subjects with the DG and others who are interested.
THE IRISH CASE - SPECIFIC AREAS OF CONCERN
The Commission's Principles. As the DG did in the EC Working Document's General Introduction, we would open our remarks on the subject of the principles that the European Commission addressed in its October 2010 communication. As explained in greater detail below, the AIB/BKIR Investor Working Group contends that the way the Irish authorities have handled the stressed Irish banks so far is enhancing moral hazard and defeating legal certainty:
• As detailed further below, the Irish 2010 Law's provisions do violence to the "normal order of ranking" of who should bear the burden of addressing a stressed Irish bank, potentially causing creditors to bear losses before shareholders do. In practice, this reversal will enhance moral hazard for equity holders.
• As also detailed further below, the Irish 2010 Law was introduced in the wake of the crisis, and it is retroactive in nature. These features, in addition to the significant period of predicted but unspecified law reform leading up to the Irish 2010 Law's passage and the current reports that the law is to change again, have all contributed to investors being greatly uncertain about relevant Irish law.
Creditor Engagement. The AIB/BKIR Investor Working Group contends the value of creditor engagement by stressed debtors is uniformly acknowledged. As has been widely written and advocated by bodies ranging from the International Monetary Fund (in connection with its lending into arrears policy) to the Institute of International Finance (the "HE") to INSOL International ("INSOL"), it is generally preferable for stressed debtors to engage their creditors sensibly in driving toward an effective and sustainable restructuring. While rare exceptions are sometimes proper in cases where an instantaneous result is required (and feasible), in general, when creditors' rights are to be curtailed - at least outside the context of an emergency transfer (though even there, the ensuing valuation and asset management work should include creditor involvement) - creditors are to be consulted pursuant to known rules of engagement.
Examples of statements of these known rules include the IIF's Principles for Stable Capital Flows and Fair Debt Restructuring (a statement of these principles is available as Annex Ito the 11 October 2010 report which is linked from this page: hap ://www f.corniempl) and INSOL's Statement of Principles for a Global Approach to Multi-Creditor Workouts (available here: la itp :/ /www. inso o rg/ad EL end e rs p df). In recent years, and under the leadership of officials from the European Central Bank among other institutions, and under the observation of the International Monetary Fund, the IIF has been expanding a consensus that their Principles should apply in quasi-sovereign or non-sovereign situations in which sovereigns have influence over the restructuring process. The IIF's intention is to include precisely the kind of situation in which Ireland currently finds itself.
Nevertheless, the Irish case has deviated sharply from these widely-acclaimed rules. The AIB/BKIR Ad Hoc Group organized in December 2010 and has sought ever since to engage AIB and BKIR in a sensible process. And although these banks and indeed the Irish authorities have been designing and implementing structures and solutions all the while (i.e., there has been no apparent timing need to implement a debt restructuring instantaneously), there has been practically zero engagement with the AIB/BKIR Ad Hoc Group, or any other similar creditor organization, during this period. Indeed, the AIB/BKIR Investor Working Group has been rebuffed in almost every circumstance. Several meetings have been organized, but the consistent message from the banks and the Irish authorities has been that no creditor engagement is indicated.
It is noteworthy that neither the Irish 2010 Law nor the Irish 2011 Bill would require or encourage any different result. Specifically, while these laws set forth procedures for bridge banks, asset/liability transfers, special management, subordinated liabilities orders, liquidation, and recovery/resolution plans, neither provides for any kind of creditor engagement, much less anything close to the kinds of creditor engagement that internationally-accepted best practices would require. Based on the experience of its members elsewhere in Europe and beyond, the AIB/BKIR Investor Working Group firmly believes that nations who wish to maximize private investor interest and minimize litigation risk, must engage their creditors squarely in connection with, among other things, (a) the valuation of net assets that are transferred from distressed financial institutions, the structure of related compensation, and the management of remaining assets, (b) the rehabilitation work of a special manager, (c) the process of winding-up of a financial institution, and (d) the formulation and implementation of a financial institution's recovery/resolution plan.?
But it seems these forms of creditor engagement are not to be required in Ireland (yet). And as is always the case when creditors are so uniformly resisted, as they have been recently in emerging markets like Argentina and Ecuador, investors' confidence in the country and its financial institutions and markets is seriously eroded. That is just what is happening in the Irish case. Although a core stated policy objective of the Irish authorities is the re-attraction of private capital flows into the Irish banks, investors in the AIB/BKIR Ad Hoc Group uniformly indicate that Ireland's current non-engagement behavior is a material factor in sharply reducing that private investor interest.
The AIB/BKIR Investor Working Group considers creditor engagement is a subject that deserves material attention in any European framework for bank
2 Even in the Icelandic case, notwithstanding media reports about how Iceland has chosen to minimize deference to creditors' rights, these forms of creditor engagement have evolved with a good degree of success. recovery and resolution. We note that Sub partEl of the EC Working Document lists requiring a creditor negotiation plan as one of the powers a supervisor may choose to deploy. But we cannot find a portion of the EC Working Document that makes creditor engagement the rule (with tightly limited exceptions), as it certainly ought to be. Accordingly, the AIB/BKIR Investor Working Group would respond to the DG's Question 24b with a definitive "no". Whether as part of the supervisors' powers, or otherwise, the framework should require creditor engagement along the lines of the IIF and the INSOL principles.
Seniority of Debt over Equity. The seniority of debt over equity is a fundamental aspect of the law and the investment climate in all working markets. The DG acknowledges this reality in Sub-part F4 and in the Annex of the EC Working Document, when it recites that shareholders of a stressed bank are to bear the first losses, and unsecured creditors are to bear only the residual losses after the shareholders' interests have been wiped out.
On the other hand, the Irish 2010 Law deviates sharply from this fundamental rule. Among other possibilities, the Irish 2010 Law includes provisions that enable the Minister for Finance to effectuate practically unlimited impairments to the claims and the fundamental rights of subordinated debt holders (including bald debt write-downs, and apparently regardless of whether the creditors' rights are governed by non-Irish law) without requiring any concessions from shareholders at all, much less requiring that shareholders' interests first be wiped out. In order to accomplish this result, the Minister simply has to request an ex parte hearing before a judge to obtain a so-called Subordinated Liabilities Order, and creditors are given a mere five days within which to object.. See Part 4 of the 2010 Law.
It is the specter of such a Subordinated Liabilities Order that has caused many investors to feel compelled to accept recently-proposed heavily-discounted tenders and exchanges proposed by Irish banks. Even if investors do not feel these banks' proposals are merited or fair under commercial dynamics or otherwise applicable legal rule, the possibility that the Irish authorities may impose even greater pain for investors, and on unpredictable bases, adjusts investors' attitudes. Again, investors' experience informs their judgment when sovereigns behave in this coercive kind of way. And the behavior results in sharply reduced investor confidence.
The AIB/BKIR Investor Working Group considers that the EC Working Document's focus, in Sub part F4 and in the Annex, on respect for the seniority of debt over equity is well placed, and this fundamental rule of investment must remain a predictable, inviolate principle for the European framework. Accordingly, at least with respect to this fundamental principle, the response to the DG's Question 30a is a definitive "yes".
Legal Certainty. Investors rely heavily on confidence that the laws that regulate their investments and the recovery of those investments are known ex ante, and they are not subject to change. Of course, investors accept that they take commercial and credit risk in making investment and investment management choices. But authorities who regulate working markets understand the value, ultimately in terms of reduced risk profile and reduced costs of capital, of preventing a market's legal/regulatory architecture from being uncertain. The DG acknowledges the fundamental importance of this subject (a) in the General Introduction to the EC Working Document, in which it recites legal certainty as a core principle and (b) in the Annex, in which the DG clarifies that any new framework is not going to be applied to debt already in issue.
On the other hand, the Irish 2010 Law had the effect of changing (limiting) fundamentally the legal rights and remedies of creditors of Irish Banks, especially subordinated creditors (as outlined above), and the law was designed specifically to address debt obligations already in issue. In addition to the provisions of the Irish 2010 Law, the sustained messages during the latter stages of 2010 from the Irish authorities about the possibility of law reform, and its potential impairing effect on creditors' rights, was itself perceived as a cudgel, useful to cause concern among investors that their rights were about to be impaired, in some then- unspecified ways. And indeed, the new appearance of the Irish 2011 Bill will add to concern that Irish law on the subject remains unsettled and subject to (perhaps material) further change, Ireland has proven willing to engage in law reform that is causing investors material concern.
The AIB/BKIR Investor Working Group considers that the EC Working Document's focus, in the General Introduction and in the Annex, on the importance of legal certainty and avoiding ex post changes to investors' rights is well placed, and this focus should remain a high priority for the European framework. Accordingly, the response to the DG's Question 62a is that senior debt in existence at the time of introduction of a statutory write-down power should be excluded from such power.
Contintent Convertible Instruments. The AIB/BKIR Investor Working Group is pleased by the DG's focus, in the Annex to the EC Working Document, on contingent convertible instruments as likely a sensible part of the European framework's treatment for subordinated debt. Indeed, the AIB/BKIR Investor Working Group's core objectives have included causing AIB, BKIR, and the Irish authorities to work with the AIB/BKIR Investor Working Group to design this kind of instrument for subordinated debt as part of the remaining recapitalization and restructuring work. To date, the AIB/BKIR Investor Working Group has not yet received indications from any of these parties on their level of interest or willingness to cooperate on this subject.
But the AIB/BKIR Investor Working Group remains committed to working toward outcomes that include contingent convertible instruments in the Irish cases. Reasons for this position include the central appeal to many (long-only) institutional investors of an instrument that would enable them to continue to invest in European banks, that will generate fixed income, and that can participate in recovery/resolution of a stressed bank on a predictable basis, without concern of unpredictable future law reform or undue regulator discretion (the AIB/BKIR Investor Working Group accordingly would most favor instruments with statutory or contractual triggers that are quantifiable and capable of being assessed in advance). As evidence of investor interest in this asset class, the AIB/BKIR Investor Working Group notes the widespread investor interest in Credit Suisse Group's recent issue of contingent convertible notes, which reportedly attracted bids of 11 times the amount on offer. The success of that offering indicates to the AIB/BKIR Investor Working Group that, were Ireland to rectify the areas of concern described in this paper, AIB or BKIR would be very well-positioned to issue similar instruments at acceptable prices as central support for their further recapitalization needs.
The AIB/BKIR Investor Group considers contingent convertible instruments are a critical component of a successful European framework, and the inclusion of these instruments as such in the Annex of the EC Working Document is the right approach for the DG to take. In response to the DG's Questions 63b and 64b, the AIB/BKIR Investor Working Group would respond that there would certainly be a broad-based market interest in this kind of instrument, as evidenced by the preferences of management of the AIB/BKIR Investor Working Group members as well as by the deep market interest in the recent Credit Suisse offering.
CONCLUSION
The AIB/BKIR Investor Working Group considers that the Irish case is worth careful study by the DG and others who are interested in the European framework. In many respects, the Irish case is proceeding in ways that are at odds with the contents of the DG's apparent thinking, and these deviations ought to be studied, so any harmful effects can be assessed and avoided in other countries. The Irish decision not to impair any senior debt seems to be consistent with the thinking in Europe, and the AIB/BKIR Investor Group firmly supports that approach. On the other hand, the AIB/BKIR Investor Working Group contends that Ireland's decision not to engage the banks' creditors is worth studying, including its harmful effects on investors' attitudes. We contend that this is a subject the DG ought to ensure is included in the European framework, and that the Irish case is good evidence as to why. And of course, while Ireland's reputation as an investment target is impacted by each week that passes without rectifying the shortcomings, there is still time for Ireland to correct things, to adjust its policies and behavior, so that its banks will be able to access the private capital markets again sooner and less expensively. Annex B OUTLINE OF PROPOSED AMENDMENT TO IMF POLICY ON SUPPORT FOR GOVERNMENTS RESTRUCTURING SOVEREIGN BOND DEBT
1. General. No government shall be entitled (a) to restructure its sovereign bond debt and (b) to enjoy any new financial support from the IMF, from and after the date (the "Commencement Date") that the IMF first discovers that such government plans or intends to restructure its sovereign bond debt, unless such government shall have fully complied with either the "Committee Guidelines" or the "Publication Guidelines" below. To the extent the IMF's lending into arrears rules are implicated, a government's compliance with these Guidelines shall be deemed to constitute its "good faith effort":
2. Committee Guidelines. Unless the government shall fully comply with the "Publication Guidelines" below:
a. If a single bondholder committee (a "Committee") that includes holders not affiliated with the government of at least [25]% of the government's total external bond debt shall not have formed within [ ] days of the publication of the Commencement Date, the government may proceed to restructure its sovereign bond debt in any legal manner.
b. If a single Committee shall have formed within [ ] days of the publication of the Commencement Date, the government shall engage and finance (as defined below) the Committee. If the Government believes it would be useful, (using form documents to be designed) the government may finance a meeting of bondholders — or a series of them in the case of multiple bond issues — convened for the purpose of authorizing the Committee to act, although in a non-binding fashion, on behalf of all bondholders in the restructuring discussions. Unless a committee's role shall have been expressly rejected at a quorate bondholders meeting, such a committee shall be deemed to be the Committee for purposes of these Guidelines.
c. For purposes of these guidelines, "engage and finance" shall mean:
• execute a letter agreement (the "Committee Letter Agreement") with representatives of the Committee (using a form document to be designed) containing the government's commitment to work with the Committee toward a consensual deal and to reimburse the Committee's reasonable expenses for so long as the government shall be in discussions with the IMF, subject to earlier termination upon completion of the bond-related deal;
• provided the Committee engages legal advisors within [ ] days of its formation, execute a letter agreement with one legal advisory team (using a form document to be designed)
Accordingly, these Guidelines will require augmentation so as to include other relevant aspects of the "good faith effort" as already prescribed by the IMF. containing the government's commitment to pay the reasonable cost of the advisory team's services;
• either publish all documents in accordance with the "Publication Guidelines" below or execute a confidentiality agreement with representatives of the Committee (using a form document to be designed) committing to share confidential information with self-selected "restricted" Committee representatives for a limited period and committing to publish all shared material nonpublic information on an agreed schedule; and
• timely abide its undertakings in each of the foregoing agreements and negotiate in good faith with the Committee toward a consensual deal that (i) is based on the collection of information that the government has shared with its creditors, (ii) respects contractual rights, (iii) includes and is based on an agreed set of governmental policies and policy reforms, (iv) is designed to match the parties' views of the government's debt sustainability, (v) provides comparable treatment to all types and classes of debt claims, and (vi) is solicited and documented in full consultation with the Committee and its advisors.
3. Committee Responsibilities. For so long as the government is in compliance with the Committee Guidelines above, and for as long as the Committee Letter Agreement remains in effect, the Committee shall be obligated to undertake the following actions (which shall be specified in the Committee Letter Agreement):
a. The Committee shall serve as the representative for bondholders in the restructuring discussion process, cooperating with the government and the other creditors in a good faith effort to achieve agreement.
b. The Committee and its members shall refrain from litigation or other collection activity against the government, and consistent with market practice, the Committee shall support the government in opposition to the litigation or collection activity of other bondholders.
c. The Committee shall cooperate with the government in the sharing of confidential information in a manner that assists the Committee in its deliberations, and the Committee shall strictly honor its confidentiality undertakings at all times.
d. Consistent with market practice, the Committee shall assist the government in attempting to build market consensus in support of any proposals that the government and the Committee jointly support.
e. Consistent with market practice, the Committee shall cooperate with the government in each reasonable way so as to maximize the speed of the restructuring process and to minimize its cost. 4. Publication Guidelines. Unless the government shall fully comply with the "Committee Guidelines" above:
a. The government shall provide to the IMF written permission (using a form document to be designed) to publish on the IMF website (i) every document that the government provides to the IMF from and after the Commencement Date through the date of publication of the exchange offer or equivalent, except to the extent that a confidentiality-bound standing committee of investor representatives (the "Standing Committee"), in consultation with the IMF staff, determines that a document is not relevant or material to the consideration of any proposed restructuring terms and (ii) every document delivered to the IMF within the [ ] days prior to the Commencement Date that the Standing Committee, in consultation with the IMF staff, determines is relevant or material to the consideration of any proposed restructuring term.
b. The IMF shall have so published each such document within [ ] days of having received such document (or the written permission to publish, if later). Timothy B. DeSieno Partner
[email protected] T +1.212.705.7426 F +1.212.508.1458 New York
Tim DeSieno represents institutional investors in their global investments as well as in restructurings in cases of financial, political or other difficulty. These restructurings regularly include cross-border workouts and insolvency proceedings in one or more countries.
Tim is currently advising the ad hoc group of holders of notes secured by the OSX3 FPSO as well as the notes issued by a large Brazilian electricity distributor in connection with its Brazilian insolvency proceedings. He is also advising the offshore lenders in connection with the largest corporate insolvency in the history of Spain.
Other ongoing and recent engagements include advising holders of foreign law debt issued by the Hellenic Republic, advising the Icelandic Banks’ note holder committee in connection with debt restructuring and policy work in the wake of the financial crisis and the banks’ nationalization (Tim advised the creditors committee in the case of Straumur’s ground-breaking composition proceedings), and advising holders of bond debt issued by Irish banks in response to the government’s intervention. Tim recently advised the Petrozuata bondholders and the Fertinitro bondholders committees in connection with these Venezuelan projects’ nationalizations and the bondholders’ at-premium cash recoveries. He is currently, similarly advising the Sidetur bondholders.
During recent years, Tim has advised creditors and creditor committees in restructurings and debt recovery efforts in connection with financial institutions in the United Kingdom and corporates in Brazil, China, Indonesia, Malaysia, Mexico, Russia and Thailand.
In sovereign debt matters, Tim is advising the Grenada Sovereign Bondholder Committee, and he advises investors in connection with ongoing developments in Greece and Argentina. He also advised the Dominican Republic bondholders committee in connection with that country’s sovereign bond debt restructuring and has advised creditors of Belize and Ecuador. He has advised several governments and multilateral organizations in the design and implementation of corporate insolvency and rehabilitation systems, including the Government of Kazakhstan most recently. Tim is a member of the Working Group of the Institute of International Finance on the Role of Indenture Trustees in Sovereign Debt Restructuring.
In the U.S., Tim advises derivatives counterparties in connection with the Lehman chapter 11 proceedings, and he served as counsel to the Chapter 11 trustee of Refco Capital Markets in connection with the design and implementation of a settlement of massive intercreditor litigation as well as a Chapter 11 plan of reorganization for all the Refco entities.
Jacob Steinfeld J.P. Morgan
Jacob Steinfeld is the head of the J.P. Morgan Latin America Corporate Research team. His group follows more than 200 companies in Latin America ranging from Investment Grade to deeply distressed. Jacob has participated in many of the recent workouts. He joined J.P. Morgan in August 2008 from Lehman Brothers. Previously, Jacob worked in the Distressed Products Group at Deutsche Bank, specializing in Emerging Markets. Jacob graduated from Emory University with a BA in Economics and Spanish and is a Fulbright and Carnegie Scholar, having spent a year in Mexico City on the Fulbright Binational Business Program and in Washington, D.C. at the Carnegie Endowment for International Peace. He is fluent in Spanish.
Dr. Christian Halász Partner, Bingham McCutchen LLP
[email protected] +49.69.677766.102 | +49.69.677766.100 (FAX) Frankfurt
Dr. Christian Halász focuses his practice on financial restructuring, special situation financing, distressed mergers and acquisitions, and insolvency, and splits his time between the London and Frankfurt offices. He has advised bondholders, hedge funds, institutional lenders and creditor committees on a wide range of complex cross-border restructurings and workouts in Germany, Europe and the U.S. Christian has also represented private equity and hedge funds in relation to the acquisition of different classes of distressed assets and the restructuring of portfolio companies. Christian has authored several publications and is a lecturer at the University of Applied Science Trier, Department Business Law. He is fluent in English, German and Italian.
Christian’s recent matters include advising the ad-hoc committees of bondholders on the financial restructurings of Dannemora Mineral, Deutz, Invitel, Northland Resources, Petroplus, Phoenix Pharmahandel, Sevan Marine, Solarworld and Uralita; representing lenders of Bavaria Yachtbau, BBS, Borussia Dortmund, Klöckner Pentaplast, Schieder Möbel and Zapf; advising the ultimate equity owner of a group of German multifamily real estate companies in connection with the refinancing of term loans, including a new CMBS securitization; advising funds in the acquisition of German law “Schuldscheindarlehen” and “Genussscheine” of Lehman Brothers, the Hellenic Republic, Cyprus and other sovereign lenders; advising numerous financial institutions in relation to claims in the German insolvency proceeding following the collapse of Lehman Brothers; advising the servicer of the Highstreet securitized senior loan facility in connection with the financial restructuring and insolvency proceeding of Karstadt; and advising financial investors in connection with the acquisition of Ecka, ISE/Innomotive, Ploucquet, Rohde and Sioux from the insolvency administrator.
Roman Popadiuk Principal, Bingham Consulting LLC
[email protected] T +1.202.373.6612 F +1.202.373.6001 Washington
Roman Popadiuk is a Principal in Bingham Consulting and a retired member of the career Senior Foreign Service. He served as the first U.S. Ambassador to Ukraine. Roman brings more than 30 years of experience in the areas of national security, political risk analysis, communications strategy and energy policy, including serving in the White House under Presidents Ronald Reagan and George H. W. Bush. He co-authored Privileged and Confidential: The Secret History of the President’s Intelligence Advisory Board. He is a member of the Council on Foreign Relations.
Spotlight: US Municipal Bankruptcy
Presented by: Chris Cox, Bingham Consulting (Moderator) Bill Lockyer, California State Treasurer Hal Horwich, Bingham McCutchen Ed Smith, Bingham McCutchen Soren Reynertson, GLC Gov. Pete Wilson, Bingham Consulting Feature
BY HAROLD S. HORWICH AND CHRISTOPHER L. CARTER Pension Obligations in Chapter 9 he recent financial problems confronted by of a rejection of a contract is that the nondebtor municipalities and counties appear likely party retains all of its rights under nonbankruptcy to lead to a test of pension plans in chapter law arising from the breach, including the right to T 6 9. The Stockton and San Bernardino chapter 9 desist from further performance of the contract. cases will probably encounter the issue first, and Thus, if a municipality rejects a CalPERS agree- will pit bondholders and other creditors against ment, CalPERS will have whatever rights it has the California Pension Employee Retirement under nonbankruptcy law arising on account of the System (CalPERS) and ultimately California breach, including the right, as set forth in the con- municipal retirees. Recent chapter 9 decisions WUDFWWRPRGLI\EHQH¿WVEDFNWRDOHYHOFRQVLVWHQW have shed some light on the likely outcome of with contributions. this battle. This article considers the recent case In addition, upon rejection, the nondebtor will law and its implications for CalPERS, retirees have a claim for breach of contract in the bank- and other pension regimes. ruptcy case. Unless the debtor’s obligations under the contract are secured, the claim for breach will Rights and Obligations of CalPERS usually be treated as an unsecured claim. The ques- tion arises as to whether the rejection claim would in Chapter 9 be entitled to any priority over general unsecured Harold S. Horwich Under Cal. Gov. Code § 20022, municipalities claims. The answer appears to be “no.” Bingham McCutchen may enter into contracts with CalPERS to provide It seems unlikely that a claim under a rejected LLP; Hartford, Conn. UHWLUHPHQWEHQH¿WVWRHPSOR\HHV8QGHUVXFKFRQ- CalPERS contract would be a claim for an admin- tracts, the municipality determines the level of ben- istrative expense, one that arises from activities of H¿WVWKDWLWZLVKHVWRSURYLGHDQG&DO3(56VHWVWKH 1 the debtor after the commencement of the bank- applicable rate of contribution, which is subject to 7 2 ruptcy. It seems unlikely that a court would hold adjustment by CalPERS at any time. In the event that the obligations under the contract arose post- that the municipality fails to pay its obligations petition since the contract was entered into pre- under the contract, CalPERS has the right to termi- bankruptcy.8 In fact, the Bankruptcy Code itself nate the agreement and demand an amount neces- provides that normally a claim for damages aris- VDU\WRIXQGIXWXUHEHQH¿WV,IWKHPXQLFLSDOLW\IDLOV ing out of the rejection of an executory contract is to pay the amount, CalPERS has the right to reduce 3 treated as a claim arising before the commencement Christopher L. Carter EHQH¿WVSD\DEOHXQGHUWKHFRQWUDFW of the bankruptcy case.9 This is consistent with the Bingham McCutchen It appears that the contract between a munici- Stockton case, in which the court found that retiree LLP; Boston pality and CalPERS is an executory contract within KHDOWKEHQH¿WVZHUHSUHSHWLWLRQFODLPV10 the meaning of § 365 of the Bankruptcy Code. An Nor does it appear likely that a successful argu- Harold Horwich is a “executory contract” is one in which each of the ment could be launched on the basis that payments partner at Bingham FRQWUDFWLQJSDUWLHVKDYHREOLJDWLRQVWKDWDUHVXI¿- are required to be made under 28 U.S.C. § 959, McCutchen LLP ciently unperformed such that default by one party which requires debtors in possession (DIPs) and in Hartford, Conn. would excuse the other party from further perfor- trustees to comply with state law on an ongoing Christopher Carter is 4 mance. Failure by an employer to make a required basis. This argument was rejected by the court in an associate in the payment would likely excuse CalPERS from mak- firm’s Boston office. In re City of Stockton with respect to retiree health ing the corresponding payments under the contract. EHQH¿WV11 It was also analyzed and rejected in an The CalPERS legislation differs materially from analogous context in Jefferson County when the the legislation establishing the Pension Benefit court found that 28 U.S.C. § 959 did not apply *XDUDQW\&RUS 3%*& ZKLFKVSHFL¿FDOO\JXDU- EHFDXVHDFKDSWHU ¿OLQJGRHVQRWFUHDWHDQHVWDWH DQWLHVSULYDWHSHQVLRQREOLJDWLRQVXSWR¿[HGOLPLWV that is managed by a trustee or DIP.12 Under PBGC legislation, the PBGC is obligated to Consequently, CalPERS would appear to have pay a guaranteed minimum amount regardless of WKHULJKWWRDGMXVWUHWLUHHEHQH¿WVWRDOHYHOFRP- whether it collects from the employer.5 The result 6 Lubrizol Enters. Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985). 1 Cal. Gov. Code § 20532. 7 11 U.S.C. § 503(b); PBGC v. Sunarhauserman Inc. (In re Sunarhauserman Inc.), 126 F.3d 2 Cal. Gov. Code § 20532. 811, 816 (6th Cir. 1997). 3 Cal. Gov. Code § 20577. 8 See LTV Corp. v. PBGC (In re Chateaugay Corp.), 130 B.R. 690 (S.D.N.Y. 1991); In re 4 Lubrizol Enters. Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043, 1045 (4th Sunarhauserman Inc., 126 F.3d at 816. Cir. 1985). 9 11 U.S.C. § 502(g). 5 See 29 U.S.C. §§ 1301-1461; PBGC v. Skeen (In re Bayly Corp.), 163 F.3d 1205, 1207 10 In re City of Stockton, 478 B.R. 8, 23 (Bank. E.D. Cal. 2012). (10th Cir. 1998). 11 478 B.R. 8. 12 In re Jefferson Cnty., 484 B.R. 427, 461-62 (Bankr. N.D. Ala. 2012).
44 April 2013 ABI Journal mensurate with contributions made by the municipality, and tection for retirees against municipal governments and the retirees would have a claim for the city’s breach of its VWDWHOHJLVODWXUHVDOWHULQJWKHYHVWHGUHWLUHPHQWEHQH¿WV REOLJDWLRQVWRSD\SHQVLRQEHQH¿WV7KLVZRXOGPHDQWKDWWKH without satisfying the protection of contracts clauses, retirees, rather than CalPERS, are the real parties in interest EXWLWLVGLI¿FXOWWRHQYLVLRQWKDWXQGHUWKHORJLFRIWKH and that they should become active in negotiations as sug- Stockton decision (which recognizes that a contracts gested by the court in the Stockton decision.13 clause does not provide protection in bankruptcy) these constitutional provisions would protect a pension obliga- Sovereignty Dimensions tion in bankruptcy. Some states provide additional protection in addition to to Pension Obligations the protection of a contracts clause. Michigan’s constitu- Section 943(b)(4) of the Bankruptcy Code appears to WLRQVWDWHVWKDWDFFUXHGEHQH¿WVRISHQVLRQSODQVDQGUHWLUH- recognize the limitations in the application of bankrupt- ment systems shall not be diminished or impaired and that cy law to municipal entities that is required by the Tenth 14 ³>I@LQDQFLDOEHQH¿WVDULVLQJRQDFFRXQWRIVHUYLFHUHQGHUHG Amendment. The Tenth Amendment recognizes the sover- LQHDFK¿VFDO\HDUVKDOOEHIXQGHGGXULQJWKDW\HDUDQGVXFK eignty of the states, and because municipalities exist under IXQGLQJVKDOOQRWEHXVHGIRU¿QDQFLQJXQIXQGHGDFFUXHG delegations of authority from the states, chapter 9 recogniz- liabilities.”20 Louisiana’s constitution offers contractual es that there are limitations on the power of the bankruptcy SURWHFWLRQVWRDFFUXHGSHQVLRQEHQH¿WVDQGSURYLGHVWKDW FRXUW7KXVDSODQFDQQRWEHFRQ¿UPHGLIWKHUHVXOWZRXOG ³>I@XWXUHEHQH¿WSURYLVLRQVIRUPHPEHUVRIWKHVWDWHDQG be that upon confirmation, the municipality would be in statewide public retirement systems shall only be altered violation of state law. by legislative enactment.”21 It is unclear whether these pro- However, not every violation of state law is beyond visions preclude modification only by state government the power of the bankruptcy laws to discharge. Cases have bodies or whether they would also apply to bankruptcy clearly recognized that bankruptcy law supersedes state laws PRGL¿FDWLRQ,ILWZHUHVLPSO\DIXUWKHUFODUL¿FDWLRQDVWR protecting contract rights, even where the state constitution 15 FRQWUDFWVFODXVHSURWHFWLRQWKHQEDQNUXSWF\PRGL¿FDWLRQ expressly protects contract rights. ZRXOGQRWEHLQFRQÀLFWZLWKWKHSURYLVLRQ,IWKHVHSURYL- There are provisions of state law that a chapter sions were intended to preclude any action that might have 9 debtor could not modify in bankruptcy even if they the indirect effect of modifying a pension obligation, then involve the payment of money. In Jefferson County, they might be a limitation on a municipality’s ability to the court wrestled with the question of whether the city commence a chapter 9 case or a limit on what obligations of Birmingham, Ala., would be granted relief from the FRXOGEHPRGL¿HGLQVXFKDSURFHHGLQJ stay so that it could seek an injunction in state court to 16 Construing the intent of state constitutions presents prevent the closure of a hospital. The court ultimately a serious quandary for a bankruptcy court. Given chap- concluded that the proposed action did not implicate the ter 9’s carve-out of sovereignty matters, in Sanitary and obligation to provide for the care of the city’s indigent Imp. Dist. 65 of Sarpy Cnty., Neb. v. First Nat. Bank of residents as a matter of state law and thus denied relief 22 17 Aurora the bankruptcy court referred to the state court’s from the stay. Clearly, even though satisfaction of this interpretation of state law that was required to resolve a obligation would require the expenditure of funds by the priority dispute among competing creditors. In the case of county, it could not be discharged as part of an adjust- pension obligations, the state court would need to deter- ment plan. There are two features of this obligation that PLQHZKHWKHUWKHIXQGLQJRIDFFUXHGSHQVLRQEHQH¿WVZDV would likely prevent it from being subject to discharge: an ongoing obligation of the municipality that affected (1) the obligation is future-oriented, and (2) it involves health, safety and welfare. A bankruptcy court might issues of health, safety and welfare, which are within the 18 instead decide state law itself, as the Fifth Circuit did in province of government and not the bankruptcy court. Mission Indep. School Dist. v. Texas.23 While a constitu- State laws that create pension obligations do not appear tional provision might give a court more pause to wade to characterize accrued pension obligations as future-oriented into state law issues, bankruptcy courts determine state or as involving issues of health, safety and welfare. Many law issues regularly and are reluctant to permit state laws states merely provide statutes that enable a municipal entity 19 providing preferential treatment to one group of creditors to enter into contracts to establish pensions. 2WKHUVVSHFL¿- to interfere with reorganizations.24 cally address pension obligations in their constitutions. There are several different formulations of this constitutional right. The most prevalent method of constitutional pension Conditioning Chapter 9 Petitions protection is referenced in a state’s constitution as being $VWDWHPD\FRQVLGHUFRQGLWLRQLQJDFKDSWHU ¿OLQJ entitled to the same protection that a contract would have upon a municipality protecting its pension obligations. As under the state constitution. This appears to provide pro- a municipality’s powers and obligations derive from the state, the state has the authority to impose conditions on 13 In re City of Stockton, 478 B.R. at 23. 20 Mich. Const. Article IX, § 24. 14 See 6 Collier on Bankruptcy ¶ 943.03[4] (16th ed. 2012). 21 Louisiana Const. Article X, § 29. 15 In re City of Stockton, 478 B.R. at 16 (“In sum, even if the plaintiffs’ benefits are vested property inter- 22 79 B.R. 877 (D. Neb. 1987). ests, the shield of Contracts Clauses crumbles in the bankruptcy arena.”). 23 116 F.2d 175 (5th Cir. 1940) (state statute was invalid to extent that it would prohibit school district from 16 In re Jefferson Cnty., 484 B.R. 427. using chapter 9 to discharge bonds held by Texas). 17 Id. at 468. 24 Butner v. United States, 440 U.S. 48 (1979). 18 See 11 U.S.C. § 904. 19 See, e.g., Conn. Gen. Stat. § 7-148. continued on page 102
ABI Journal April 2013 45 Pension Obligations in Chapter 9 from page 45
¿OLQJFKDSWHU 6RPHMXULVGLFWLRQVSURKLELWFKDSWHU ¿O- fully argue that the plan could not be carried out without ings, while others provide blanket authority for the munic- favoring the retirees. LSDOLW\ZLWKRXW¿UVWVHHNLQJDSSURYDOIURPWKHJRYHUQRU25 A state could also insist that the municipality grant a $WKLUGJURXSDOORZVWKHVWDWHWRLPSRVHFRQGLWLRQV¿O- security interest in its property in order to secure accrued ing for chapter 9; for example, California now requires a pension obligations (and then wait out the preference period municipality to engage in a neutral-evaluation process for before filing the chapter 9 petition). While this route is a DVSHFL¿HGSHULRGRULWVJRYHUQLQJERDUGPXVWGHFODUHD well-traveled one in chapter 11, it may not be successful in ¿VFDOHPHUJHQF\26 chapter 9. Unlike chapter 11, a municipality must prove that While a state may have the power to impose condi- it engaged in good-faith negotiations with its creditors prior tions on a municipality’s commencement of chapter 9 to entering proceedings.29 Sustaining the burden of proof on proceedings, a bankruptcy court is likely to be unfriend- this issue may be impossible when the municipality has, in ly to conditions that favor one group of creditors over effect, fully paid one group of creditors immediately before another. The Mission Independent School District deci- commencement of negotiations with the other groups, and sion is a good example27 because the state had advocated thereby preordained the outcome of those negotiations. an interpretation of state law that either allowed the dis- trict to enter chapter 9 only if it did not impair bonds Conclusion held by the state or did not allow the district to file chap- It is nearly certain that there will be extended litiga- ter 9 at all. The court found an interpretation of state law WLRQRYHUWKHVWDWXVRISHQVLRQEHQH¿WVLQFKDSWHU SUR- that permitted the district to file chapter 9 and impair the FHHGLQJV7KH¿QDQFLDODQGVRFLDOVWDNHVDUHWRRKLJKWR bonds held by the state. avoid it. The early indications are that pension obligations If a state were to impose a condition that pension obliga- DUHVXEMHFWWRPRGL¿FDWLRQLQFKDSWHU SURFHHGLQJV7KH WLRQVQRWEHLPSDLUHGLQDFKDSWHU FDVHDFRXUWFRXOG¿QG FODLPVRIHQWLWLHVVXFKDV&DO3(56ZKLFKSURYLGH¿QDQFLDO that any plan unfairly discriminates against other unsecured intermediary functions, do not appear to enjoy any special creditors. Unfair discrimination is not present if the treat- status in chapter 9 and their agreements with municipalities ment is reasonable, necessary, proposed in good faith and 28 are executory contracts just like any others. The protec- proportionate to its rationale. ,WZRXOGEHGLI¿FXOWIRUWKH tions provided by state constitutions do not appear to confer KROGHUVRIDFFUXHGSHQVLRQEHQH¿WVWRVDWLVI\WKLVVWDQGDUG any rights beyond ordinary contracts, and contracts clauses $FFUXHGSHQVLRQEHQH¿WVDUHEDVHGRQVHUYLFHVWKDWKDYH almost certainly yield to bankruptcy powers. It is untested already been performed, and the recipients of those ben- whether a state could successfully protect pension obliga- H¿WVZLOOQRWEHZRUNLQJIRUWKHPXQLFLSDOLW\RQDQRQJRLQJ WLRQVE\UHTXLULQJSD\PHQWRIWKHPDVDFRQGLWLRQWR¿OLQJD basis. Thus, it seems unlikely that the debtor could success- FKDSWHU FDVHRUE\SUHIHUULQJWKHPSULRUWR¿OLQJDFKDSWHU
25 See, e.g., Ala. Code § 11-81-3 (blanket authority); but see, e.g., Ga. Code § 36-80-5 (prohibiting chapter 9. It seems likely, however, that bankruptcy courts will be 9 filing). unfriendly to such strategies. abi 26 In re City of Stockton, 475 B.R. 720, 727-29 (Bankr. E.D. Calif. 2012). 27 116 F.2d 175. 28 See In re Graphic Commc’ns Inc., 200 B.R. 143, 148 (Bankr. E.D. Mich. 1996). 29 11 U.S.C. § 109(c)(5)(B).
Copyright 2013 American Bankruptcy Institute. Please contact ABI at (703) 739-0800 for reprint permission.
102 April 2013 ABI Journal State Review Team Finds On February 19, 2013, the six-person Review Team appointed by Financial Emergency in Michigan’s Governor to conduct a detailed financial review of the City City of Detroit of Detroit delivered its report to the Governor. The Report concludes that a financial emergency exists in the City. What is Next for the City of Detroit? As a result of the Review Team’s conclusion, the Governor is required to take action under Michigan’s emergency financial manager law by no later than March 21, 2013.
The following flow chart summarizes the next steps to be taken in the financial review process of the City of Detroit.
Michigan’s emergency manager law is intended to allow the state to monitor the financial affairs of Michigan cities and to appoint a manager in situations where a financial emergency exists. Under current law (Public Act 72 of 1990), the state-appointed manager is referred to as an emergency financial manager (EFM). An EFM has authority to manage the financial affairs of a city. Effective March 28, 2013, under a new law (Public Act 436 of 2012), the manager is referred to as an emergency manager (EM). An EM has authority to manage essentially all affairs of the city, including exercising all powers otherwise vested in the mayor and city council. Any EFM appointed by the state before March 28, 2013 will be vested automatically with all the powers of an EM on March 28, 2013.
With prior authorization by the state, an EFM or an EM has the power to file for bankruptcy of the City under Chapter 9 of the U.S. Bankruptcy Code applicable to municipal bankruptcies. We discuss after the flow chart what to watch for if the City moves in the direction of commencing a Chapter 9 case.
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Ed Smith Tim Horner 212.705.7044 616.752.2180 [email protected] [email protected]
Ken Kopelman Stephen Grow 212.705.7278 616.752.2158 [email protected] [email protected] Review Team Report Delivered 2/19/2013 Concluded Financial Emergency Exists
By 3/21/2013, Governor Must Make 1 of 3 Determinations
Serious Financial No Serious Financial Problem Exists But Financial Emergency Exists Problem Exists Consent Agreement Adopted
Within 10 Days of Governor’s Determination, Governor Must Mayor or City Council May Request Hearing Assign Management Conducted By Governor of Financial Emergency to Emergency Loan Board Consisting of 3 State Officials Governor Revokes Governor Confirms Financial Emergency Financial Emergency Determination Determination Emergency Loan Board Must Appoint Emergency Financial Manager (EFM)
City May Appeal Financial Emergency No Appeal Determination to Circuit Court
Court Does Not Court Sets Aside Set Aside Financial Financial Emergency Emergency Determination and Determination or EFM Appointment EFM Appointment
EFM Manages the Financial Affairs of the City until 3/28/13. Thereafter, EFM has the Expanded Powers of an Emergency Manager (EM) and Manages Essentially All Affairs of the City, Including Exercising All Powers Financial Review Otherwise Vested in the Mayor and City Process Terminates Financial Review Council. With Prior Authorization By the Financial Review - City Must Comply Process and EFM State, an EFM or an EM Has the Power to File Process Terminates with Terms and Appointment for Bankruptcy of the City Under Chapter 9 Conditions of Terminates of the U.S. Bankruptcy Code Applicable to Consent Agreement Municipal Bankruptcies.
Bingham.com WNJ.com Here are some Expect the City to reach out to its major expect bondholders and other creditors things to watch creditor groups. One of the requirements to claim that Michigan law provides for Detroit to be eligible to commence them a “statutory lien” (as defined in the for if Detroit a Chapter 9 case is that it must make a Bankruptcy Code) on particular revenues of starts to move in good-faith effort to negotiate with its major the City since a “statutory lien” will likewise the direction of creditor groups or show that it is futile to do not be subject to cut-off of the interest in so. If there is an objection to the filing based post-petition revenues. commencing a on eligibility, the “order for relief,” which Certain contracts, like collective bargaining results in the automatic stay preventing Chapter 9 case agreements, are treated in a Chapter 9 creditor actions, will not occur in a Chapter case just like ordinary executory contracts. 9 case until the bankruptcy court addresses They do not receive in a Chapter 9 case the objection and determines that Detroit is the favored treatment that they receive in a eligible for Chapter 9. Chapter 11 case. If the City commences a Chapter 9 case, Expect creditors to claim special class it would ideally want to file a plan and treatment or priority status over other disclosure statement with its petition or creditors in a Chapter 9 bankruptcy case shortly thereafter. That may mean that there based upon particular state laws and the might be weeks of negotiations with major constitution in Michigan that may impose creditor groups to formulate the basis of a different requirements and provide different plan before a Chapter 9 case is commenced. protections for different types of municipal Don’t assume that in a Chapter 9 case some obligations outside of bankruptcy. pre-petition claims will not be paid in the But don’t assume that there will be any ordinary course or as part of a settlement. special treatment for any particular class Unlike in a Chapter 11 case, the bankruptcy of general unsecured claims. While a court often cannot control how the City bankruptcy court will recognize a state runs its operations. The bankruptcy court law scheme by which some general in many cases cannot prevent the City from unsecured claims are subordinated to making payments or settling pre-petition others, it may not be clear that Michigan has claims. established such a scheme, notwithstanding Expect to see swap counterparties use to constitutional or statutory protections given their advantage the “safe harbors” in the to some obligations under Michigan law. On Bankruptcy Code that apply to financial the other hand, there is much less guidance contracts. Those “safe harbors” apply in a in a Chapter 9 case than in a Chapter 11 case Chapter 9 case just like in a Chapter 11 or as to what constitutes “fair and equitable Chapter 7 case. treatment” of even similarly situated creditors under a plan. Don’t assume that creditor treatment in a Detroit Chapter 9 bankruptcy case will be Expect the EFM or EM to take charge for the the same as in past or ongoing municipal City. Don’t look to the bankruptcy court to bankruptcies in California or other states. use a bunch of tools to control the Chapter The Bankruptcy Code requires greater 9 case. The bankruptcy court has fewer deference to state law in a municipal tools in the tool box than it has in a Chapter bankruptcy under Chapter 9, so the 11 case. The bankruptcy court cannot particular state laws matter much more order the appointment of a trustee or the significantly than in a corporate bankruptcy conversion of the case to a liquidation under under Chapter 11. Chapter 7. The bankruptcy court’s primary tool is the dismissal of the case. But, even Some secured creditors with a consensual then, the case could be refiled. security interest in post-petition revenues consisting of so-called “special revenues” Remember that there is much less case law (as defined in the Bankruptcy Code) may interpreting Chapter 9 than Chapter 7 or find that their security interest continues Chapter 11. Novel issues will emerge and in post-petition revenues even though in a will need to be addressed without much Chapter 11 case a security interest in post- historical precedent. petition revenues may be cut off. Also,
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Chris Cox Partner, Bingham McCutchen LLP President, Bingham Consulting LLC
T +1.714.830.0606 F +1.714.830.0700 Orange County
Chris Cox is a partner in the Corporate Practice Group at Bingham McCutchen LLP, and President of Bingham Consulting LLC, a global strategic consulting firm.
In private practice prior to joining Bingham, Mr. Cox was a partner in the international law firm of Latham & Watkins, and a member of the firm’s national management. In 1986 he left Latham to work as a White House counsel to President Ronald Reagan. During a 23-year Washington career, he was Chairman of the U.S. Securities and Exchange Commission, Chairman of the Homeland Security Committee in the U.S. House of Representatives, and the fifth-ranking elected leader in the House.
Mr. Cox is a graduate of Harvard Law School, where he was an editor of the Harvard Law Review, and Harvard Business School, where he later taught corporate and individual income tax.
Bill Lockyer California State Treasurer
Bill Lockyer was elected on November 7, 2006 as California’s 32nd State Treasurer and re-elected on November 2, 2010. The Treasurer is the State’s banker. It’s a bank that processes trillions of dollars in transactions every year.
The Treasurer sells California’s bonds, invests its money and manages its cash. In addition, the Treasurer manages financing authorities that help provide good-paying jobs, better schools, improved transportation, quality health care, more affordable housing and a cleaner environment. And the Treasurer handles those duties while sitting on the governing boards of the nation’s two largest public pension funds – the California Public Employees’ Retirement System and the California State Teachers’ Retirement System.
It’s a big job. Here are some of what Treasurer Lockyer has accomplished: -Managed the State’s multi-billion dollar Pooled Money Investment Account (PMIA) through the 2007-09 recession without losing a penny of principal. -Protected taxpayers from unjustifiably high-interest rates by winning major reforms of the way credit rating agencies grade bonds issued by states and local governments. -Led the successful effort to keep corruption out of public pension funds and ensure investment decisions serve workers and taxpayers, not special interests and their politically-connected middlemen. -Launched unprecedented campaign to increase the purchase of California bonds by individual investors, including radio ads and a first-of-its-kind web site that connects investors with brokers. -Sold more bonds than any Treasurer in California history to finance critical infrastructure projects and generate thousands of jobs. -Directed more than $1.3 billion of financial assistance to California small businesses that helped create or preserve 73,120 jobs. -Revitalized agency that provides financial assistance to manufacturers of electric vehicles and renewable energy products, and sponsored successful legislation that makes it less expensive for schools to supply their facilities with renewable energy. -Expanded access to health care for Californians who depend on small and rural clinics by increasing the availability of low-cost loans to build facilities and buy equipment. -Helped families cope with rising college costs by expanding ScholarShare, California’s “529” college savings program – number of account holders increased by 55.3 percent and assets under management up by 57.5 percent.
Lockyer’s public service career has spanned more than three decades. From 1999-2006, he served as California Attorney General and fashioned one of the most impressive records of accomplishments in the office’s history. He created the nation’s most effective and sophisticated DNA forensic crime laboratory. He cracked down on Medi-Cal fraud, established the Megan’s Law website to track registered sex offenders, and recovered billions of dollars for defrauded energy ratepayers, consumers and taxpayers.
Prior to his election as Attorney General in 1998, Lockyer served 25 years in the California Legislature. He culminated his Capitol career as Senate President pro Tempore, crafting agreements to balance the state budget and make government work better for taxpayers. Lockyer graduated from the University of California, Berkeley.
Lockyer earned his law degree from McGeorge School of Law in Sacramento while serving in the State Senate. He also received a teaching credential from California State University, Hayward. He is married to Nadia Maria Lockyer and has a daughter, Lisa, and a son, Diego.
Harold S. Horwich Partner, Bingham McCutchen LLP
[email protected] T +1.860.240.2722 F +1.860.240.2583 Hartford
Harold Horwich is head of the firm’s insurance practice. He concentrates on representation of insurance companies and insurance company receivers in transactions and insolvencies. He has represented receivers in property-casualty companies and healthcare companies, and has written extensively on insurance company insolvency.
Hal has represented the receivers of First Connecticut Life Insurance Company, Covenant Mutual Insurance Company, Westbrook Insurance Company, Suburban Health Plan Inc., American Preferred Provider Plan of the Mid-Atlantic Inc., American Mutual Liability Insurance Company (ancillary receivership), and PRS Insurance Group (Chapter 11 of Insurance Holding Company). He has also received the designation of Certified Insurance Receiver — Multiline Insurers from the International Association of Insurance Receivers. In October 2005, he was appointed by the insurance commissioner of the state of Connecticut as the chairman of the Task Force on Insurance Company Runoff and Reorganization.
In addition to insurance insolvency, Hal has also represented insurance companies in a wide variety of insolvency problems and transactions. These include complex claim situations involving insolvent insureds or mass torts, insolvent insurance brokers or agents, loss responsive insurance programs, surety and financial guaranty bonds, and reinsurance transactions.
Representative bankruptcy cases include GAF Corporation; Stone & Webster Engineering; The LTV Corporation; Allegheny Health Education and Research Foundation; Pan Am Corporation; Eastern Air Lines Inc.; National Convenience Stores; and Al Copeland Enterprises Inc. Hal advised a group of ceding insurers in the Lloyds reconstruction and renewal, and has participated in numerous reinsurance disputes and transactions.
Soren Reynertson GLC Advisors
Mr. Reynertson is the Managing General Partner of GLC Advisors (“GLC”), an advisory firm he co-founded in 2009. GLC has been ranked among the top 10 restructuring advisors in the US by Thomson Reuters for each of 2010, 2011 and 2012.
Mr. Reynertson was previously a Managing Director in UBS’ Restructuring Group based in New York. Mr. Reynertson was also Head of the European Strategic Finance Group at Morgan Stanley in London. Mr. Reynertson held various roles within UBS’ Restructuring team in New York and London.
Prior to UBS, Mr. Reynertson held positions with AlixPartners and PriceWaterhouse. Throughout his career, Mr. Reynertson has worked with companies and their creditors on exchange offers, out-of-court workouts, bankruptcy reorganizations, debt financing and M&A.
Mr. Reynertson holds a gaming license with the State of Pennsylvania, received an MBA from Columbia Business School and a BA from Emory University.
Edwin E. Smith Partner, Bingham McCutchen LLP
T +1.617.951.8615 F +1.617.345.5003 Boston
T +1.212.705.7044 F +1.212.752.5378 New York
Edwin E. Smith is a Partner in the New York City and Boston offices of Bingham McCutchen LLP. He concentrates his practice in general commercial and insolvency law. He is a member of the teaching faculty at the Morin Center for Banking Law Studies at Boston University Law School, where he has taught secured transactions and teaches transnational lending and trade finance. He has also served as a lecturer on secured transactions at Northeastern University Law School of Law, Harvard Law School and Suffolk Law School.
As a Uniform Law Commissioner for the Commonwealth of Massachusetts, he has served as a member of the drafting committees for the 1995 revisions of Article 5 (letters of credit) and the 1999 revisions of Article 9 (secured transactions) of the Uniform Commercial Code and as the chair of the drafting committee that formulated the 2002 amendments to Articles 3 (negotiable instruments) and 4 (bank deposits and collections) of the Uniform Commercial Code. He served on the drafting committees for the Uniform Certificate of Title Act (2005), the Uniform Assignment of Rents Act (2005), the Uniform Manufactured Housing Act (2012) and as chair of the Joint Review Committee that drafted the 2010 amendments to Article 9 of the Uniform Commercial Code. He is currently serving as chair to the drafting committee to consider amendments to the Uniform Fraudulent Transfer Act and as a Uniform Law Commission representative to the Permanent Editorial Board of the Uniform Commercial Code. Mr. Smith is a past Chair of the Uniform Commercial Code Committee of the Business Law Section of the American Bar Association and a past member of the Council for the Business Law Section. He also served as a U.S. delegate on the United Nations Convention on the Assignment of Receivables in International Trade and as a U.S. delegate to the United Nations Commission on International Trade Law (UNCITRAL) working group on creating a secured transactions guide for legislation in United Nations member countries.
He is a member of the American Law Institute, the National Bankruptcy Conference (for which he serves on the executive committee), the American College of Bankruptcy (for which he serves on the board of directors) and the International Insolvency Institute and is a past President of the American College of Commercial Finance Lawyers. He is a graduate of Yale University and Harvard Law School.
Gov. Pete Wilson Of Counsel, Bingham McCutchen LLP Principal, Bingham Consulting LLC
[email protected] T +1.213.680.6777 F +1.213.830.8777 Los Angeles
Bringing more than 30 years of dedicated public service as governor of California, U.S. senator, mayor of San Diego and California state assemblyman, Pete Wilson is a principal in Bingham Consulting, based in the firm’s Los Angeles office. He is also of counsel at Bingham McCutchen LLP.
With a deep knowledge of policies, people and processes of government at all levels, he counsels that today’s successful businesses need to work with governments – not only in Washington, D.C. – but with state and local governments to anticipate and avoid regulatory compliance problems.
As governor of California from 1991 to 1999, he is credited with leading California from the depths of recession to prosperous economic recovery. Insisting on strict budget discipline and rehabilitation of the state’s then-hostile environment toward investment and job creation, Pete obtained tax and regulatory relief for small businesses; and created the state Trade and Commerce Agency to enable job creators to obtain permits and other approvals from state and local agencies. He enabled private market-based unsubsidized health coverage for employees of small businesses and obtained anti-fraud measures that drove down workers’ compensation premiums by 40 percent.
Under his leadership, California also enacted sweeping welfare and criminal justice reforms and historic education reforms.
Corporate Debt Restructuring
Presented by: Mark Deveno, Bingham McCutchen (Moderator) Yuki Sakai, Bingham McCutchen Naomi Moore, Bingham McCutchen James Roome, Bingham McCutchen A Practical Guide to Japanese Insolvency Procedures BINGHAM TOKYO Bingham’s Tokyo office, known as Bingham McCutchen Murase, Sakai Mimura Aizawa—Foreign Law Joint Enterprise, consists of more than 70 lawyers (most of whom are Japanese bengoshi). We are one of the largest foreign law firms in Japan. Our Tokyo team has a renowned track record in major Japanese domestic insolvencies and out-of-court restructurings as well as high profile cross-border transactions involving numerous jurisdictions. Chambers Asia honored Bingham with a top-tier ranking for restructuring and insolvency in Japan each year from 2008–2011.
ADDITIONAL INFORMATION This article is intended as a basic overview of insolvency laws and procedures in Japan as of September 2011. Please seek formal legal advice regarding a particular transaction or investment. If you have questions regarding insolvency proceedings in Japan or investing in distressed assets, please contact:
Hideyuki Sakai Yuri Ide [email protected] [email protected] Tokyo Tokyo T +81.3.6721.3131 (Direct) T +81.3.6721.3160 (Direct)
Mark W. Deveno Taro Awataguchi [email protected] [email protected] Tokyo Tokyo T +81.3.6721.3242 (Direct) T +81.3.6721.3159 (Direct)
New York T +1.212.705.7846 (Direct to both Tokyo and NY)
Bingham McCutchen LLP 1 OVERVIEW OF JAPANESE PRACTICE In many ways, Japan’s insolvency laws are similar to those of the United States—they provide a rational mechanism for distributing the value of any company that is being reorganized or liquidated. Due to an established court system, creditors can expect insolvency cases to produce consistent results for similarly situated creditors, whether foreign or domestic. However, compared to U.S. norms, there are significant differences in practice, procedure and cultural expectations.
These differences stem, in part, from local cultural (as compared to those of the U.S.) can be better expectations regarding Japanese business organi- understood: zations and capital markets creditors. More so than Ǯ The reorganization process in Japan relies heavily their U.S. counterparts, Japanese corporations on court-appointed professionals (trustees, are often viewed as serving the interests of their examiners, supervisors and others) to drive employees, suppliers and customers rather than the restructuring process. emphasizing shareholder returns. In addition, Ǯ Due to less onerous notice and disclosure historically, bank lenders in Japan built a much closer obligations, these professionals have greater relationship with their borrowers than might be autonomy than do court-appointed professionals typical in the United States, especially when acting as in the United States. a borrower’s primary bank or “main bank.” With that The professionals are likely to operate with closer relationship (at least in the context of insolvency Ǯ a primary goal of ensuring that the business cases) came a sense of responsibility on the part of continues as a going concern, so as to preserve the main bank, and a corresponding willingness on jobs if at all possible.1 the part of the main bank to accept results supportive As a practical matter, cases are often advanced via of a restructuring effort. Although lending practices in Ǯ private communications between court-appointed Japan have evolved significantly over the past decade, professionals, rather than via formal motions it is rare, even today, for a Japanese financial institution and court hearings. Indeed, the professionals to aggressively prosecute its rights to the detriment of themselves are routinely permitted ex parte a debtor’s other constituents. Against this backdrop, communications with the court for purposes of the following key differences in Japanese practice shaping the direction of a case.
Ǯ Court hearings tend to be rare. For instance, although a trustee requires court approval before taking several types of actions, the laws do not “Due to an established court condition that approval on the trustee having first system, creditors can expect provided creditors with notice and an opportunity to object. insolvency cases to produce Ǯ Likewise, a trustee has very few public disclosure consistent results for similarly requirements in respect of the debtor’s financial situated creditors, whether well-being. For instance, the laws do not require foreign or domestic. However, U.S.-style monthly operating reports to creditors, nor do they require a disclosure statement in compared to U.S. norms, there support of a plan of reorganization.2 are significant differences 1 A reorganization case in the U.S. can also be expected to focus on preservation of the in practice, procedure and business as a going concern. However, a case in the U.S. is likely to focus more critically on corporate restructuring in addition to financial restructuring. Corporate restructuring can cultural expectations.” shed unprofitable business lines in a process that may, itself, translate into a loss of jobs. 2 As a technical matter, debtors and trustees in Japan have monthly reporting obligations to the court. The applicable reports, however, are not as detailed as the monthly operating reports required in the U.S. In addition, the reports, or portions thereof, are often provided solely to the court on a confidential basis and not available to creditors.
Bingham McCutchen LLP 2 Ǯ There is no official creditors’ committee appointed institutions) are beginning to more actively question to protect creditor interests.3 the assumptions and strategies of the court-appointed professionals. Creditors are seeking more disclosure Ǯ As a result of the factors discussed above, a court- supervised restructuring process in Japan tends to in order to better understand and assess their be far less transparent than in the United States.4 restructuring options. In short, they threaten to disrupt the culture of consensus. The risk of creditor interests being treated unfairly, at least in domestic (not cross-border) cases, is Due to this changing dynamic, the Japanese insolvency mitigated by what can best be described as a “culture system continues to evolve. As a practical matter, of consensus.” Among other things, Japanese courts however, the system has not fully caught up with the impose significant pressure on a trustee to informally demands of these creditors. The system’s preference obtain majority consent for key proposals before filing for consensus permits the largest creditors—creditors the same and, at a minimum, before the court needs to who control the votes of a class—to obtain a voice in rule on the same. This system has the potential to work the process. However, the system’s lack of required well in conjunction with the cultural assumptions noted notice, disclosure and hearings makes it difficult for previously. A trustee, or a debtor subject to supervision, smaller creditors (even financial creditors) to play an takes on the role of diligently working to implement a active role. Nonetheless, we believe that this evolution restructuring for the benefit of all constituents (i.e., to is moving in a positive direction for foreign creditors preserve the company, jobs, supplier relationships, and the voice they seek in restructuring cases. etc., if at all possible). In turn, significant financial creditors are given a back-channel voice regarding the formulation of a restructuring plan and can be expected to take positions supportive of the restructuring effort. “As balance sheets and This support derives, in part, from the creditors’ respect for, and faith in, the court-appointed professionals. corporate structures All of this has the potential to result in the rapid become more complex—in development and approval of plans of reorganization— particular, as a growing typically involving the sale of a business to a “sponsor” number of foreign (whether before or after confirmation).5 institutions lend to and/or As balance sheets and corporate structures become acquire the debt of Japanese more complex—in particular, as a growing number of borrowers—the constructs foreign institutions lend to and/or acquire the debt of Japanese borrowers—the constructs of the Japanese of the Japanese system are system are being tested. These foreign institutions being tested.” (and, now, an increasing number of Japanese
3 As a technical matter, certain insolvency laws permit the court to recognize a “creditors’ committee.” However, this is not a creditors’ committee as contemplated in the U.S. The fees of such committees are not anticipated to be funded by the estate, nor are such committees expected to be as active as their U.S. counterparts. Indeed, the practice of appointing creditors’ committees has gained little traction in Japan. However, in 2009 and 2010, Bingham obtained recognition of and represented the first-ever officially recognized creditors’ committee in a Japanese rehabilitation proceeding. 4 We note that the court process in Japan does not involve a publicly accessible docketing system. This is perhaps not surprising given the limited notice and disclosure requirements in cases. Instead, what little data is produced is available solely to creditors in interest (and not to the public at large) at the office of the court clerk. This has the potential to chill secondary market activity due to concerns about possessing material, non-public information. 5 Notwithstanding the system’s culture of consensus, valuation of a secured creditor’s collateral is a common area of dispute in rehabilitation proceedings. Typically, a trustee can be expected to produce and use low appraisals in negotiating the secured and deficiency claim amounts held by creditors. Given the preference for consensus, however, agreed terms will typically be reached between the parties without the need for a final litigated resolution. Bingham McCutchen LLP 3 HIGH-LEVEL SUMMARY OF INSOLVENCY LAWS There are four types of insolvency laws in Japan— As a general matter, we note that the civil rehabili- two that contemplate rehabilitation of the debtor tation law is more commonly employed than the and two that contemplate liquidation and dissolution corporate reorganization law—with use of the of the debtor. Each of those laws is outlined at a high corporate reorganization law typically reserved for level below. larger, higher-profile and more complex cases.
Rehabilitation Laws Liquidation Laws Corporate Reorganization: The corporate Bankruptcy: The bankruptcy law was published in reorganization law came into effect in 1952. It is June 2004 and went into effect on Jan. 1, 2005.8 The modeled on Chapter X of the U.S. Bankruptcy Act bankruptcy law provides for a proceeding in which of 1898. Under the law, only a stock corporation a trustee is appointed by the court to liquidate the (known as “KK”) may be a debtor.6 That said, the assets of a debtor and distribute the proceeds of such vast majority of companies in Japan are KKs. As a liquidation to creditors in their order of priority. As a general matter, the corporate reorganization law may technical matter, the liquidation process applies to be used to modify the rights of all classes of creditors both secured and unsecured assets. However, the law (both secured and unsecured). Until very recently, does not impose a stay upon foreclosure actions. As all corporate reorganization cases involved the a practical matter, holders of security interests are appointment of a bankruptcy professional, typically an typically permitted to exercise their security rights established bankruptcy lawyer, as “trustee” to run the and/or requested to consent to the trustee’s efforts debtor’s affairs. In recent years, however, courts have to liquidate their secured collateral. begun to permit quasi-debtor-in-possession cases. Special Liquidation: The most recent version of the Civil Rehabilitation: The civil rehabilitation law special liquidation law—which is a sub-part of the was published on Dec. 14, 1999, and went into effect Corporation Act—was published in July 2005 and on April 1, 2000.7 Any type of Japanese company went into effect on May 1, 2006. Overall, the special may be a debtor under this law. Cases under the liquidation law provides for a simplified liquidation civil rehabilitation law are intended to be debtor- procedure that may be used in consensual situations. in-possession cases, although a trustee may be Most often, the law is employed by parent companies appointed if warranted. Although there are certain to wind down subsidiaries. The law permits the exceptions to the general rule, a civil rehabilitation company, after a shareholder vote, to approve its own case generally serves to modify only the rights choice of a liquidator, but requires that liquidator to of unsecured creditors—thus, use of a corporate obtain creditor approval of a “plan of liquidation.” The reorganization case (rather than a civil rehabilitation procedure applies only to general unsecured claims and case) may be necessary when a company’s balance cannot be used to alter secured creditor rights and/or sheet is sufficiently complex so as to require involuntary priority claims that exist under non-bankruptcy laws. changes to the rights of secured creditors. The bankruptcy law is more commonly employed to achieve a liquidation than the special liquidation law. 6 There are four basic types of “companies” or incorporated business entities under Japanese law. These are: (1) stock corporations (kabushiki kaisha, generally referred to as “KK”), (2) incorporated totally limited liability partnerships (godo kaisha), (3) incorporated partially limited liability partnerships (goshi kaisha) and (4) incorporated unlimited liability partnerships (gomei kaisha). Of these, the KK is most prevalent and is therefore most likely to be the debtor in an insolvency proceeding. 7 The civil rehabilitation law effectively replaced two predecessor laws—the composition law and the corporate arrangement law—which both permitted a debtor to remain in possession. Due to significant deficiencies within those laws, however, neither was 8 The bankruptcy law replaced a predecessor law that was also referred to as the “bankruptcy actively employed as an insolvency solution. law.”
Bingham McCutchen LLP 4 We generally find that the vast majority of our clients are interested in reorganization and rehabilitation proceedings. Accordingly, on the remaining pages, we summarize some of the key features of the corporate reorganization and civil rehabilitation laws from a practical perspective.
Who are the key players and what are their roles?
Corporate Reorganization Law Civil Rehabilitation Law
Trustee: An individual appointed by the court to run DIP: More often than not, management of the debtor the debtor’s affairs and to develop its restructuring remains in place during a civil rehabilitation case. Plan. Although historically the trustee has been an Like in the U.S., a court may appoint a trustee to independent bankruptcy professional, recent cases replace management if the debtor is determined have permitted the appointment of an existing unfit to manage. member of management. Supervisor: In most civil rehabilitation cases, Examiner: Like in the U.S., although not common, the court will appoint a supervisor to monitor the examiners may be appointed to fill any number debtor’s affairs. In this capacity, the supervisor of specific and identified investigatory tasks. will voice an opinion as to approval or disapproval More recently, however, examiners have begun of many trans-actions of the debtor. to be appointed in all cases where a member of management has been appointed as the trustee. No Creditors’ Committee: The laws applicable to In this regard, the examiner provides independent creditors’ committees are virtually identical to those oversight of the trustee’s activities—at least key included in the corporate reorganization law. In turn, activities. we note that although a supervisor may be appointed to monitor a debtor’s affairs, a supervisor is not No Creditors’ Committee: As noted above, creditors’ likely to be as proactive as a creditors’ committee committees, as contemplated in the U.S., do not in the U.S. exist. The corporate reorganization law permits the establishment and recognition of a “committee” of collective creditors, but such committees do not serve the same function as a U.S. creditors’ committee. We note that although an examiner may be appointed to monitor a debtor’s affairs, examiners are not anticipated to be as proactive as a creditors’ committee in the U.S.
Bingham McCutchen LLP 5 Do creditors have any opportunity to voice their opinion as to who should fill the above referenced roles of monitoring the debtor’s affairs? What duties (if any) do the “players” have to report to creditors?
Corporate Reorganization Law Civil Rehabilitation Law
Creditors are not typically afforded an opportunity to Generally speaking, the answers to these inquiries voice their views as to preferred examiner candidates. are the same as those pertaining to corporate reorganization cases, provided that a supervisor, Although, as a technical matter, the examiner owes rather than an examiner, would be involved. certain fiduciary duties to creditors, as a practical matter, the examiner works for the court. Thus, the examiner will report solely to the court regarding his or her views as to the debtor’s activities. That said, certain key reports, such as those pertaining to Plan confirmation, may be filed and made available for creditor review.
As a practical matter, an examiner may be willing to entertain the views of creditors if so requested. The size of the creditor(s) involved in making such a request and the relationship between counsel to such creditor(s) and the examiner will impact the degree to which the examiner considers such requests. None- theless, as discussed elsewhere in these materials, we note that examiners are not likely to be as active or influential as a U.S.-style creditors’ committee.
Is there an automatic stay or, as a practical matter, a stay issued in most cases?
Corporate Reorganization Law Civil Rehabilitation Law
As of “commencement” of a corporate reorganization As of “commencement” of a civil rehabilitation case, case, an automatic stay comes into effect that pro- an automatic stay comes into effect that prohibits, hibits, among other things, both (i) the debtor from among other things, the debtor from paying and/ paying and/or creditors from attempting to collect or creditors from attempting to collect unsecured unsecured pre-commencement obligations and (ii) pre-commencement obligations. The stay does not secured creditors from attempting to exercise their apply to enforcement of security rights by a secured security rights. The stay does not, however, prevent creditor. In addition, the stay does not prevent creditors from exercising rights of set-off. creditors from exercising rights of set-off.
As a technical matter, all cases in Japan, even volun- The same “gap period” applies as in corporate tary cases, involve a “gap” period. That is, there reorganization. is a period between the filing of an application for commencement and the date at which the court enters an order actually commencing the case. There is no automatic stay during this period, but courts routinely enter injunction orders that serve the same basic purposes as the applicable automatic stay.
Bingham McCutchen LLP 6 May the debtor/trustee operate outside of the ordinary course (e.g., sell significant assets, enter into new contracts, make significant capex investments, etc.) without court approval? If court approval is required, is that approval on notice to all creditors, with an opportunity for objecting creditors to be heard?
Corporate Reorganization Law Civil Rehabilitation Law
Generally speaking, the trustee will need court Generally speaking, the answers to these inquiries approval before taking actions outside of the ordinary are the same as those pertaining to corporate course. In turn, the court may solicit the views of the reorganization cases, provided that a supervisor, examiner in respect of such activities. rather than an examiner, would be involved.
However, the debtor need not serve all creditors with notice of the intended action, nor must a public hearing be held. Thus, individual creditors who feel the debtor’s actions are harmful to value may not be afforded an opportunity to object. Indeed, they may not even be provided notice of the activity until after the fact.
As a practical matter, with respect to sales of significantly all assets, the courts will typically hold a meeting of creditors at which creditors may voice their views to the court. In turn, although there is insufficient precedent to say with certainty, we believe that most examiners will require the debtor to produce evidence of a market bid process before the examiner will voice support for a sale of substantially all assets.
The above demonstrates that general unsecured creditors have less of a voice in the debtor’s actions than they might typically have in the United States. Certain creditors, however, have even greater rights. In particular, we note that (i) executory contracts may not be assigned without consent of the counterparty thereto and (ii) liens on assets may not be stripped simply by producing evidence of sale at fair value (thus giving secured lenders significant consent rights to sales).
Bingham McCutchen LLP 7 By when must a Plan be filed and confirmed?
Corporate Reorganization Law Civil Rehabilitation Law
Plan Timing: Plans must be submitted by a date Plan Timing: Plans must be submitted by a date established by the court, provided that the date established by the court, provided that the date must must be within one year of commencement of the be within roughly nine months of commencement of case. This period may be extended, where special the case. Technically, the date set by the court shall circumstances exist, up to twice by the court and not be more than two months after expiration of the thereafter may be extended only if unavoidable “claim examination period.” conditions are found. There is no statutory limitation on the period of extension, but requests for such extensions are strictly scrutinized.
What type of claims may be addressed by a Plan?
Corporate Reorganization Law Civil Rehabilitation Law
Claims Addressed: A corporate reorganization Claims Addressed: Generally speaking, a civil Plan may address the rights of secured creditors, rehabilitation case addresses only the rights of unsecured creditors and equity holders. ordinary unsecured creditors and equity holders. The claims of unsecured priority creditors (such as labor claims) are exempt from the civil rehabilitation proceeding. Secured creditors are permitted to exercise their security rights during the proceedings and their deficiency claims (if any) become unsecured claims in the proceedings. Creditors with claims exempt from the proceeding (secured creditors and priority unsecured creditors) are not required to file proofs of claim in the proceeding.
Bingham McCutchen LLP 8 What votes are necessary to confirm a Plan?
Corporate Reorganization Law Civil Rehabilitation Law
Plan Voting: Claims are generally grouped into two Plan Voting: Claims are generally grouped into one classes: secured and unsecured. Votes are counted single unsecured class, for which votes of a majority by amount of claims (with the number of claimants in both number (of those voting) and amount (of all holding such claims being moot). The required voting claims in the aggregate) are necessary. Shareholder percentages work as follows: votes are generally deemed moot and unnecessary unless the debtor is solvent. Ǯ Secured Class: (i) 2/3 in amount to simply extend maturities, (ii) 3/4 in amount to approve a Interestingly, claims that are not voted are counted haircut and (iii) 9/10 in amount to approve a Plan that will liquidate the debtor’s business. as “no” votes for purposes of counting the “amount” of votes (all claims in the aggregate). Claims that are Ǯ Unsecured Class: Simple majority in amount not voted are not counted, however, for the purpose required to approve a Plan. of establishing a majority in “number” (of those Ǯ Equity: Simple majority in amount required to voting). approve a Plan (but equity holders are permitted to vote only when the debtor is solvent).
Interestingly, claims that are not voted on are counted as “no” votes. Thus, the trustee and/or debtor faces a significant burden in terms of encouraging all creditors to vote.
Must a Plan treat similarly situated creditors in a consistent manner?
Corporate Reorganization Law Civil Rehabilitation Law
Similar Treatment: Generally speaking, similarly Similar Treatment: Generally, the same as corporate situated creditors must receive similar treatment. reorganization cases. Like in the U.S., there are some exceptions to this general rule, including (i) convenience claim treatment, resulting in greater recovery percentages for small claims, and (ii) possible equitable subordination of shareholder and management claims. We note that the convenience claim process tends to be liberally employed in Japan—often pegging the convenience claim threshold at a number that ensures improved recoveries for virtually all trade creditors (to the detriment of financial lender claimants).
Bingham McCutchen LLP 9 Must a Plan satisfy an equivalent of the U.S. absolute priority rule?
Corporate Reorganization Law Civil Rehabilitation Law
Respect for Priorities: The corporate reorganization Respect for Priorities: This point is largely moot in laws respect the priority of creditor claims, but do the context of a civil rehabilitation case given that the so through a “relative,” rather than “absolute,” proceeding does not apply to secured creditors (i.e., priority rule. This rule essentially provides that a given that there is only one creditor class). However, junior creditor may recover some level of recovery we note that it is not uncommon in small- or medium- notwithstanding the fact that a senior creditor has sized cases for creditors to determine that the not recovered in full, provided, however, that the best prospects for reorganization are with existing junior creditor must receive less favorable terms management and equity holders in place—thus than the senior creditor. By way of example, it is permitting a retention of equity by such parties. not unheard of for a Plan to propose that secured creditors will be paid 90 percent of the value of their security, with the balance used to improve recoveries of unsecured creditors.
As a practical matter, what is the typical form of exit from a case (e.g., sales or debt for equity)?
Corporate Reorganization Law Civil Rehabilitation Law
Corporate reorganization cases typically end with The practice in civil rehabilitation cases is generally the debtor finding a buyer (“sponsor”) to acquire the the same as that of corporate reorganization cases. debtor’s assets, with the proceeds of such sale being used to fund creditor recoveries. Technically, debt for equity swaps are permitted under the laws, but, in practice, they are very rarely employed.
A Plan may be confirmed without a sponsor having been located. In such cases, the Plan will provide alternative paths: (i) one path by which the trustee will continue to run the business and pay a stream of creditor distributions over time and (ii) an alternative path by which, if the trustee finds a sponsor, the business may be sold, so as to prepay the creditor distributions. In either instance, the reorganization case will remain open and subject to the court’s jurisdiction until the significant majority of creditor distributions have been paid.
Bingham McCutchen LLP 10 What is a typical timeline for a case?
Corporate Reorganization Law Civil Rehabilitation Law
Pre-Filing: One to two weeks of debtor consultation Pre-Filing: One to two weeks of debtor consultation with the court. with the court.
Day 1: Filing, entry of injunction order, appointment of Day 1: Filing, entry of injunction order, appointment a “provisional” trustee and private notice to creditors of a supervisor and private notice to creditors by the by the petitioner. petitioner.
Week 3: Entry of a formal commencement order, Day 15: Entry of a formal commencement order. appointment of a trustee and, as applicable, appointment of an examiner. Week 6: Claims bar date.
Week 9: Claims bar date. Weeks 6–11: Asset evaluation and claim examination period. Weeks 9 –20: Asset evaluation and claim examination period. Week 12: Submission of a Plan of Reorganization. (This period may extend to as long as roughly 36 Week 21: Submission of a Plan of Reorganization. weeks or more in complex cases. If so, all dates (This period may extend to as long as 52 weeks or hereafter would be revised accordingly). more in complex cases. If so, all dates hereafter would be revised accordingly). Weeks 12–24: Submission of supervisor’s report and holding of creditors’ meeting for voting on the Plan. Weeks 21–25: Plan voting. Week 24: Plan confirmation. Week 26: Plan confirmation. Thereafter: Implementation of the Plan until the Thereafter: Implementation of the Plan until the significant majority of claim distributions have significant majority of claim distributions have been paid. This can last anywhere from months been paid. This can last anywhere from months to several years. to several years.
Bingham McCutchen LLP 11
Overview of People’s Republic of China (PRC) Reorganization Proceedings1
1. Overview
1.1. Under the Enterprise Bankruptcy Law (effective June 1, 2007), either the debtor or any creditor2 may apply to the court for the commencement of bankruptcy proceedings in respect of a PRC company if:
(a) the debtor is unable to pay its debts as they become due and does not have enough assets to pay off all debts or clearly lacks the ability to do so; or
(b) there is an obvious possibility that the debtor will lose its capability to repay its debts.
1.2. The court may place the debtor in one of three proceedings:
(a) reorganization;
(b) conciliation; or
(c) liquidation.
2. As discussed below, the procedures for reorganization are largely similar to those of a Chapter 11 proceeding.
3. Automatic Stay
3.1. The court’s acceptance of the bankruptcy application triggers an automatic stay suspending:
(a) any attachment on the debtor’s property or enforcement proceedings during the whole bankruptcy period (including the reorganization period); and
(b) any civil litigation or arbitration related to the debtor (with any new litigation to be brought only in the court that has accepted the bankruptcy application) until the administrator has taken control over the debtor's property.
1 We are not licenced to practice PRC law and this memo remains subject to review by local counsel.
2 Subject to certain conditions, (i) the entity responsible for liquidation of the debtor may apply to the court for the commencement of bankruptcy liquidation proceedings, and (ii) the shareholder(s) of the debtor repenting at least one-tenth of the debtor’s registered capital may apply to the court for the commencement of reorganization proceeding before the court declares the debtor bankrupt.
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3.2. Both secured and unsecured creditors are subject to the stay of proceedings, except that secured creditors may apply to the court to enforce their security rights if it is likely that the secured property will suffer damage or diminution in value such that their rights as secured creditor would be prejudiced.
3.3. Creditors’ rights in respect of any guarantor of the debtor or other joint debtor are not affected by the reorganization.
3.4. During the reorganization period, there is a freeze on (i) shareholder distributions, and (ii) equity transfers by directors, supervisors and senior management unless otherwise approved by the court.
4. Appointment of Administrator
4.1. Upon acceptance of the bankruptcy application, the court must also appoint an administrator. The administrator can be an institution or individual.
4.2. The administrator has broad powers, including:
(a) taking possession of and managing the debtor’s property;
(b) investigation and reporting on the debtor’s property status;
(c) determining internal management affairs;
(d) determining daily expenses;
(e) determining whether the debtor should continue to operate its business before the first creditors’ meeting;
(f) managing and disposing of the debtor’s property;
(g) participating in legal proceedings on behalf of the debtor;
(h) calling for a creditors’ meeting;
(i) engaging the managers of the debtor for managing the business of the debtor; and
(j) other functions as authorized by the court.
4.3. In a reorganization proceeding, however, the debtor may apply to the court to manage its own property and business affairs. If granted, the administrator will return control over the debtor’s property and business affairs to the then officers, directors and managers of the debtor. In this situation, the debtor would have the powers of the administrator. However, the debtor would remain subject to the administrator’s supervision throughout the reorganization process.
4.4. Consequently, the debtor’s officers, directors and managers will have only limited control over the company’s operations. They themselves may also be
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subject to individual strictures (e.g., restrictions on their ability to leave the jurisdiction).
4.5. At a creditors’ meeting, the creditors can resolve to appoint a creditors’ committee, comprising of up to eight representatives of the creditors and one representative of the employees or trade union of the debtor. The role and powers of the creditors’ committee is much more limited than those of a creditors’ committee appointed in a US Chapter 11 proceeding. The creditors’ committee plays a largely supervisory role with respect to the reorganizational process. The administrator is required to provide timely reports of the debtor’s financial activities to the creditors’ committee. The creditors’ committee is also empowered to request the administrator and/or debtor to provide relevant documents and information. The creditors’ committee may seek relief from the court if the administrator and/or debtor fail to comply with its requests.
5. Plan of Reorganization
5.1. Within 6 months of the date on which the court rules that the debtor should conduct reorganization, the debtor and/or administrator must submit a reorganization plan to the court and the creditors’ meeting. A reorganization plan must at contain the following:
(a) the debtor’s plan for business operations;
(b) classification of the creditors’ claims;
(c) the plan for the adjustment of the claims;
(d) the plan for payment of the claims;
(e) the period of time for implementing the reorganization plan;
(f) the period of time for supervising the implementation of the reorganization plan; and
(g) other plans conducive to the debtor's reorganization.
5.2. Within 30 days of the receipt of the reorganization plan, the court must convene a creditors’ meeting. The debtor and/or administrator are required to explain and answer inquiries regarding the reorganization plan. There are no specific requirements regarding what information must be disclosed to creditors about the reorganization plan.
(a) All creditors may vote on the reorganization plan. Adoption at the creditors’ meeting requires the affirmative vote of a majority in number of creditors of the same class present at the creditors’ meeting representing two-thirds or more in value of the total claims in each of the following creditor classes:
(i) secured creditors;
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(ii) labor creditors;
(iii) tax creditors;
(iv) unsecured creditors (including a small-claim sub-class if appropriate)
(b) Shareholders may also vote as a separate class if the reorganization plan adjusts their interest. Otherwise, shareholders may only send non-voting delegates to discuss the reorganization plan at the creditors’ meeting.
5.3. Within 10 days of adoption by all classes of creditors (and shareholders, if applicable), the debtor or administrator must apply to the court for approval of the reorganization plan. Even if the reorganization plan is not adopted by all classes of creditors (and shareholders, if applicable), the debtor and/or administrator may still apply to the court for approval if:
(a) claims of secured creditors will be fully repaid from the relevant secured properties, the losses incurred as a result of the delayed repayment are equitably compensated and the security rights over such properties are not materially impaired, or alternatively, the voting class has adopted the reorganization plan;
(b) claims of employees and tax agencies will be fully repaid, or alternatively, the relevant voting classes have adopted the reorganization plan;
(c) the ratio of claims of unsecured creditors that would be repaid according to the reorganization plan is not less than the ratio that would be repaid under liquidation procedures at the time the plan was submitted for approval, or alternatively, the voting class has adopted the reorganization plan;
(d) the adjustment of the interests of shareholders under the reorganization plan is fair and equitable, or alternatively, the shareholders have adopted the reorganization plan;
(e) the reorganization plan treats equitably the members of the same voting class and the priority of the payment claims is not against the priority in liquidation procedures; and
(f) the reorganization plan is feasible.
5.4. Within 30 days or receipt of the reorganization plan, the court will make its final approval determination. If the plan is approved, the debtor will go forward with implementation. If the plan is not approved, the court will declare the debtor bankrupt and place the company in liquidation proceedings.
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6. Cross-Border Considerations
6.1. The Enterprise Bankruptcy Law also provides that the bankruptcy court may adjudicate, recognize and enforce foreign court judgments involving debtors’ assets in the PRC. Upon consideration of international treaties and principles of reciprocity, a bankruptcy court shall recognize and enforce a foreign bankruptcy judgment if it does not:
(a) breach the fundamental principles of PRC law;
(b) injure the PRC’s sovereignty, security, or social interests; or
(c) impair the rights and lawful interests of creditors in the territory of the PRC.
6.2. We note, however, that these provisions of the Enterprise Bankruptcy Law are relatively untested. We expect that, it may be quite difficult in practice to seek recognition and enforcement of foreign judgments in the PRC, especially when the foreign court is located in a jurisdiction which has not executed a treaty on mutual judicial assistance with the PRC.
Bingham McCutchen LLP
European Restructurings and Insolvencies Bingham Institute 2013 Corporate Debt Restructuring Discussion October 15, 2013 Disclaimer
• This presentation has been prepared by Bingham McCutchen (London) LLP (“Bingham”) • This presentation should not be relied upon or any other third party as being definitive or comprehensive, and specific local law advice should be sought by relevant counsel if further detail is required in specific jurisdictions • This presentation does not contain legal advice, either generally or about a particular investment and so should not be treated as such • This presentation is confidential and must not be disclosed or distributed to any third parties without the prior written consent of Bingham • This presentation does not create any attorney-client relationship between Bingham and any other third party
2 Agenda
1. Introduction 2. EC Regulation 3. Overview of Selected Jurisdictions: • UK • France • Germany • Spain • Netherlands 4. Specific Topics • HY Structures • Chapter 11 in Europe • Sovereign Debt Restructuring • Freefall Insolvency 5. Case Studies
3 Introduction
• The overall level of restructuring and insolvency activity in Europe over the past two years has been mixed • Corporate insolvencies in the core European countries have decreased, whereas corporate insolvencies in the peripheral European countries have increased significantly • We have seen occasional pending defaults by high yield issuers during 2013, including Codere (Spain), ATU (Germany) and New World Resources (Czech Republic) but no widespread default and the new issue market is wide open • Sovereign default has been widely threatened but so far Greece is the only sovereign issuer to negotiate haircuts, and none have defaulted • Continued failures by smaller banks and financial institutions (e.g. Co-operative Bank) but generally driven by insolvency rather than illiquidity • Banks' capital in Europe has not been restored and bank lending remains at a low ebb, giving widespread opportunities to alternative lenders
4 Introduction
• Over the past 10 years, a number of European jurisdictions have reformed their insolvency laws • these changes were primarily to facilitate corporate recoveries and restructurings • some reforms are relatively recent and the jury is still out as to what impact these reforms will have (such as in Spain) • Notwithstanding these reforms, US remains virtually unique in terms of a) strong debtor in possession, b) realistic DIP financing, c) no wrongful trading regime, d) strong creditors’ committees and e) activist, specialist courts • European jurisdictions generally split between common law in England and Ireland and civil law elsewhere, impacting the flexibility and speed at which law can develop • Over 45 countries in Europe, each with different insolvency processes – no such thing as “European version of Chapter 11” • The political landscape is important (e.g. Greece, Iceland, etc) • Consensual, out of court restructurings remain the preferred approach for corporate restructurings as court proceedings tend to be liquidation procedures • EC Insolvency Regulation can facilitate cross border insolvency and restructuring
5 EC Regulation Introductory Topic EC Regulation
• EC Regulation has introduced a framework to encourage better co-ordination of pan- European insolvencies, by securing reciprocal recognition and enforcement of insolvency proceedings in different Member States • In force since 31 May 2002, the Regulation has direct effect in all Member States, except Denmark • Regulation introduces the concept of Centre of Main Interests (COMI), which determines the jurisdiction of a company's main insolvency proceedings • Main proceedings will be automatically recognised in each other Member State but secondary insolvency proceedings can be commenced in any Member State where the company has an establishment
7 Introductory Topic EC Regulation
• COMI is where the company's administration takes place, and which is ascertainable to third parties - presumed to be the place of incorporation but this presumption can be rebutted • The ability to move COMI has allowed forum shopping by companies to facilitate successful restructurings - principally to England • COMI shifting is reasonably straightforward for holding companies but in practice very difficult for operating companies with commercial activities based in a particular Member State • Regulation does not apply to banks, insurance companies or credit institutions (which are governed by separate rules) • Some finance documents seek to limit the ability of debtor companies to shift COMI
8 European Insolvency Overview – UK UK General Observations
• English legal system is well known for providing debtors and creditors with flexible tools that can be used to implement creative restructuring solutions (e.g. administration + pre-pack, CVA etc) • Common law system, with experienced, commercial judges • UK seen as a sophisticated jurisdiction for complex restructurings, as evidenced by the number of foreign companies that choose to pursue restructuring proceedings in England • Wind Hellas - Greek company that moved its COMI to England for 2010 and 2011 restructurings, prompted claims that “England has become a bankruptcy brothel” • Rodenstock / Metrovacesa – German and Spanish companies with English law governed finance documents, deemed sufficient to fall within English court’s jurisdiction for purpose of a Scheme of Arrangement notwithstanding relatively weak other links to England
10 UK Administration and Pre-Pack Sales • Overriding purpose of Administration is to rescue company as a going concern. If not reasonably practicable, then Administrator must try to achieve a better result than would be achieved in a winding up. If not reasonably practicable, then Administrator may realise property to make distributions to secured creditors • Administration creates a moratorium during which no insolvency proceedings can be initiated, and no enforcement of security permitted, without the consent of the Administrator or the court • Creditors able to select administrator of their choice, but must be licensed insolvency practitioner • Administrator has extensive powers: can do all things necessary for carrying on the business of the company, can dismiss directors, can sell property, can make distributions • Creditors’ Committee appointed, but has very weak powers, and is principally consultative • Administration often used in conjunction with a pre-packaged sale of the business or assets of an insolvent company where the sale is concluded immediately after the appointment of the administrator • Sale can be to a third party or to some or all of the company’s creditors, e.g. Wind Hellas • Administrator needs to be comfortable with the price obtained or can face liability • Pre-packs of overseas companies have been implemented following a shift of COMI under the EC Regulation
11
UK Scheme of Arrangement
• Not an insolvency procedure, but a mechanism contained in Part 26 of the Companies Act 2006, which allows the court to sanction a “compromise or arrangement” that has been agreed between the relevant class(es) of creditors or members and the company • Scheme binds members or creditors within a class, regardless of any contractual restrictions • For a Scheme to be approved, a majority in number of creditors, representing three quarters in value, in each class of those voting on the Scheme must vote in favour of it • A Scheme also requires the sanction of the court • Courts will sanction Scheme of a company that has a “sufficient connection” with England, including the choice of English law and jurisdiction in finance documents (e.g. Rodenstock) • Schemes are widely used by overseas companies to restructure English law governed finance documents (which are commonly used in Europe)
12 Case Studies Rodenstock
Rodenstock: Scheme of Arrangement
Facts Key Factors Outcome
• Europe’s fourth largest • Court considered three • Court concluded that the Scheme manufacturer and distributor of discretionary factors: should be sanctioned spectacle lenses and frames • sufficient connection with • Incorporated and had its COMI in England based solely on the Germany exclusive jurisdiction clause in the SFA; • No assets or establishment in the UK, but was party to an English law • Scheme would be effective in SFA with an exclusive jurisdiction binding the opposing creditors, clause in favour of the English based on expert opinion that courts the Scheme would be legally effective in Germany; and • Applied to the court for the sanction of a Scheme of Arrangement that • Scheme was one which, amended the terms of the SFA objectively, an intelligent and honest creditor acting in its own • A small group of lenders submitted interests might reasonably evidence to the court opposing the approve Scheme on the basis of jurisdiction and discretion
13 UK Local Processes Compared to Chapter 11
CHAPTER 11 FEATURE UK
Debtor in Possession Insolvency practitioners take control of company Company Exclusivity (Filing of Plan) Cram Down (Plan binding on For instance, Scheme of Arrangement or CVA all creditors) Court driven process Most processes have some court involvement, although recent reforms introduced “out of court” administration
DIP Financing No alternative to DIP Financing, however open to parties to structure rescue financing typically done by contractual agreement Creditors Committee Exist, but limited role Active, specialist courts Sophisticated regime and experienced judges, but no Bankruptcy Court per se Wrongful trading concept (none in US)
14 European Insolvency Overview – France France General Observations
• Generally seen as a debtor-friendly jurisdiction • Workouts are done on an entirely consensual basis or under one of France’s pre- bankruptcy workout procedures with court supervision • Main restructuring process is sauvegarde, the primary aim of which is to encourage reorganisation at an early stage • French judiciary is relatively unsophisticated and inflexible (civil law jurisdiction) • Unlike in some other European jurisdictions, the sauvegarde procedure is relatively commonly used by French companies, and over the past few years we have seen a number of sauvegarde cases such as Eurotunnel, Belvédère, Coeur Defense and Thomson (now known as Technicolor) • French courts generally willing for the sauvegarde plan to affect a French group which includes companies from other jurisdictions (e.g. Belvédère plan affected a number of Polish companies, Coeur Defense plan affected a Luxembourg parent company (recently confirmed by the Court of Appeal)) – this extra-territorial reach can mean that a complex group structure can be restructured through a sauvegarde process
16 France General Observations
• Sauvegarde triggers an automatic stay on enforcement (subject to very few exceptions) • Certain limitations on sauvegarde: • No ability to affect shareholders without their consent. This has led to a number of situations where the equity receive more than they would normally be due to receive, as effective consideration for them consenting to be bound by the sauvegarde process (in Thomson, the existing equity received 15% of the new enlarged equity) • Despite accelerated procedure, no ability to effect a pre-packaged sale through the sauvegarde procedure (cf. administration sale in England) • Court is debtor-friendly and ex parte communications are common
17 France Sauvegarde Compared to Chapter 11 CHAPTER 11 FEATURE FRANCE Debtor in Possession Directors/managers retain control, but are supervised and assisted by the administrateur judiciaire
Company Exclusivity Creditors do not have the power to propose a plan themselves (proposals are (Filing of Plan) made by the company)
Cram Down Dissenting minority within each committee / class can be crammed down (by a 2/3 (Plan binding on all creditors) majority in value)
Court driven process An insolvency judge is appointed in the opening judgment to oversee the whole process
DIP Financing Post-petition claims arising for the purpose of funding the observation period or in connection with goods or services provided to the company for the running of its activities during that period (such claims benefit from a statutory privilege)
Creditors Committee Two creditors “committees” (banks and major suppliers) and one separate group of bondholders, but do not really operate as committees; they are really voting classes
Active, specialist courts No specialist insolvency courts
Wrongful trading concept Failure to file for insolvency within the statutory maximum period of 45 days is no (none in US) longer criminally sanctioned, but non-pecuniary / professional sanctions can be ordered
18 European Insolvency Overview – Germany Germany General Observations
• Generally favourable to creditors; however, changes to the German Insolvency Code (Insolvenzordnung) effective from 1 March 2012 have: • simplified the applicability of self-administration proceedings, and • introduced a special type of self-administration proceeding, the protective shield proceeding • German law does not currently provide for formal out-of-court restructuring procedures • Under German insolvency law, insolvency proceedings consist of two stages: (i) the preliminary proceeding and (ii) the final insolvency proceeding • The final insolvency proceeding can be formed as a regular insolvency proceeding or as an insolvency plan proceeding • The protective shield proceeding enables the management of the company to apply for self- administration and agree with its main stakeholders on a pre-packed insolvency plan before the opening of final insolvency proceedings • Over-indebtedness and illiquidity are mandatory legal grounds, while imminent illiquidity is the optional legal ground for the opening of insolvency proceedings
20
Germany General Observations
• Management of the company is under a stringent duty to file for insolvency without undue delay (in no case later than three weeks) following the establishment of one or more of the mandatory insolvency grounds – otherwise they risk personal, civil and criminal liability • Shareholder loans generally subordinated in an insolvency of the debtor • Upstream and cross-stream guarantees and other collateral can only be given in limited circumstances by German corporate entities • There is a potential risk of lender liability in connection with lending to a distressed borrower if the viability of a restructuring plan is not carefully assessed
21 Germany Local Process Compared to Chapter 11
CHAPTER 11 FEATURE GERMANY Debtor in Possession Protective Shield Proceeding / Self-Administration Proceeding
Company Exclusivity Insolvency Administrator and company can file plan (Filing of Plan) Cram Down Insolvency Plan Proceeding (Plan binding on all creditors) Court driven process
DIP Financing
Creditors Committee Active, specialist courts Wrongful trading concept Most file within three weeks (none in US) Liability of management for payments after illiquidity or over- indebtedness, if not acted as a prudent business person
22 European Insolvency Overview – Spain Spain General Observations
• Generally, a debtor-friendly jurisdiction (as formal insolvency processes are extremely unattractive) • Insolvency in Spain (concurso) has traditionally been a very lengthy and difficult process, so pre-insolvency procedure (where the debtor can obtain some time to try to reach agreements with its creditors for 4 months) is being used frequently • Spain has some onerous documentation requirements: restructuring documents are frequently “public deeds” that are notarised by the public notary, in order to qualify as prima facie evidence of the obligations and thereby qualify for a shorter court enforcement procedure • c.97% of insolvencies ended up in liquidation • Spanish insolvency process is burdensome and not recommended as it typically results in significant value deterioration
24 Spain General Observations
• Insolvency Act has recently been substantially amended in order to introduce concepts similar to cram-down mechanisms and DIP financing (a reaction to current economic climate) but these have not yet proven to be helpful • Not yet much guidance available on how the new laws will be interpreted by the courts, and there are a number of ambiguities and uncertainties within the drafting of the new laws • Key concept introduced recently is a safe harbour for clawback risk in the form of a creditor- approved “Refinancing Agreement” • Prioritised treatment of up to 100% of new money (50% super priority, 50% privileged) is intended to incentivise investors to provide rescue financing • Refinancing Agreements, together with cram down mechanism (i.e court homologation only needs to be approved by 75% of financial institution creditors - an amendment has recently been approved to reduce this to 55%), could also enable rescue financing to be put in place in circumstances where unanimous consent from the financial institutions is not forthcoming
25 Spain Concurso Compared to Chapter 11
CHAPTER 11 FEATURE SPAIN
Debtor in Possession Directors remain in control if voluntary concurso (although decisions to be authorised by insolvency administration); if mandatory concurso, directors do not remain in control
Company Exclusivity Creditors can also file it at a later stage (Filing of Plan)
Cram Down Although not binding on secured creditors or equity (Plan binding on all creditors)
Court driven process
DIP Financing But no non-consensual layering of security allowed (in both concurso and pre-insolvency proceedings)
Creditors Committee
Active, specialist courts Extremely slow process
Wrongful trading concept Partially (directors liability) (none in US)
26 European Insolvency Overview – Netherlands Netherlands General Observations
• Two types of insolvency proceedings governed by rules of Dutch Bankruptcy Code • Suspension of payments • Bankruptcy • In bankruptcy, certain transactions can be declared void by the trustee on the basis of fraudulent conveyance. Outside of bankruptcy, creditors have similar rights (i.e. as opposed to relying on the trustee to enforce these rights) • Suspension of payments often converts into bankruptcy in practice • Creditors have limited rights to influence the bankruptcy proceedings • c.95% of all bankruptcy proceedings end with the liquidation of the company • Moratorium may be granted in both bankruptcy and suspension of payments proceedings
28 Netherlands Akkoord / Composition
• During suspension of payments / bankruptcy, company may propose an akkoord or composition to its unsecured creditors. If such composition is rejected, no new composition may be offered at a late stage • Composition is a binding settlement agreement between company and unsecured creditors • No specific requirements as to terms and conditions or contents of composition • Composition requires approval of the majority of the unsecured, non-preferred and admitted creditors, representing at least 50% of the unsecured, non-preferred and admitted claims • If proposed composition is rejected by creditors / court, the trustee will continue liquidation of the company • In practice, compulsory liquidation commences from the beginning of bankruptcy but will be cancelled if it is likely a composition will be offered or if the company is sold as a going concern
29 Netherlands Local Process Compared to Chapter 11 CHAPTER 11 FEATURE NETHERLANDS
Debtor in Possession
Company Exclusivity (Filing of Plan)
Cram Down Plan binding on all unsecured, non-preferred and admitted creditors (Plan binding on all creditors)
Court driven process
DIP Financing No formal procedure; financing provided on case by case basis
Creditors Committee
Active, specialist courts Each court has special bankruptcy section
Wrongful trading concept With respect to dividend payments, directors who knew (or (none in US) reasonably should have known) that the company would no longer be able to continue to pay its due and payable debts, may be held personally liable for the deficit which has occurred pursuant to the dividend payment
30 Special Topics Special Topics Historical landscape for HY bonds in Europe
Restructuring landscape for high yield bonds in Europe back in 2000: • No historical high yield bond market • All court processes essentially liquidations • Limited availability of restructuring regimes, particularly to bind classes • No availability of DIP loans
Addressing these issues: • Exchange offers where possible • Pioneered use of schemes of arrangement in UK, Dutch Akkoord in Netherlands, e.g. Versatel, Song Networks, Completel, Marconi
32 Special Topics How have things changed?
How have HY bond structures moved on in Europe? • Record issuance • More senior secured bond debt • Incurrence based HY covenants • Weighted voting of banks in senior secured notes • 90% voting threshold
Is this going to have any impact on how we go about restructuring bonds? • Limitation on use of procedures, e.g. Dutch Akkoord, Swedish composition • More forum shopping to UK for scheme of arrangement • Increased impact of Chapter 11
33 Special Topics Chapter 11 as a restructuring tool Has there been any historical use of Chapter 11 to restructure HY bonds for European companies? • Relatively little (cost, familiarity) • In some cases for: • Securities law purposes to make use of 1145, e.g. Versatel • Automatic stay on termination of contracts, e.g. MPF, Cenargo, Petromena, Monitor Oil • Use of European Intercreditor: Truvo
How did these companies obtain jurisdiction in the US? • US parents with group filings e.g. Truvo, Viatel • Partial jurisdiction, e.g. MPF, Remedial Offshore, Petromena • Tenuous jurisdiction, e.g. Monitor Oil • Manufactured jurisdiction, e.g. Cenargo
34 Special Topics Chapter 11 as a restructuring tool
What is the requirement for a non-US debtor to file in the US? What is the current state of play in the courts?
• 109 • Funds in bank account • Holding shares in US subs sufficient in Delaware
Have local creditors and bondholders always accepted the US filings? • Cenargo (Lombard provisional liquidation in UK) • Monitor Oil (bondholder abstention application) • Petromena (Jurong application)
Are there developments or issues in the US that bondholders need to be worrying about, or any benefits to Chapter 11? • DIP funding / stay on termination • Equitable subordination • Clawback / litigation in Chapter 7 • Disclosure 35
Special Topics Recognition Will Chapter 11’s usually be recognised on the continent? • Private international laws
• UNCITRAL
When using a European process to restructure a HY bond, will this be recognised in the US? • US jurisdiction clauses • Chapter 15
36 Special Topics Sovereign Debt Restructurings
• Many sovereign bonds are governed by English law • Collective action clauses common, but generally limited to particular issues or series of bonds • If governed by local law, risk that law may change • Bondholder meetings and voting requirements may cause issues • Sovereign immunity raises similar issues to those in the US • BUT political imperatives always trump, and make local law bonds particularly risky investments (e.g. Greece)
37 Special Topics Example of European “Freefall Insolvency” – Petroplus
• Illustrates that EC Regulation does not always solve the problems of a cross border European group • One of Europe’s largest refining companies – very complex group structure with numerous intercompany loans • Refineries in France, Germany, Switzerland, Belgium and UK • Headquarters in Switzerland
• Example of disorganised and dramatic “freefall” insolvency that happened in a matter of days
Petroplus Holdings AG $150m Convertible Bonds (2015) $1.6bn Senior Bonds (2014, 2017, 2019)
Petroplus International B.V. Petroplus Finance Limited
Petroplus Marketing AG Belgian Petroplus Refining Raffinerie Corporation Ingolstadt N.V. GmbH
Petroplus Finance 2 Limited Petroplus Petroplus Refining & Marketing Ltd Petroplus Holdings France SAS Refining Cressier SA
38 Special Topics Example of European “Freefall Insolvency” – Petroplus
DECEMBER 2011/JANUARY 2012
M T W T F S S
Dec 27 28 29 30 31 Jan 1 Bank lenders Provisional freeze $1bn financing uncommitted agreement with credit line, share bank lenders and price falls by announcement more than 40% to shut down the same day refineries in France, Belgium and Switzerland
2 3 4 5 6 7 8 Bank lenders freeze Company's remaining credit facility
9 10 11 12 13 14 15 Temporary agreement between Company and bank lenders
39 Special Topics Example of European “Freefall Insolvency” – Petroplus
JANUARY 2012 M T W T F S S 23 24 25 26 27 28 29 Swiss stock PwC appointed • Swiss holding Belgian Refinery exchange Joint company of Corporation N.V. announces Administrators of the Petroplus file for judicial suspension of Petroplus group, and its reorganisation the Company’s Refining & Swiss proceedings shares Marketing subsidiary file Limited and for Petroplus composition Refining proceedings Teesside • Petroplus’ Limited, both UK French entities subsidiaries placed in rehabilitation proceedings • Petroplus’ German subsidiaries file for insolvency proceedings
40 Special Topics
Example of European “Freefall Insolvency” – Petroplus
• 6 August 2012 – Netherlands Petroplus International B.V. declared bankrupt • 24 August 2012 – Bermudan entities Petroplus Finance Limited and Petroplus Finance 2 Limited wound up
• Extremely messy process • Very limited co-operation amongst European insolvency practitioners, due to intercompany position, most estates have claims against other estates • Limited transparency on process and timing of distributions • No real co-operations between European insolvency practitioners • No single jurisdiction is dominant in the process
41 Case Studies Case Studies Bulgarian Telecom
Bulgarian Telecom: Scheme of Arrangement
Facts Key Factors Outcome
• Former incumbent telecom • Two banks heavily exposed • Consensual restructuring operator in Bulgaria privatised and through all tranches but most eventually achieved based on sale subsequently on-sold concentrated in junior debt - giving to third party and substantial write- rise to conflicts downs of 1st lien debt • Weak telecoms regulation and extensive litigation resulting in poor • Implementation of non-voluntary • Co-investment rights for 2nd lien performance against plan restructuring uncertain due to lack and mezzanine lenders of precedent in Bulgaria and • EUR 1bn of 1st lien debt, EUR • Implementation by English sponsor challenge to Dutch 200m of 2nd lien debt and EUR schemes of arrangement based on security 400m of Mezzanine, giving English law and jurisdiction leverage of 7x • Mezzanine partnered with new operator to propose deal but • Dutch holding companies borrower projections ratcheted down of Holdco facility while Bulgarian company borrower of Opco facility • Sale process commenced after lengthy negotiations with • English law loan facilities with mezzanine proved unsuccessful English law intercreditor agreement permitting release of 2nd lien and • Government and local interests mezzanine on enforcement considered vital to outcome – though eventually influence uncertain
43 Case Studies Wind Hellas
Wind Hellas (2010): Scheme of Arrangement + Administration Pre-Pack
Facts Key Factors Outcome
• Third largest telecommunications • Consent of RCF and SSNs • SSNs own Newco, which in turn provider in Greece required in order to trigger owns Wind automatic release in ICA of SUNs • Owned by Egyptian mogul, Naguib • SUNs remain in old group Sawiris • RCF would not consent unless paid off in full • COMI shift to the UK in 2009, • RCF fully repaid following which Wind was bought • SSNs effected a debt for equity • New group virtually debt free by a Sawiris controlled vehicle, swap by means of a Scheme of Weather Finance III via a pre-pack Arrangement administration sale • RCF and SSNs instructed Security • €1.8m debt comprising RCF, Agent to sell Wind to Newco by hedging, Senior Secured Notes means of an administration pre- (SSNs) and Senior Unsecured pack sale Notes (SSNs) • Release provision required cash bid, hence used daylight facility and round tripped waterfall proceeds • Security Agent invoked release provision in ICA to release security and guarantees
44 Case Studies Invitel
Invitel Group: Complex Consensual Restructuring
Facts Key Factors Outcome
• Owned by Mid Europa Partners • Complex cross border • Restructuring Agreement Limited, a private equity firm elements reached with approx. 40% of outstanding Noteholders, • Offers wide range of • Sponsor/Noteholderr control increased to 70% telecommunication s services in issues Hungary; is the second largest • COMI shift to England and • Large retail component in the fixed line provider in Hungary Scheme of Arrangement and SSNs Consent Solicitation to be run • Dutch Issuer of €329m Senior • Tax together Q4, 2013 Secured Notes (SSNs) listed on
the Lux stock exchange is the • €155m of Reinstated Notes, with parent of two main Hungarian remaining balance converted Opcos into 49% of equity in the Group • Challenging trading • Sponsor invests €25m and environment, and special taxes retains 51% of equity in Group imposed by the Hungarian government led to inability to make a coupon payment
45 Case Studies Truvo
Truvo: Chapter 11
Facts Key Factors Outcome
• Belgian yellow pages business co- • Capital structure included five US • Company agreed plan support owned by Apax and Cinven, holding companies giving agreement with banks and filed for experienced severe decline in jurisdiction in New York chapter 11 in New York 2008/9 • However, chapter 11 would not • Plan of reorganization was pre- • EUR 1.1bn cov-lite senior loan provide any means of releasing agreed and provided for sale of governed by English law owed to a guarantees and security of equity in US holdco to the banks syndicate of banks European subsidiaries unless they • To meet requirements in were Debtors • EUR 645m of New York law high intercreditor agreement, the banks yield bonds, subordinated to senior • Intercreditor agreement contained circulated funds from a daylight debt by English law intercreditor provision – common in European facilty to acquire the equity agreement intercreditors – allowing banks to • Bond claims and guarantees then force release of bond claims and • Cov-lite loan did not allow action by released by the banks using power guarantees banks although they were likely to in the intercreditor agreement be impaired at maturity while • Intercreditor release provision • Settlement reached with subordinated bonds were receiving required any enforcement sale to bondholders following litigation coupons be in cash and to discharge the bank debt in full • Combination of chapter 11 and • Issuer and bonds were unable to English law intercreditor agreement reach a consensual restructuring • Bondholders organised but key to implementation constrained by conflicts of interest
46 MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
UK (England & Wales)
James Roome, Tom Bannister and Paul Durban www.practicallaw.com/9-501-6812 Bingham McCutchen (London) LLP
FORMS OF SECURITY Floating charge. A floating charge secures a group of assets, which fluctuate with time, such as cash in a trading 1. What are the most common forms of security granted over bank account. Assets secured by a floating charge are immovable and movable property? What formalities must the identified generically rather than individually (for example, a security documents, the secured creditor or the debtor comply borrower’s undertaking and assets or inventory). with? What is the effect of non-compliance with these formalities? Unlike a fixed charge, a floating charge allows the borrower to deal with the charged assets in the ordinary course of business Immovable property without the charge holder’s consent. If certain events occur Common forms of security. The most common forms of security (usually events of default set out in the charging instrument), over immovable property are: the floating charge effectively becomes a fixed charge in relation to all assets over which it previously “floated”, and which remain Mortgage. A mortgage is a transfer of ownership in land or in the borrower’s possession. At this point, the floating charge other property to secure the payment of a debt or to discharge crystallises and the borrower is then unable to dispose of the some other obligation. The debtor has a right of redemption, assets without the lender’s consent. under which the creditor must transfer title back to the debtor when the debt is repaid or the obligation discharged. In the order of payment on an insolvency, floating charge holders Fixed charge. A fixed charge is typically taken over a specific, rank behind fixed charge holders and certain other creditors (see valuable asset (such as land, machinery, ships or aircraft). Question 2). Title and possession remain with the borrower, but the Pledge. A pledge is a way to create security by delivering an borrower cannot usually dispose of the asset without the asset to a creditor to hold until an obligation is performed (for lender’s permission or until the debt is repaid. This can cause example, a debt is repaid). The creditor takes possession of Country Q&A difficulties where the relevant assets (for example, accounts the asset while the debtor retains ownership. The creditor can receivable) are used in the ordinary course of the borrower’s sell the pledged asset if the obligation is not performed. business and therefore floating charges are used in these cases (see below, Movable property: Floating charge). Lien. A lien is the right to retain possession of another person’s property until a debt is settled. Liens arise A lender holding a fixed charge has recourse to the asset if the automatically under English law in certain types of borrower defaults under the loan. The lender usually has a power commercial relationships, such as a client’s relationship of sale over the asset, or the power to appoint a fixed charge with his solicitors or bankers. They can also be created receiver to deal with and realise the asset on its behalf (because contractually. A lien does not confer a right on the holder to of concerns over lender liability, the second option is normally dispose of the relevant asset if the debt is not paid. used). The lender therefore has a claim over the proceeds of sale in priority to other creditors. Where the sale proceeds are less Formalities. Formalities for creating a security interest depend on than the amount of the loan, the lender has an unsecured claim the nature of the asset over which security is to be granted and for the balance, but if there is a surplus after repayment of the the nature of the security interest to be granted. loan, the balance must be returned to the borrower. To be effective against liquidators, administrators and buyers of A fixed legal mortgage or charge is the best security interest relevant assets for value, most mortgages and fixed charges, and available as it gives the secured lender a proprietary interest in the all floating charges created by a company must be registered with asset ahead of the costs and expenses of office holders appointed Companies House within 21 days of their creation. Registration on an insolvency (other than those of the receiver appointed by the is not a requirement for attachment; an unregistered charge is lenders), and the claims of floating charge holders, preferential effective against the company provided it is not in liquidation or creditors and unsecured creditors (see Question 2). administration.
Movable property Pledges and liens do not require registration.
Common forms of security. The most common forms of security Security over certain assets may also require registration at specialist over movable property are: registers (for example, land, certain intellectual property rights,
Mortgage and fixed charge. See above, Immovable property. ships and aircraft).
© This article was first published in the Restructuring and Insolvency multi-jurisdictional guide 2013/14 and is reproduced with the permission of the publisher, Practical Law Company. MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
Effects of non-compliance. If these security interests are not sometimes provide for title to be retained by the trade creditor until registered, these charges will be void against secured creditors, all outstanding amounts due to the trade creditor have been paid and against a liquidator or administrator and creditors generally (and not simply the price for the particular goods sold). in a liquidation. Difficult issues can arise where goods which are subject to a retention of title clause are mixed or incorporated with other CREDITOR AND CONTRIBUTORY RANKING goods as part of a manufacturing process or the clause provides that, if the buyer sells the goods, it must account to the trade 2. Where do creditors and contributories rank on a debtor’s creditor for the sale proceeds. insolvency?
4. Can creditors invoke any procedures (other than the formal In corporate insolvencies, creditors and shareholders are paid in rescue or insolvency procedures described in Question 6 the following order of priority: and 7) to recover their debt? Is there a mandatory set-off of mutual debts on insolvency? Fixed charge holders. Fixed charge holders are paid up to the amount realised from the assets covered by the fixed charge (net of the costs of realising those assets). If the value of Court judgment the charged assets is less than the amount of the debt, the charge holder can claim the balance as an unsecured creditor An unpaid creditor can bring proceedings against a debtor seeking (or under any valid floating charge in its favour). a judgment for the debt. If the debt is undisputed, judgment can be sought on a summary basis. Liquidators. Liquidators’ fees and expenses have priority over preferred creditors and floating charge holders (subject Once judgment has been obtained, the creditor can enforce it by to restrictions relating to certain expenses which have not seeking either: been authorised or approved by floating charge holders, A charging order over the debtor’s property. by preferential creditors or the court) (see Question 14, Insolvency expenses regarding liabilities under financial An order requiring a third party to pay a receivable due to support directions issued by the Pensions Regulator). the debtor to the judgment creditor instead.
Preferred creditors. Preferred creditors are mainly Receivership employees with labour-related claims (such as unpaid wages and contributions to occupational pension schemes). Receivership is an out-of-court enforcement mechanism for secured creditors. If the debtor defaults under the relevant Floating charge holders. Floating charge holders are paid up security documents, the secured creditor can appoint a receiver to the amount realised from the assets covered by the floating over secured assets to satisfy its debt. charge. From 15 September 2003, part of the proceeds from realising assets covered by the floating charge must Any duty the receiver owes to the company, its directors, other be set aside and made available to satisfy unsecured debts creditors and shareholders is secondary to the receiver’s duty to (prescribed part). The prescribed part is calculated as 50% realise the charged assets on behalf of the appointing chargee. of the first GB£10,000 of net floating charge realisations and 20% of the remainder, subject to a cap of GB£600,000. The There are two main types of receivership under English law:
Country Q&A prescribed part must not be distributed to floating charge Administrative receivership. Under the Insolvency Act 1986 holders, unless the claims of unsecured creditors have been (see Question 6, Administrative receivership). satisfied and there is a surplus. Fixed charge receivership. Where the creditor has fixed Unsecured creditors. Unsecured creditors are creditors who charges over specific assets, the creditor can appoint one or do not have a security interest in the debtor’s assets. more fixed charge receivers over those specific assets. The Interest. Interest incurred on all unsecured debts post- receiver’s main function is to sell the charged assets and to liquidation. account to the creditor for the sale proceeds (net of costs). A fixed charge receiver need not be an authorised insolvency Shareholders. Any surplus goes to the shareholders practitioner. according to the rights attached to their shares. Insolvency set-off UNPAID DEBTS AND RECOVERY The rules of insolvency set-off are mandatory and cannot be varied by contract. Where a creditor proves in a liquidation or 3. Can trade creditors use any mechanisms to secure unpaid administration (see Question 6 and Question 7, Liquidation), debts? Are there any legal or practical limits on the operation an account must be taken of the mutual dealings between the of these mechanisms? creditor and the company in liquidation or administration. The sums due from one party will be set off against the sums due from the other, except that sums due from the insolvent party will not The main mechanism used by trade creditors to secure unpaid be taken into account if the other party had notice, at the time debts is a retention of title clause in sale contracts. This provides they were incurred, of: that title in goods does not pass from the trade creditor to the buyer A resolution or petition to wind up. until it has received full payment for the goods. These clauses
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). The administration procedure is a way of facilitating The administration procedure is a way of facilitating www.practicallaw.com/restructure-mjg An administrator can be appointed by court order. An An administrator can be appointed by court order.
jurisdiction? One or more creditors of the company. One or more creditors of the company. A company through its directors or shareholders. Qualifying floating charge holders. The company. directors. The company’s
There is also an out-of-court procedure for placing a company in administration, which is available to both: Administration Objective. of its assets. It a rescue of a company or the better realisation with protection allows an insolvent company to continue to trade ( from its creditors through a statutory moratorium Conclusion the company as a The main aim of administration is to rescue thinks this is not if the administrator going concern. However, be achieved for reasonably practicable or that a better result can to achieve a better creditors as a whole, the second objective is is likely if the company is creditors than result for the company’s wound up (without first being in administration). the administrator The third objective, which only applies if thinks it is not reasonably practicable to achieve the first two objectives and if it will not “unnecessarily harm” the interests of the creditors as a whole, is to realise property to distribute the proceeds to the secured or preferential creditors. The 2002 Act does not explain what constitutes “unnecessarily harming” and it still remains to be seen what practical impact this will have on an decision to sell assets. administrator’s Initiation. application is usually made by: Enterprise Finance Guarantee Enterprise launched the Enterprise 2009 the UK government In January scheme is a loan guarantee (EFG). The EFG Finance Guarantee and bank lending to small additional aimed at facilitating (SMEs) with viable business cases but medium-sized enterprises By providing lenders with a government- insufficient security. aim is to facilitate lending that would backed guarantee, the and to ensure that SMEs can obtain otherwise not be available investment they require. the working capital and Service Business Payment Support Revenue & Customs (HMRC) introduced In late 2008, the UK HM Service (BPSS) to meet the needs a Business Payment Support by the economic downturn. The BPSS is of businesses affected who are experiencing difficulties in available to all businesses and on time. Although the HMRC review paying tax due in full scope to suggest each case on an individual basis, there is as arranging for tax payments to tailored options (such temporary, be made over a longer period). PROCEDURES RESCUE AND INSOLVENCY 6. procedures in your What are the main rescue/reorganisation about this publication, please visit about Practical Law Company, please visit about Practical Law Company, for reform proposals). Question 14 FOR MORE FOR INFORMATION Transfer of the banking business to a third party, to to a third party, of the banking business Transfer facilitate a private sector solution. business to a publicly bank’s of all or part of the Transfer controlled ‘’bridge bank’’. of the bank into temporary public sector ownership. Transfer An application for an administration order or notice of an order or notice of an for an administration An application appoint an administrator. intention to
Special rescue and insolvency procedures for banks Special rescue and insolvency procedures for force in February The Banking Act 2009 (2009 Act) came into 2009 Act is the 2009. The most significant aspect of the the government special resolution regime (SRR) which gives and other deposit- authorities various powers to deal with banks mechanisms are taking institutions which are failing. The rescue SRR provides for referred to as “stabilisation powers” and the three stabilisation options in relation to UK banks: STATE SUPPORT STATE 5. for distressed businesses available? Is state support The process to recover cross-border debts is complex and the costsThe process to recover cross-border a debtor with assets in several memberof recovering a debt from Parliament the European However, states can often be prohibitive. proposals for the freezing and disclosurehas recently approved draft cases. The proposed remediesof debtors’ assets in cross-border orders (andappear to be similar in nature to English law freezing addition to thoseancillary disclosure orders) and would be in Further details, including the remedies available under national law. implementation,application procedure and time frame for possible are still under discussion (see Cross-border debt recovery MULTI-JURISDICTIONAL GUIDE 2013/14 MULTI-JURISDICTIONAL AND INSOLVENCY RESTRUCTURING The 2009 Act also introduces new insolvency and administration regimes for banks and building societies. The main features of the new bank insolvency procedure are based primarily on the existing liquidation provisions of the Insolvency Act 1986. The new bank administration procedure is to be used when part of the business of the bank has been sold to a third party or transferred to a “bridge bank” under the SRR and a bank administrator is appointed by the court to administer the affairs of the insolvent residual bank. Certain amendments to the 2009 Act have recently been introduced by the Financial Services Act 2012 (2012 Act). These largely relate to technical amendments to the SRR, in particular changes to reporting requirements following the use of stabilisation powers and compliance with EU commitments, particularly state aid. The 2012 Act also extends the SRR and the bank administration procedure to investment firms as it applies to banks and the SRR to UK clearing houses with certain modifications. All amounts, including future, contingent and unliquidated sums, and unliquidated including future, contingent All amounts, are brought into account. insolvency set-off takes place as In the case of an administration, of the intended distribution is issued at the date on which notice retrospective effect as at the date of by the administrator with administration. MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
Administration is potentially available to both UK and foreign- Length of procedure. The administrator’s appointment terminates registered companies. The rules concerning cross-border one year after the date the appointment took effect. However, insolvencies are complex but the availability of the administration the appointment can be extended by the court for a specified procedure generally depends on a company’s centre of main period, or with the creditors’ consent for a period not exceeding interest (COMI) being located in the UK. A company’s COMI six months. depends on where it conducts the administration of its interests on a regular basis and should be ascertainable by third parties Conclusion. An automatic statutory moratorium, which comes (see Question 13). into effect when an application for administration or a notice of intention to appoint an administrator is filed, helps the Substantive tests. In most cases, an administration cannot begin administrator achieve the objectives of the administration. The unless it can be demonstrated that both: moratorium is a stay on creditors from taking any legal action or enforcing their security against the company or its property. The company is, or is likely to become, unable to pay its debts. There is no direct impact on employees if an administrator is appointed Administration is likely to achieve one of the purposes (see and the procedure does not interfere with company contracts. above, Objective). The way in which an administration is concluded depends on its If a qualifying floating charge holder appoints an administrator, objective. Administration usually results in one or more of the there is no requirement for the company to be insolvent, following: although the floating charge underlying the appointment must The administrator selling the company’s assets and be enforceable. distributing their proceeds to creditors and shareholders.
Consent and approvals. Where the court appoints the administrator, A composition of creditors’ claims through a company the applicant must notify any qualifying floating charge holder. voluntary arrangement (see below, Company voluntary If a qualifying floating charge holder has already appointed an arrangement). administrator or administrative receiver, the court does not usually A scheme of arrangement (see below, Scheme of arrangement). grant an administration order. Where the appointment is made out of court, the company or its directors must give all persons Liquidation and dissolution of the company (see Question holding a qualifying floating charge five business days’ written 7, Liquidation). notice of their intention to appoint an administrator, who must also be identified in the notice. This is to enable a qualifying floating Company voluntary arrangement charge holder to appoint its own administrator if it does not approve Objective. A company voluntary arrangement (CVA) is a form of of the company’s or directors’ proposed choice. statutory composition between a company and its creditors. Its aim is to enable a company in financial difficulty to propose a Supervision and control. One or more licensed insolvency compromise or arrangement with its creditors. practitioners can be appointed as administrators. The administrators: Initiation. A CVA can be commenced by a company’s directors, or
Are officers of the court (whether or not appointed by the if the company is already in administration or liquidation, by the court) and act as the company’s agent. company’s administrators or liquidators.
Country Q&A Have very extensive management powers (see Question 11). A copy of the proposed arrangement is filed in court, but the court has no active involvement in the procedure. While it does Have investigatory and enforcement powers, including powers to apply to the court to unwind pre-insolvency not need to be prefaced by an administration, it is often used transactions (see Question 10, Challenging pre-insolvency in conjunction with administration because a CVA does not transactions). itself provide for a moratorium unless the company is a “small company” (this is based on the company’s financial returns). The directors’ management powers generally cease although A CVA is available to the same companies as for administration the administrator may leave some or all of the powers with the (see above, Administration: Initiation). directors of the company. (For information regarding carrying on the business during insolvency, see Question 11.) Substantive tests. There are no formal requirements that a company must satisfy to be placed into this procedure. Therefore, Protection from creditors. See below, Conclusion. The the company does not need to demonstrate that it is, or is likely administration does not prevent trading parties cancelling to become, insolvent. contracts with the company. It is a typical term of many contracts (including intellectual property licences) that the agreement may Consent and approvals. A CVA must be approved by creditors be terminated upon the company entering into an insolvency holding at least 75% in value of the claims held by all unsecured procedure, such as administration. The administrator is given creditors voting at a meeting convened for this purpose. no power (unlike a liquidator; see Question 7, Liquidation) to Shareholders must also approve the CVA by a majority vote, but disclaim onerous property. However, an administrator can cause if the creditors approve the CVA and the shareholders do not, the insolvent company to breach the terms of the contract and the creditors’ approval prevails (although dissenting shareholders allow the counterparty to sue for damages. If successful, the can challenge the CVA by applying to the court on the grounds of counterparty would rank as an unsecured creditor. unfair prejudice or procedural irregularity).
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.) There is no moratorium so creditors There is no moratorium The directors of the company remain The directors of the company No consent or approval is required. Question 11 The duration of a scheme depends on its terms. The duration of a scheme The appointment of an administrative receiver www.practicallaw.com/about/practicallaw
Once the scheme has been sanctioned by the court Once the scheme has www.practicallaw.com/restructure-mjg Any holder of a floating charge over all or substantially Administrative receivership is an out-of-court enforcement
Voted to reject the scheme. Voted Did not attend the scheme meeting. Did not receive notice of the scheme.
Secured creditors can also be bound if their class approves the Secured creditors can also be bound if their scheme. the procedure does There is no direct impact on employees and not interfere with company contracts. its terms and the The scheme is concluded in accordance with company reverts to its former status. Administrative receivership Objective. legislative changesmechanism for secured creditors. As a result of Act), this processintroduced by the Enterprise Act 2002 (2002 and and generally only for securitisations is now used very rarely, regulated industries. satisfy a secured The mechanism is used to realise assets to debt. Any duty the administrative receiver owes to creditor’s and shareholders is its directors, other creditors the company, secondary to his duty to realise the charged assets on behalf of the appointing secured creditor. Initiation. assets created before 15 September 2003 all of a company’s can appoint one or more administrative receivers after an event of default. Subject to certain limited exceptions, the changes introduced by the 2002 Act now prevent the appointment of an administrative receiver in relation to floating charges created after 15 September 2003. Administrative receivership is available to a company incorporated in the UK. Substantive tests. is subject to the enforcement provisions contained in the security documents. Consent and approvals. (in person or by proxy) vote in favour of it. Once all required of it. Once all required or by proxy) vote in favour (in person the at the scheme meetings, approved the scheme classes have or approve it. the court to sanction parties request Supervision and control. regarding carrying on the business in control. (For information see during insolvency, Protection from creditors. action against the company up until the can take enforcement is sanctioned. In relation to company point at which the scheme is that a scheme will not interfere contracts, the default position company. with the contracts of the Length of procedure. Conclusion. it binds the and a copy of the order filed at Companies House, creditors who did company and all of its creditors, including any any of the following: ). about this publication, please visit about Practical Law Company, please visit about Practical Law Company, see above, Company voluntary .) FOR MORE FOR There is generally no protection but There is generally no If a proposal for a CVA is approved, it for a CVA If a proposal All classes of creditors affected by the see above, Administration The duration of a CVA depends on its terms. depends The duration of a CVA . The company must be liable to be wound up Question 11 ), a scheme of arrangement (scheme) enables a ), a scheme of arrangement (scheme) enables The CVA binds the company and all creditors, The CVA Like a CVA ( Like a CVA A scheme can be initiated by the company itself or by A scheme can be initiated by the company itself INFORMATION Scheme of arrangement Objective. arrangement scheme must approve the scheme. A class approves the scheme if at least 75% in value and more than half in number of the creditors in that class present and voting at the scheme meeting company to reach a compromise or arrangement with its creditors company to reach a compromise or arrangement or with certain classes of its creditors. Initiation. The process is relatively administrator or liquidator. the company’s as it involves both complex, time consuming and can be costly, various classes of applications to court and meetings of the by the scheme. creditors and shareholders who may be affected Since the preparatory steps of a scheme are not protected from creditor actions, when they are used in restructuring scenarios, they are often used in tandem with administration, which does provide a moratorium ( A scheme is generally available to companies registered in the it may also be available in the case of a non-UK UK. However, registered company which could be wound up in the UK, if it has its centre of main interest or an establishment in the UK or potentially some other sufficient connection. Substantive tests in the UK, but does not need to show that it is (or is likely to become) insolvent. Consent and approvals. Supervision and control. Supervision MULTI-JURISDICTIONAL GUIDE 2013/14 MULTI-JURISDICTIONAL AND INSOLVENCY RESTRUCTURING supervision of a licensed implemented under the is normally do everything directors must The company’s insolvency practitioner. handsof the company into the put the relevant assets possible to in otherwise remain The directors do, however, of this supervisor. regarding carrying on the business duringcontrol. (For information see insolvency, Protection from creditors. processes, including the enforcement of a moratorium on legal a CVA. is available for small companies contemplating security, one and three months. In relation The moratorium lasts between will not the default position is that a CVA to company contracts, of the company. interfere with the contracts Length of procedure. Conclusion. meeting orirrespective of whether they attended the creditors’ did not receivereceived notice of it (although any creditor who under thenotice of the creditors’ meeting is entitled to treatment the as if he received notice of it, and has 28 days to challenge CVA does the CVA from the date he becomes aware of it). However, CVA to be bound by it. not bind secured creditors unless they consent the procedure does There is no direct impact on employees and not interfere with company contracts. The is concluded once its terms have been implemented. A CVA returns to its company reverts to its former status and control directors and shareholders. MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
Supervision and control. The administrative receiver controls the While the rules relating to cross-border insolvencies are complex, affairs of the company. The directors’ powers of management are CVL and compulsory liquidation are potentially available to suspended. (For information regarding carrying on the business both UK and foreign-registered companies, provided they during insolvency, see Question 11.) can demonstrate they have their centre of main interest or an establishment in the UK or potentially some other sufficient Protection from creditors. The appointment of an administrative connection. MVL is only available to companies incorporated in receiver does not create an automatic moratorium. Creditors the UK. can therefore commence or continue legal actions against the company. In relation to the treatment of company contracts, Substantive tests. The most common ground on which creditors the position is broadly similar to administration (see above, petition the court for a compulsory winding-up order is that the Administration: Protection from creditors) in that the appointment company is unable to pay its debts, which is deemed if any of the of an administrative receiver does not affect company contracts following occur: unless provided for in the contract itself. A creditor who is owed more than GB£750 by the company serves a statutory demand on the company and the Length of procedure. There is no time limit, but an administrative company fails to pay. receiver usually seeks to realise and distribute assets as quickly as possible. A judgment remains unsatisfied.
Conclusion. Administrative receivers have the power to sell all or It is proved to the court that the company is unable to pay part of the company’s business and assets to satisfy the secured its debts as they fall due.
creditors’ claims. It is proved to the court that the company’s liabilities (including contingent and prospective liabilities) are more There is no direct impact on employees and the procedure does than the company’s assets. not interfere with company contracts. A court can also wind up a company if it can be shown that it is Once a sale has occurred and the administrative receiver has just and equitable to do so. accounted to the secured creditor for the proceeds of sale (net of costs), control of the company is returned to the directors for An MVL must be supported by a statutory declaration sworn by either continued operations or final liquidation (see Question 7, the directors that the company will be able to pay its debts in full, Liquidation). together with interest, within 12 months of the start of the MVL.
Consent and approvals. Resolutions for MVL and CVL must 7. What are the main insolvency procedures in your jurisdiction? be approved by 75% of shareholders voting at the relevant shareholders’ meeting. A CVL also requires approval by a majority Liquidation by value of the company’s creditors at a meeting called for that purpose. A court order is required to place a company into Objective. There are two types of liquidation: compulsory liquidation. Voluntary liquidation. This is not a court proceeding and can be started in relation to a solvent company (members’ Supervision and control. See below, Conclusion and, for further voluntary liquidation (MVL)) and an insolvent company information regarding carrying on the business during insolvency, Country Q&A (creditors’ voluntary liquidation (CVL)). see Question 11.
Compulsory liquidation. This is a court proceeding. Protection from creditors. See below, Conclusion.
Liquidation is used to wind up a company, and realise and Length of procedure. This depends on the substance of the distribute its assets to creditors and shareholders. liquidation and the company’s situation.
Initiation. Voluntary liquidation is initiated by a shareholders’ Conclusion. Compulsory liquidation (unlike an MVL or CVL) resolution to wind up the company. Compulsory liquidation is provides for an automatic stay or moratorium by prohibiting any started by the presentation of a petition to the court by any of action or proceedings from being started or continued against the following: the company or its property, without leave of the court. Once the court makes a winding-up order, the company’s directors are The company. automatically dismissed and replaced by the liquidator, who is The company’s shareholders. vested with extensive powers to act in the name of the company (see Question 11). The company’s directors.
The company’s creditors. On a compulsory liquidation and CVL, employees’ service contracts are automatically terminated, unlike an MVL. A company and its directors are not required to file for liquidation on insolvency, but may wish to do so to avoid incurring liability for Company contracts are not automatically terminated but a wrongful or fraudulent trading (see Question 9). liquidator has the ability to terminate onerous contracts under section 178 of the Insolvency Act 1986 to facilitate a winding-up.
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) or a preference, and The court can set aside a see above, Preferences Floating charges created by an www.practicallaw.com/about/practicallaw A preference is a transaction by a company
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the company enters into the transaction in good faith the company enters into the transaction in good and for the purpose of carrying on its business; believing at the time, there were reasonable grounds for that the transaction would benefit the company.
see above, Transactions at an undervalue see above, Transactions aside? If so, who can challenge these transactions, when and aside? If so, who can challenge Are third parties’ rights affected? in what circumstances? Transactions at an undervalue. Transactions consideration, transaction entered into by a company for no value of the or for significantly less consideration than the transaction, unless both: Preferences. by putting surety or guarantor that prefers a creditor, of the that party (in a hypothetical insolvent liquidation would have company), into a better position than that party been in if the transaction had not taken place. The court can set aside a preference if there is evidence that the company was influenced by a desire to prefer the creditor. The vulnerable period is six months before liquidation or administration starts, unless the preferred creditors are connected to the company (for example, the company’s directors), in which case the period is two years. of floating charges. Avoidance insolvent company in the year before the insolvency are invalid, except to the extent of the value of the consideration given to the company by the lender when the charge was created. This period is extended to two years where the charge was created in favour of a “connected person” ( a transaction is only a transaction at an undervalue Generally, ( a floating charge is only avoided, if at the time the company enters into the transaction or creates the charge, it is unable to pay its debts or becomes unable to do so as a consequence of the transaction or preference. The vulnerable period is two years before the start of The vulnerable period is two years before the liquidation or administration.
If an insolvent company is an employer with an occupational with an occupational company is an employer If an insolvent can, the pensions regulator pension scheme, defined benefit are notices on persons who circumstances, serve in certain other company (including or associated with the connected group, directors and shareholders with members of a corporate control), which may make them liable one-third or more voting pension obligations. for the company’s SETTING ASIDE TRANSACTIONS be set pre-insolvency transactions 10. an insolvent debtor’s Can transactions Challenging pre-insolvency or administration, the liquidator or liquidation On a company’s to avoid or unwindadministrator can apply to the court for an order The insolvency. certain transactions that took place before the if it determinescourt has wide discretion to grant these orders or unwound.that a pre-insolvency transaction should be avoided to the position itThe overriding principle is to restore the company had not occurred. would have been in if the improper transaction follows: The transactions that can be set aside are as about this publication, please visit about Practical Law Company, please visit about Practical Law Company, A liquidator, any A liquidator, FOR MORE FOR Any person who is or was knowingly A successful wrongful trading action imposes INFORMATION other party be held liable for an insolvent debtor’s debts? other party be held liable for an insolvent debtor’s of a restructuring or insolvency procedure? Can stakeholders orof a restructuring or insolvency influence the outcome of the procedure?commercial/policy issues a party to the carrying on of business by a company with intent to defraud creditors may be liable to contribute to the assets. Criminal penalties may also be imposed company’s for fraudulent trading even if the company is not insolvent. trading. Wrongful personal liability on directors if they allow a company to or ought reasonably to have continue trading after they knew, known, that there was no reasonable prospect of avoiding it is a defence to a wrongful insolvent liquidation. However, trading action if the directors can show that, from the relevant time, they took every step to minimise the potential loss to the creditors. This allows directors to continue with a company’s restructuring if they conclude that there is a reasonable prospect of avoiding liquidation and improving the return to creditors. Fraudulent trading. Misfeasance or breach of fiduciary duty. creditor or any contributory can bring proceedings against any officer of the company or anyone involved in promoting, in connection with any forming or managing the company, alleged misfeasance or breach of fiduciary or other duty.
LIABILITY LIABILITY 9. entity (domestic or foreign) or parent partner, Can a director, directors (including de facto The main ways in which a company’s contribute to the and shadow directors) can be held liable to assets are as follows: company’s While English insolvency procedures are favourable to senior While English insolvency involve negotiations between lenders, most restructurings outside of any statutory procedure. creditors and the company Influence on outcome of procedure and lenders) are the creditors (including bondholders Typically, proposal and arequired to vote on the acceptance of a restructuring majorities or scheme can be defeated if the statutory proposed CVA of creditors do not vote in favour of it. affect the outcome In relation to commercial or policy issues that current economic of the restructuring or insolvency procedure, the and businesses downturn clearly has a direct effect on employees priority to promote and in the present climate it is a high political boost investment and safeguard employment. economic recovery, the financial Rehabilitation of debtors so that they can survive make a fresh crisis, operate more efficiently and where necessary, start, is a key element in these policy objectives. STAKEHOLDERS’ ROLES STAKEHOLDERS’ 8. the most significant role in the outcome Which stakeholders have Stakeholders The company is dissolved once the liquidator has realised all the liquidator has realised is dissolved once the The company made distributions to and, where applicable, assets company’s shareholders. creditors and MULTI-JURISDICTIONAL GUIDE 2013/14 MULTI-JURISDICTIONAL AND INSOLVENCY RESTRUCTURING MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
Transactions defrauding creditors. This is similar to a ADDITIONAL FINANCE transaction at an undervalue (see above, Transactions at an undervalue), but the court only makes an order to unwind a 12. Can a debtor that is subject to insolvency proceedings obtain transaction if it is satisfied the transaction was entered into additional finance both as a legal and as a practical matter to defraud creditors by putting assets beyond the reach of (for example, debtor-in-possession financing or equivalent)? claimants against the company. No time limit applies for Is special priority given to the repayment of this finance? unwinding the transaction.
Dispositions after the start of winding-up. Any disposition of a company’s property made after winding-up has started is Administration and liquidation void, unless the court orders otherwise. This provision can An administrator or liquidator can raise money on the security cause difficulties, as a compulsory winding-up is deemed to of the unencumbered assets of the company. Such additional start when the petition is presented, rather than on the date funding has priority over all claims (other than those secured by a of the court order. fixed charge) as an expense of the administration or liquidation.
Third party rights CVA and scheme of arrangement The rules concerning third party rights in pre-insolvency The raising of finance and the use of assets as security tends to transactions are complex. Although third party rights may be be a matter for agreement between the company and its creditors. affected, there is generally protection for bona fide purchasers Typically, the company will look to its existing lenders to provide acquiring property or benefits for value without notice of the additional funding. relevant circumstances. Persons who are not direct recipients, parties to the transaction, or connected with the company or the MULTINATIONAL CASES parties to the transaction, are usually accorded a broad defence. 13. What are rules that govern a local court’s recognition of concurrent CARRYING ON BUSINESS DURING INSOLVENCY foreign restructuring or insolvency procedures for a local debtor? Are there any international treaties or EU legislation governing 11. In what circumstances can a debtor continue to carry on this situation? What are the procedures for foreign creditors to file business during rescue or insolvency proceedings? In particular, claims in a local restructuring or insolvency process? who has the authority to supervise or carry on the debtor’s business during the process and what restrictions apply? Recognition Section 426 of the Insolvency Act 1986 provides a statutory Administration. On appointment, an administrator assumes framework for the reciprocal co-operation with English courts in management of a company and, although the directors usually relation of a number of former UK colonies and dependencies. remain in place, they cannot exercise any powers in a manner When considering whether to provide assistance, the court can that is inconsistent with the administration (directors can be apply substantive English insolvency law or the law of the foreign dismissed by the administrators at any time). jurisdiction if it is consistent with English law.
The administrator can do anything necessary or expedient for the Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation) requires the English courts to automatically recognise
Country Q&A management of the company’s affairs, business or property, such as: insolvency proceedings started in other EU member states and contains detailed provisions on concurrent proceedings in different Sell the company’s assets. member states (see below and Question 14, Proposed amendments
Borrow money on behalf of the company. to the Insolvency Regulation).
Bring or defend proceedings. Directive 2001/24/EC on the reorganisation and winding up of credit institutions provides for a single set of winding-up or During the administration, the administrator must report to reorganisation proceedings to be commenced in the EU member creditors and seek approval for his proposals. If a creditor believes state in which a credit institution has been authorised to take up that the administration is not being conducted properly, he can its business. Subject to certain exceptions, the home member apply to court for the removal of the administrator. state’s insolvency rules apply throughout the EU and any decision relating to the commencement of reorganisation or winding-up CVA and scheme of arrangement. The directors remain in control of the procedures is automatically effective in another member state. company, continue to trade and undertake the company’s business, unless otherwise provided by the terms of the CVA or scheme. Concurrent proceedings The UNCITRAL Model Law on Cross-Border Insolvency 1997 was Liquidation. Once the court makes a winding-up order, the company’s implemented in England and Wales on 4 April 2006 by the Cross- directors are automatically dismissed and replaced by the liquidator Border Insolvency Regulations 2006. The Regulations provide who is vested with extensive powers to act on the company’s behalf. uniform legislative provisions to deal with cross-border insolvency The liquidator can continue to operate the company’s business if and promote: this achieves better realisation of the assets than an immediate liquidation, but it is rare for a liquidator to do so. Co-operation between the courts and competent authorities involved in cases of cross-border insolvency.
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Question 4, Cross-border debt recovery Proposed amendments to the Insolvency Regulation Proposed amendments EU Commission outlined new legislative In December 2012, the Regulation. plans to update the Insolvency there is a shift in emphasis from Under the current proposals insolvency proceedings across Europe to recognition of formal The proposals promoting pre-insolvency and rescue procedures. faced in cross- also recognise some of the practical challenges the extent to which border insolvency cases and seek to increase in those insolvency office holders and courts should co-operate cases, including in group company situations. will be The proposal for an amended Insolvency Regulation also the Council of considered by the European Parliament and current proposals the EU before it is adopted. Even then, the the amending suggest a lead-in time of up to two years once regulation becomes effective. See also As the final phase of the modernisation work, the Insolvency work, the Insolvency phase of the modernisation As the final will set of Rules which to produce a new Service intends It is the Insolvency Rules. and entirely replace restructure during will be published that a draft set of Rules anticipated Rules will not come into force before 2013 although the new The ongoing delays have occurred October 2014 at the earliest. Challenge” “Red Tape the government’s partly as a result of the latter part of 2012, gave interested programme which, during to comment on insolvency legislation that parties the opportunity complicated. was considered to be overly about this publication, please visit about Practical Law Company, please visit about Practical Law Company, FOR MORE FOR ) that liabilities under financial support directions issued by) that liabilities under financial support directions INFORMATION A more flexible regime for the advertising and/or publicity of insolvency events. Enabling an insolvency office holder to recover costs and expenses incurred before his appointment as an expense of the administration. Facilitating the delivery of documents electronically between insolvency office holders and creditors and allowing remote attendance at creditors’ meetings. Cross-Border Insolvency Regulations 2006. Cross-Border Insolvency The rescue of financially troubled businesses. The rescue of financially Insolvency Regulation. Fair and efficient administration of cross-border insolvency cross-border insolvency administration of Fair and efficient and other the interests of all creditors that protects including debtors. interested persons, the value of the debtors’ and maximisation of The protection assets.
Bloom and ors v The Pensions Regulator and ors [2010] EWHCBloom and ors v The Pensions Regulator and The Insolvency Rules Over the last few years, the Insolvency Service has implemented a series of modernisation changes to the Insolvency Rules (which supplement the Insolvency Act 1986). Some of the most important changes include: Insolvency expenses the High CourtIn October 2011 the Court of Appeal confirmed Lehman Brothersjudgment in the cases of Nortel Networks and ( 3010 (Ch) they have gone intothe Pensions Regulator against companies after the administration,administration should be treated as an expense of floating chargerather than provable debts and, therefore, rank above process. holders and unsecured creditors in the insolvency the status of the The ruling has a significant impact both on so-called “moral hazard” powers, which Pensions Regulator’s support directions, enable it to issue companies with financial The decision has and the priority of claims in administration. been appealed to the Supreme Court given its public importance and the case has been provisionally listed for May 2013. REFORM 14. any proposals for reform? Are there Procedures for foreign creditors Procedures for foreign debts due to foreign creditors can file claims for Generally, manner as local them in UK insolvency proceedings in the same into sterling. creditors. Foreign currency debts are converted are not prejudiced, if to ensure that local creditors However, recovery made in there are concurrent proceedings abroad, any into account. the foreign insolvency proceedings will be taken International treaties treaties apply: The following international MULTI-JURISDICTIONAL GUIDE 2013/14 MULTI-JURISDICTIONAL AND INSOLVENCY RESTRUCTURING MULTI-JURISDICTIONAL GUIDE 2013/14 RESTRUCTURING AND INSOLVENCY
CONTRIBUTOR PROFILES
JAMES ROOME TOM BANNISTER Managing Partner of Bingham’s Partner London Office and Co-Head of the Bingham McCutchen (London) LLP firm’s Financial Restructuring Group T +44 20 7661 5300 Bingham McCutchen (London) LLP F +44 20 7661 5400 T +44 20 7661 5300 E [email protected] F +44 20 7661 5400 W www.bingham.com E [email protected] W www.bingham.com
Professional qualifications. England and Wales, 1984; Hong Professional qualifications. England and Wales, 2005 Kong, 1985 Areas of practice. Restructuring; insolvency. Areas of practice. Restructuring; insolvency. Recent transactions Recent transactions Advised noteholders, bondholders and other creditor groups Representing: in a number of significant workouts and restructurings of European companies, including the Quinn Group, Connaught Noteholders of Atrium European Real Estate (formerly Meinl plc, Waterford Wedgwood, 20:20 Mobile, MJ Maillis, two major European Land), BAA, Concordia Bus, Damovo Group, UK homebuilders, Level One, Sea Containers Ltd, Pendragon, Elektrim, Focus DIY, Head NV, Independent News & Media, Johnston Press, Focus DIY, Nybron, IWP International plc, Irish Nationwide Building Society, Kremikovtzi, Marconi Cordiant Communications Group plc, Jarvis plc, Leeds United Corporation, Petroplus, Phoenix Pharmahandel, Preem Football Club, Marconi Corporation plc - an Irish household AB, Schefenacker, SwissAir, Truvo, Vantico International, and leisure products group, Albert Fisher Group plc, Mayflower Versatel Telecom International, Welcome Break, and Wind Corporation plc and Gate Gourmet. Hellas.
Lenders in LBO restructurings, including Alliance Medical, Arcapita, Bulgaria Telecom, Europackaging, European PAUL DURBAN Directories, Findus, Gala Coral, Ineos, Mauser, Monier, Partner Schieder Möbel, TMD Friction and Viridian. Bingham McCutchen (London) LLP A mezzanine syndicate on the restructuring of Level One, a T +44 20 7661 5300 real estate securitisation vehicle. F +44 20 7661 5400 E [email protected] Numerous financial institutions in relation to prime broking, W www.bingham.com derivative and bond claims following the collapse of Lehman Brothers. Country Q&A The junior debt holders on the restructuring of Queens Moat Professional qualifications. England and Wales, 2006 Houses. Areas of practice. Restructuring; insolvency. The EGO BV bondholders in the administration of TXU Recent transactions Europe. Acted as counsel to creditor groups in the restructurings of three major Icelandic banks, three major Irish financial Non-professional qualifications. Bachelor of Laws, Southampton institutions, Filmax Entertainment, Straumur-Burdaras University; Legal Practice Course, Lancaster Gate College of Law. Investment Bank, Damovo Group SA, Greycoat Limited, Kremikovtzi AD, Torex Retail plc, Leeds United plc, Meinl Professional associations/memberships. The Law Society of European Land, Nexus Floating Production, Pearl Group England and Wales; City of London Law Society (Insolvency Holdings and Northern Rock plc. Committee); Association of Business Recovery Professionals (R3); INSOL Europe; INSOL International; Insolvency Lawyers’ Avised the institutional investors in secured and unsecured Association. private placements involving European companies such as Heijmans NV, Hampson and the Quinn Group.
Advises on English insolvency law issues.
Non-professional qualifications. Legal Practice Course, BPP Law School; Postgraduate Diploma in Law, BPP Law School; Bachelor of Arts, History, University of Oxford, Balliol College.
Professional associations/memberships. The Law Society of England and Wales.
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October 2013 Disclaimers
• We have prepared this presentation (the “Presentation”) as a generic summary concerning certain selected provisions under the German Insolvency Code and the German Bond Act.
• The Presentation is not meant to provide answers to specific questions, but rather to give a brief generic overview to some general topics and issues with respect to German Insolvency Law and the German Bond Act.
• This Presentation is not intended to be conclusive nor should it be assumed that it necessarily addresses every relevant issue and detail under the German Insolvency Code, the German Bond Act or any other provision of applicable German law.
• Tax issues are not addressed in this Presentation and any tax issues arising in connection with the topics raised in this Presentation have to be addressed separately by tax advisers.
• In our experience, the path or outcome of complex debt restructurings can never entirely be pre- determined. Experience shows that achieving success in a restructuring will require discussions and positioning with all stakeholders, and that initial strategies will need to be reconsidered and re- developed with the passage of time, and depending on the actions taken by other parties, which can never be reliably predicted.
• This presentation is strictly confidential and must not be disclosed or distributed by recipients without the prior written consent of Bingham.
1 Index 1. General Overview on German Insolvency Law A. General Considerations B. The Preliminary Insolvency Proceeding C. Creditors’ Representation D. The Final Insolvency Proceeding E. Ranking of Creditors in Insolvency F. Insolvency Claw-back 2. Selected Topics under German Insolvency Law A. Shareholders’ Rights in Insolvency – Debt-to-Equity Swap B. Protective Shield Proceeding C. Self-Administration D. Rescue Financings – DIP Type Financings 3. German Bond Act A. General Overview on German Bond Act B. Amendments to Bond Terms by Majority Resolution (“collective action clauses”) C. Bondholder Resolutions D. The Joint Bondholder Representative E. Insolvency Proceedings F. Debt-to-Equity Swaps G. Restriction of Individual Termination Rights
2 1. General Overview on German Insolvency Law
3 1. General Overview on German Insolvency Law
A. General Considerations
. Proceeding: The German insolvency proceeding is a single proceeding consisting of two stages: (1) the preliminary insolvency proceeding and (2) the (final) insolvency proceeding. The final insolvency proceeding itself can be formed as a regular insolvency proceeding (Regelinsolvenzverfahren) or as an insolvency plan proceeding (Insolvenzplanverfahren). In addition, both proceedings can be conducted as a sort of debtor-in-possession proceeding, the so-called “self-administration” (Eigenverwaltung). . No group insolvency: German law does NOT provide for a group-wide insolvency regime. However, German insolvency courts have, in exceptional cases, permitted the appointment of only one insolvency administrator over various companies if the insolvencies are closely related. The legislator is currently considering to change the German Insolvency Code (Insolvenzordnung) in order to include various coordination mechanics between the various proceedings relating to different group companies; however, the basic principle of separate insolvency proceedings for the various group members will remain in place. German . Creditor friendly: Contrary to US law with its debtor-friendly Chapter 11 proceedings, German insolvency law is Insolvency generally more favourable to creditors. Law . No formal out-of-court restructuring: Other than under the German Bond Act (see below) and in connection with the – restructuring of credit institutions under the German Bank Restructuring Act, German law does currently not provide General for formal out-of-court restructuring procedures such as creditors’ voluntary arrangements (CVA), schemes of arrangements (SCA) or similar proceedings as known in other jurisdictions. An out-of-court restructuring is therefore Principles more complicated in Germany than in other jurisdictions, e.g. in the US or England. . Insolvency administrator: The (preliminary) insolvency administrator (“PIA”/“IA”) is independent, bound to protect the assets of the insolvency estate and to maximise recovery for all the creditors. He has a key role in the German insolvency proceeding. The IA is entitled to administrate the insolvency estate and to enter into all contracts on behalf of the debtor. Further, the IA is entitled to sell and transfer assets and manage the debtor’s business. While the PIA/IA is appointed by the court, changes to the German Insolvency Code introduced in 2012 have significantly strengthened the ability of creditors to influence its appointment. Further, the creditors’ assembly can elect a different insolvency administrator than the court appointed administrator, but this is rarely the case. . Insolvency plan proceeding: The insolvency plan proceeding allows creditors to vote in favour of an insolvency plan and, under certain circumstances, to cram-down non-consenting classes of creditors and/or shareholders.
4 1. General Overview on German Insolvency Law
A. General Considerations (cont‘d)
. Self administration: The debtor may apply for self-administration proceeding which keeps the debtor and its managers in charge of the business. However, the debtor’s actions are supervised by a court-appointed trustee (Sachwalter). . Protective shield proceeding: The protective shield proceeding (“PSP”), which was introduced in 2012, enables the management of the debtor to apply for a self-administration and to agree with its main stakeholders on a “pre-packed” insolvency plan within a period of three months. . Insolvency reasons: Two mandatory and one optional legal ground for the opening of insolvency proceedings exist: (i) illiquidity (Zahlungsunfähigkeit) and (ii) over-indebtedness (Überschuldung) (both mandatory), and (iii) imminent illiquidity (drohende Zahlungsunfähigkeit) (optional). . Initiation: Insolvency proceedings can be initiated by: (i) the debtor or its creditors if the debtor is over-indebted (Überschuldung), i.e., the liabilities on the balance sheet exceed the assets on the balance sheet, and the going concern of the business is not deemed to be predominantly likely (positive Fortführungsprognose) under the given German circumstances; (ii) the debtor or its creditors if the debtor is unable to meet its due payment obligations (illiquidity; Insolvency Zahlungsunfähigkeit); or (iii) only the debtor if it can foresee it will be unable to meet its due payment obligations Law (imminent illiquidity; drohende Zahlungsunfähigkeit), whereby the usually accepted forecast period includes the – current and the following financial year. General . Management duties: If a mandatory insolvency ground has been established, the company’s management is obliged Principles to file for insolvency without undue delay, and in any event no later than three weeks following the establishment of one or more insolvency grounds. Failure to comply with such obligation can result in personal civil and criminal law liability for the relevant manager. . Creditors’ claims: Beside fees and costs of the PIA/IA and the proceeding and administrative claims (including, under certain circumstances, debtor-in-possession type financings, see below for more details), most creditors’ claims are treated as ordinary insolvency claims with no preference.
5 1. General Overview on German Insolvency Law
A. General Considerations (cont‘d)
. Shareholder subordination: Shareholder loans and similar claims are treated as subordinated debt in a corporate insolvency if (i) no natural person is personally liable as a shareholder without limitation for the indebtedness of the company and (ii) the respective shareholder owns (directly or indirectly) more than 10% of the shares. As a consequence, such shareholder can neither demand repayment of its claims as an ordinary creditor nor enforce its security interests in insolvency. Further, it may have to repay in full any payments received on its subordinated claims (including any proceeds from security enforcement) if they were made within one year prior to the filing for the opening of insolvency proceedings or after such filing. An exception of this statutory subordination may apply if a creditor of an insolvent company becomes its shareholder in order to restructure such company (so called “restructuring privilege”). The restructuring privilege usually requires some form of documented restructuring concept, evidencing the intention of the equitizing shareholder to support a sustainable and serious restructuring. The statutory exemption ends upon achievement of a successful restructuring. . Claw-back: Various claw-back provisions and hardening periods are stipulated by the German Insolvency Code which German are running from one month to 10 years, depending on the specific circumstances of any particular case. Insolvency . Lender liability: There is a potential risk of lender liability in connection with the prolongation of existing credits as well Law as the granting of rescue financings to distressed borrowers, particularly if a delay of the insolvency is intended to – improve the lender’s (security) position to the detriment of other creditors. General Principles
6 1. General Overview on German Insolvency Law
B. The Preliminary Insolvency Proceeding
. Assessment and preservation: The PIA is obliged to assess (i) if the value of the assets of the debtor cover the costs of the insolvency proceeding, (ii) if the ground for insolvency exists (i.e. illiquidity, over-indebtedness or, as the case may be, imminent illiquidity) and (iii) to preserve the assets of the insolvency estate. . No enforcement: Creditors are basically prohibited from debt enforcement (Zwangsvollstreckung) and, to a certain extent, enforcement of collateral (excluding real estate mortgages and, generally, share pledges which may basically be enforced despite the preliminary insolvency proceeding). . Management actions: Except in the case of a PSP and of self-administration, management’s actions are basically subject to the consent of the PIA during a preliminary insolvency proceeding. Important . Preparation of proposals: The PIA usually prepares a proposal for the first creditors’ meeting which decides on the Principles course of the insolvency proceeding going forward (i.e. insolvency plan, sale of business, liquidation of assets). . Taxes: Certain taxes, in particular VAT, that become due during preliminary insolvency proceedings are administrative claims and therefore preferred in the insolvency proceeds waterfall.
. Insolvency payments: State aid (compensation claims) to cover salaries of employees (Insolvenzgeld) provides a significant tool for financing the insolvency proceeding. It covers a maximum of three months salary (capped at monthly salaries in an amount of approximately €6,000) and is paid by the Federal Employment Agency for the time period before the opening of (final) insolvency proceedings. This is the main reason why the debtor is often kept in a State Aid preliminary insolvency proceeding for a period of three months until a (final) insolvency proceeding is opened. The Federal Employment Agency assumes the salary claims of the employees. The claim assumed by the Federal Employment Agency is treated as an ordinary unsecured insolvency claim.
7 1. General Overview on German Insolvency Law
C. Creditors’ Representation
. Representation: During the preliminary proceeding, the interests of the creditors are primarily represented by the preliminary creditors’ committee (“PCC”) (if the requirements for its creation have been met), the creditors’ assembly, and as the case may be, the creditors’ committee. There is no right of a specific creditor to be appointed to the PCC or the creditors’ committee. . Creditors’ assembly: The creditors’ assembly consists of all secured and unsecured creditors and decides if the debtor will be liquidated or its business contained in order to be either sold as a going concern in an asset deal (leaving the liabilities behind) or reorganised in an insolvency plan (which may also entail disposals of assets not seen as core to the restructured Important business, i.e. certain production facilities no longer intended to be operated). Principles . Right to elect new IA: At the first creditors’ assembly, creditors representing more than 50 % by face value of the claims of the creditors participating in the meeting (unsecured creditors have the same vote as secured creditors) may elect a new insolvency administrator. This right is seldomly used in practice for timing reasons and will most probably be even less used given the new right of the PCC introduced in 2012 to influence the appointment of the PIA/IA. . Creditors’ committee: The creditors’ assembly may appoint a creditors’ committee to support and supervise the administrator. Most of the rights of the creditors’ assembly can be transferred to the creditors’ committee. In praxithe creditor’s committee will be in most cases identical with the PCC. . Members: The PCC should consist at least of members from each of, (i) the secured creditors, (ii) the creditors with the highest claims, (iii) the small creditors and (iv) the employees (usually a representative of the respective union). Other typical members might be suppliers, the German pension protection fund (Pensionssicherungsverein PSVeG), and credit insurers. . Duty to appoint: The insolvency court is required to establish a PCC, if two of three following prerequisites are met within the financial year preceding the filing: (i) minimum balance sheet total (Bilanzsumme) of €4,840,000 after deducting the designated deficit (ausgewiesener Fehlbetrag), (ii) minimum turnover of €9,680,000 within the last 12 months prior to the PCC relevant accounting date, or (iii) annual average of at least 50 employees. However, a PCC does not need to be established if there is a cessation of business of the debtor or the court suspects that the establishment of a PCC would be inappropriate compared to the size of the estate or would cause a delay resulting in an adverse effect for the assets of the debtor. . Appointment of PIA/IA: Introduced in 2012, creditors are now enabled to influence the appointment of the (preliminary) insolvency administrator. The proposal supported by an unanimous decision of the PCC binds the court as long as the proposed person meets the statutory requirements. The prior involvement of the suggested person will not automatically lead to a disqualification of such person per se, however the participation of such person in the preparation of an insolvency plan will be seen most probably as a reason for disqualification.
8 1. General Overview on German Insolvency Law
D. The Final Insolvency Proceeding
. Opening: The insolvency court opens an insolvency proceeding if the value of the debtor’s assets sufficiently covers the costs of the proceedings (including fees for the insolvency administrator), and an insolvency ground is given. Important . Summons of creditors: The insolvency court summons creditors to submit their claims to the insolvency administrator. Principles . Types of proceedings: There are mainly three types of routes (which can be combined) available within an insolvency proceeding: (i) Liquidation/Sale of Assets as a Going Concern (übertragende Sanierung), (ii) Insolvency Plan (Insolvenzplanverfahren) and (iii) Self-Administration (Eigenverwaltung) (including PSP).
Liquidation / . Sale: The insolvency administrator is charged with selling the assets of the company, the entire company or parts of the company to a prospective purchaser. Assets Sale
. Initiation: The insolvency plan may only be initiated by the insolvency administrator or the debtor. However, the creditors’ assembly has the right to instruct the insolvency administrator in order to establish an insolvency plan. . Court rejection: The insolvency court will reject the insolvency plan if (i) it is in breach of the provisions regarding the submission, the content, or the establishment of classes, (ii) it has no chance of being accepted by the participants or, (iii) upon motion of an objecting creditor, it is prima facie evidenced that the plan is less favorable to the participant than a liquidation. Participants are creditors and shareholders affected by the insolvency plan. . Participants’ acceptance: The participants’ acceptance of the plan requires that (1) more than 50 % of voting members in each class of participants vote in favour, (2) the amount of claims of consenting participants is higher Insolvency than half the amount of the total claims of the voting participants in each class and (3) subject to cram down of Plan dissenting participants under certain circumstances (see below), all classes of participants consent to the plan. Subordinated creditors are usually automatically written-down and excluded from voting. . Consent: The insolvency plan can only address existing claims and shareholder rights, but not alter (without the consent of the respective creditor concerned) other existing contractual rights. . Cram-down: The creditors constitute one or even more voting classes if the insolvency plan affects creditor rights. A cram-down of a non-consenting creditor class is allowed if they: (i) are NOT treated worse by the plan than in a liquidation, (ii) adequately participate in the economic value distributed to other creditors, and (iii) the majority of all voting classes participating in the insolvency plan accepted the plan. “Adequate participation” means that (i) no creditor receives more than par value and (ii) no pari passu or junior has received any higher distribution (Absolute Priority Rule).
9 1. General Overview on German Insolvency Law
D. The Final Insolvency Proceeding (cont‘d)
. Initiation: The self-administration has to be applied by the debtor, and the insolvency court has to order it. However, the insolvency court has to withdraw its order if requested by the creditors’ assembly. Self- . Characteristics: The self-administration (Eigenverwaltung) keeps the debtor and its managers in charge of the Administration business. However, the debtor is not allowed to act in its sole discretion and is supervised by a court-appointed trustee (Sachwalter). For further details see below. . PSP: The PSP is a special type of self-administration (for further details see below).
10 1. General Overview on German Insolvency Law
E. Ranking of Creditors in Insolvency
(i) Costs of the insolvency proceedings (i.e. costs of the court, fees and expenses of the administrators)
(ii) Administrative costs (Masseverbindlichkeiten) (i.e. claims resulting from new contracts entered into by the insolvency administrators and third parties (including, under certain circumstances, debtor-in-possession type financings, see below), certain tax claims (i.e. VAT) triggered by the administrator)
(iii) Segregation rights (Aussonderungsrechte) (i.e. property not being part of the insolvency estate, i.e. due to a retention of title, has to be released by the administrators)
(iv) In connection with mortgages and land charges, certain property related claims, expenses, fees and tax claims.
(v) Secured creditors: Secured creditors will have the priority granted by such security. Second ranking security is possible and can be subject to agreement between the respective holders of security as to the priority of the enforcement of the relevant charges. To the extent a secured claim is not fully covered by the proceeds resulting Insolvency from the security enforcement, the not-covered part of such claim is deemed to be an unsecured claim (except Waterfall where the parties agreed on a limited recourse). (vi) Insolvency creditors (i.e. all unsecured claims, to the extent duly filed and accepted by the insolvency administrator): These claims rank pari passu and are entitled to pro rata distribution of the remaining insolvency proceeds.
(vii) Statutorily subordinated shareholder loans
(viii) Contractually subordinated claims
(ix) Equity claims of shareholders
11 1. General Overview on German Insolvency Law
F. Insolvency Claw-back
. Invalid transactions: Transfer transactions (Verfügungen) relating to assets of the insolvency estate entered into with the debtor after the opening of insolvency proceedings are in principle invalid by operation of law, if not approved by the IA/PIA. Important . Challenge by IA: Legal actions (Rechtshandlungen) provided prior to the opening of insolvency proceedings and Principles diminishing the value of the estate to the detriment of insolvency creditors may be challenged by the IA if certain conditions are met. Any such assessment needs to be made on a case-by-case basis, depending on the specific circumstances of any particular case.
Transaction Hardening period
security given or payment received which the provider was not legally obliged to normally 1 month, but could be up to 3 grant or pay months if the beneficiary knew of the illiquidity or the adverse effect of the Overview action for other creditors on security given or payment received during illiquidity, if beneficiary knew at time of 3 months certain taking security or receiving payment that provider was (or was likely to become) Claw-back illiquid Scenarios repayment of shareholder loan 1 year and applicable entering into an onerous contract with a person with a close relationship (e.g. 2 years affiliates) to the debtor if such contract was directly disadvantageous for creditors Hardening Periods gratuitous benefit granted by debtor if it does not receive consideration or derives 4 years benefit
security granted to secure shareholder loans 10 years
intentional harming of other creditors 10 years
12 2. Selected Topics under German Insolvency Law
13 2. Selected Topics under German Insolvency Law
A. Shareholders’ Rights in Insolvency – Debt-to-Equity Swaps
. Usually shareholder resolutions required: Applicable German corporate law usually requires shareholder resolutions on capital increases to allow for the issuance of new shares and for other important corporate measures with the requisite majority (not less than 75 %). Thus, other than in connection with certain exceptions under the German Bond Act (see below) and in connection with restructurings of credit institutions pursuant to the German Bank Restructuring Act, an equitization of creditors’ claims can usually not be effected without the consent of the affected shareholders. . Insolvency plan: The insolvency plan can effect the corporate measures (i.e. capital increases for consideration in kind, capital decreases, exclusion of subscription rights) necessary to equitize the creditors’ debt (debt-to-equity swap) against non-consenting shareholders if certain preconditions are met. Corporate . Creditor consent required: However, notwithstanding majority resolutions of bondholder meetings pursuant to the Measures German Bond Act, a debt-to-equity swap (i.e. exchange of shareholder rights against pre-petition claims) cannot be effected under an insolvency plan without the consent of the affected creditors, which means that creditors cannot be equitized against their will. . Transfer of rights: Furthermore, the insolvency plan can also provide for, among other things: (i) the transfer of shares and shareholder rights and/or (ii) the continuation of the business. . Adequate compensation: An insolvency plan affecting shareholder rights has to provide for an adequate compensation of the shareholders (however, in praxi, such compensation will be rather low or even zero given the equity value in an insolvent company). . No change of control: The German Insolvency Code avoids that measures approved in an insolvency plan could trigger change of control clauses. . Cram-down: The shareholders constitute one or even more voting classes if the insolvency plan affects shareholder rights (i.e. through equitization or transfer of shares). A cram-down of a non-consenting shareholder class is allowed if they: (i) are NOT treated worse by the plan than in a liquidation, (ii) adequately participate in the economic value Dissenting distributed to other stakeholders, and (iii) the majority of all voting classes participating in the insolvency plan Shareholders accepted the plan. . Adequate participation: In this context “adequate participation” means that (i) no creditor receives more than par value and (ii) no shareholder ranking pari passu or junior with the crammed-down shareholders has received any higher distribution (Absolute Priority Rule).
14 2. Selected Topics under German Insolvency Law
A. Shareholders’ Rights in Insolvency - Debt-to-Equity Swaps (cont’d)
. No issuance below par value: German corporate law requires that shares must not be issued below par value (for this reason the debt-to-equity swap offer requires in a first step a reverse equity split via capital reduction and thereafter a capital increase against contribution in kind). As the value of creditors’ claims to be equitized under an insolvency plan will often be reduced significantly due to the insolvency of the debtor, the insolvency plan has to adequately reflect such decline in value. Thus, any such claims will not be taken into account with their book value but only with a reduced value. The insolvency plan needs to clearly reflect this by way of a fair valuation of any claim to be equitized. . Difference protection: Creditors participating in a debt-to-equity swap under an insolvency plan are protected from claims potentially resulting from a difference between the value of the contributed claims and the value received by the creditor. Affected participants in the insolvency plan which do not agree with the value of equitized claims determined by the insolvency plan are only entitled to challenge the insolvency plan itself, any further legal actions in this context are excluded. However, in order to mitigate any personal liability risks involved, the competent insolvency Further administrator will usually request an expert opinion on the value of any equitized claims. Details . Shareholder subordination: Residual claims of an equitizing creditor may become subject to shareholder on subordination in an insolvency of the debtor in case that such equitizing creditor owns (directly or indirectly) more Debt-to-Equity than 10 % of the debtor’s shares pursuant to applicable German statutory law (see above). This can become an Swaps imminent problem in case of a subsequent (additional) insolvency of the debtor after the insolvency plan has been under an sanctioned and the debt-to-equity swap has become effective. However, any creditors equitizing claims in connection Insolvency with an insolvency plan will usually benefit from the so called restructuring privilege (see above). Plan . Take-over law: A debt-to-equity swap can potentially trigger a mandatory take-over offer, if an equitizing creditor alone or by acting in concert with other shareholders acquires control of more than 30% of the voting rights in a listed debtor. However, the competent German regulator (BaFin) may grant an exemption if the control has been acquired as part of a restructuring.
15 2. Selected Topics under German Insolvency Law
B. Protective Shield Proceeding
Insolvency Plan Proceedings PSP (Planverfahren)
Insolvency Plan approval hearing (Erörterungs- und Abstimmungstermin)
Transactions in the ordinary Appointment Opening of insolvency Filing for course of business Creditors’ Court acceptance of preliminary proceeding/ insolvency* do not require assembly of plan trustee self-administration preliminary trustee‘s approval
Examination of claims hearing (Prüfungstermin) Preparation of insolvency plan Up to 3 months Filing of claims Preliminary Insolvency Proceeding for creditors
maximum few hours timeframe 3 weeks to 3 months
5 weeks to 5 months
*Debtor files for opening of insolvency proceedings due to either (i) over-indebtedness or (ii) imminent illiquidity, but NOT for illiquidity.
16 2. Selected Topics under German Insolvency Law
B. Protective Shield Proceeding (cont’d)
. Pre-packed insolvency plan: The Protective Shield Proceeding – PSP (“Schutzschirmverfahren” – vorinsolvenzliches Sanierungsverfahren) is aimed at enabling the management of the debtor to agree with its main stakeholders on a “pre-packed” insolvency plan (within a period of three months). The formal voting and acceptance of the insolvency plan is adopted after opening of a final insolvency proceeding. . General requirements: The following general requirements need to be fulfilled in order to establish a PSP: (i) (voluntary) insolvency filing for imminent illiquidity or over-indebtedness, (ii) application for self-administration, (iii) no circumstances are known indicating that self-administration could adversely affect creditors, and (iv) the confirmation of an independent insolvency expert regarding the imminent illiquidity of the debtor and that its proposed restructuring is not deemed to be futile. . Procedure: If the requirements for a PSP are met, the insolvency court will grant a grace period of up to three months for the preparation of an insolvency plan and appoint a preliminary trustee (Sachwalter) instead of a (preliminary) insolvency administrator. . Debtor’s proposal: The preliminary trustee is proposed by the debtor and the insolvency court may only deviate from Important the debtor’s proposal if the proposed person is deemed to be obviously inappropriate. Principles . No general transfer restrictions: During the PSP (other than in a usual preliminary insolvency proceeding), if the application for self-administration is not obviously futile, neither a general prohibition on the transfer of its assets (allgemeines Verfügungsverbot) is imposed on the debtor nor an order of the court is issued that any transfers of the debtor’s assets requires the prior consent of a preliminary insolvency administrator (Zustimmungsvorbehalt). . Preservation measures: The insolvency court may order certain preservation measures (Anordnung vorläufiger Maßnahmen), pursuant to applicable provisions of the German Insolvency Code, e.g. the implementation of a PCC, and, especially if so applied by the debtor, the stay or temporary restriction on measures of debt enforcement (Zwangsvollstreckung) against the debtor (unless real estate mortgages are concerned). . Illiquidity: The court has to be informed of the illiquidity of the debtor, however the illiquidity has no automatic impact on the PSP.
17 2. Selected Topics under German Insolvency Law
B. Protective Shield Proceeding (cont’d)
. Advance information: The court has to inform the debtor in advance if it intends to reject the application for self- administration in order to enable the debtor to withdraw its voluntary filing for insolvency. . Termination: The court has to terminate the PSP if during the grace period (i) the envisaged restructuring becomes Other futile or (ii) the PCC or, under certain circumstances, a creditor, applies for termination of the PSP. . No publication: If properly coordinated with the insolvency court and subject to the measures decided by the court, the PSP does not need to be published via the typical publication instruments in case of an insolvency of a debtor.
18 2. Selected Topics under German Insolvency Law
C. Self-Administration
. Debtor’s application: The debtor may apply for self-administration with the competent insolvency court. . Limited rejection: The insolvency court may only reject the application for self-administration if there is evidence that self-administration would probably prejudice the creditors as a whole. Important Principles . Unanimous PCC support: Before making a decision, the court has to hear the PCC. If the PCC unanimously supports the application for self-administration, it is not deemed prejudicial to the creditors. . Debtor and trustee: During self-administration, the debtor and its management remain in charge of the business but the debtor’s actions are supervised by a court-appointed trustee (Sachwalter).
Debtor`s application for self-administration
Court`s assessment, if PCC is to be heard (Does the hearing of PCC evidently lead to a negative effect on the debtor`s financial position?) Court decision No negative effects to be expected Negative effects to be expected about application for Hearing of PCC Assessment, if circumstances are known, No unanimous that order for self-administration could Self- support negatively effect the creditors of application Administration Unanimous support of application NO YES
Rejection of application Order for self-administration (written reasoning required)
19 2. Selected Topics under German Insolvency Law
D. Rescue Financings – DIP Type Financings
. No priming: “Debtor-in-possession” (“DIP”) – type financings resulting in preferred claims ranking only behind the costs of the insolvency proceeding (Masseverbindlichkeiten) are under certain circumstances possible but may in particular not prime existing secured debt. . Personal liability of PIA/IA: The (preliminary) insolvency administrator is generally personally liable for any preferred claims (Masseverbindlichkeiten) incurred by a legal action of the PIA/IA. However, the administrator is not liable in case that he could not foresee at the time of incurrence of such preferred claim that the assets of the insolvency estate will likely not be sufficient to satisfy such claim. Thus, in praxi, the PIA/IA will only enter into any DIP type financing if supported by a sufficient business plan relating to the continuance of business, which results in an exclusion of its potential personal liability. . Banks reluctance: Historically, German banks are generally reluctant to provide DIP type financings and thus, the German market for such special financings is currently underdeveloped (except for the pre-financing of state aid insolvency payments (Insolvenzgeld)). This may change in the future, particularly in connection with PSP / self- administrations. Important . Claw-back risks: Potential claw-back risks involved in the granting of pre-insolvency rescue financings as well as DIP Principles type financings, need to be carefully assessed. It will often be advisable to obtain a restructuring opinion (Sanierungsfähigkeitsbescheinigung) from a qualified restructuring expert prior to financing. . Usury risk: The adequacy of interest and fees payable for rescue financings and DIP type financings needs to be carefully assessed in order to avoid potential voidance and unenforceability of claims under German statutory law.
20 2. Selected Topics under German Insolvency Law
D. Rescue Financings – DIP Type Financings (cont‘d)
. Consensual: On a consensual basis, “new money facilities” are generally possible provided that existing creditors agree to super senior ranking and participation on existing security interests. If a consensual deal is not possible, obtaining of secured “new money facilities” is hardly possible as usually no free assets remain to be granted as security at such stage. . Claw-back risks: Potential claw-back risks need to be carefully assessed and mitigated. Pre-Insolvency . Lender liability: Potential lender liability risks need to be carefully assessed and mitigated, e.g. by a restructuring Rescue opinion, and the granting of new financings may particularly not delay an insolvency to improve an existing lender’s Financing (security) position to the detriment of other creditors. . CRO: In connection with the granting of rescue financings, creditors often request the implementation of a (specific) chief restructuring officer at the management of the debtor. In particular in this context, creditors need to be careful in order not to qualify as “quasi-shareholders” resulting in a subordination of their claims pursuant to German statutory law due to “shareholder-like” influence on the debtor.
. Order of business continuity: In case the insolvency court orders continuance of business (Unternehmensfortführung), the PIA needs to secure liquidity of the debtor and - depending on the particular position of the PIA ordered by the insolvency court - the creation of preferred DIP type financing claims (Masseverbindlichkeiten) by the PIA may be possible. However, in praxi, this is often difficult and remains subject to explicit court approval at this procedural stage. DIP Type Financing . Available assets: Following the opening of insolvency proceedings, new assets resulting from a continuance of business may be available to secure preferred DIP type financing claims (e.g. trade receivables) as the transfer of during the future assets of the debtor (e.g. by global assignment of receivables) becomes invalid following the opening of Preliminary insolvency proceedings pursuant to German statutory law. However, potential claw-back risks need to be carefully Insolvency assessed. Proceeding
21 2. Selected Topics under German Insolvency Law
D. Rescue Financings – DIP Type Financings (cont‘d)
. Incurrence of preferred claims: During the PSP, if so applied by the debtor, the court has to order that the debtor is entitled to incur preferred claims (Masseverbindlichkeiten). Thus, the flexibility of the debtor increases significantly in DIP Type a PSP to agree on a DIP type financing compared to the situation in a usual preliminary insolvency proceeding Financing (where the availability of such tool depends on the PIA and/or court sanctioning). during . Trustee’s consent: As the entering into new credit agreements by the debtor is not part of its usual business, the PSP / Self- consent of the trustee (Sachwalter) is required for obtaining DIP type financings. The trustee is personally liable for administration repayment of the preferred claims (Masseverbindlichkeiten) similar to the PIA/IA.
. Insolvency administrator: If the final insolvency proceeding has been opened over the debtor’s assets, preferred DIP DIP Type type financings can be entered into by the IA on behalf of the insolvency estate. Such DIP type financings may be Financing secured subject to availability of assets, resulting from the continuation of business or the successful claw-back of during asset transfers. For potential personal liability of the IA, see above on preliminary insolvency proceedings. Final . No claw-back: Claw-back risks do normally not exist regarding financings during final insolvency proceedings. Insolvency . Loan Ceiling: The insolvency plan may foresee that creditors providing financing to the debtor or a business Proceeding transferee during the monitoring period at the insolvency plan shall be granted senior ranking ahead of ordinary insolvency creditors. The insolvency plan has to determine the maximum threshold for such loans. . Banking license: Lending into Germany usually requires a German banking license (or a EU passport). It needs to be assessed on a case-by-case basis whether any exceptions from this general regulatory requirement may apply. . ”Change-of-control”: Provisions making the granting of DIP type financings conditional upon the appointment of a specific PIA/IA or trustee are very problematic and may particularly result in personal liability of the debtors’ management, the PIA/IA and/or trustee (but normally not for the lenders). Other . Insolvency payment: State aid (compensation claims) to cover salaries of employees (Insolvenzgeld) provides a significant tool for financing the insolvency proceeding. It is paid by the Federal Employment Agency to the relevant employee for the maximum time period of three months before the opening of final insolvency proceedings. Thus, bank financings of employees’ salaries during the preliminary insolvency proceeding are customary in the German market (whereby such financings are secured by assignment of the relevant state aid compensation claims).
22 3. German Bond Act
23 3. German Bond Act
A. General Overview on new German Bond Act
. New German Bond Act: In 2009, the new German Bond Act (Schuldverschreibungsgesetz, SchVG) came into force, resulting in fundamental changes to the legal regime applicable to German law-governed bonds. . Increasing issuances: The number of bonds issued under German law and subject to the German Bond Act is currently increasing. As a result of limited bank lending activities, new bond issues are oftentimes structured pari passu with existing credit facilities. Important . Contractual relationships: Bonds issued under German law are considered to create contractual relationships among the Principles issuer and each bondholder. On this basis, the consent of the issuer and all bondholders is required to validly agree on amendments to the bond terms, unless the bond terms or statutory law provide otherwise. . Aims of German Bond Act: By introducing the new German Bond Act, the German legislator was in particular aiming to: (i) align German bond laws with international standards in order to make the choice of German law more attractive, (ii) increase the scope of application of German bond law, and (iii) facilitate the restructuring of German law governed bonds outside of insolvency proceedings.
. Issuances from 5 August 2009 on: Subject to certain exceptions set out below, the German Bond Act generally applies to all bonds which are issued under German law on or after 5 August 2009. It applies to bonds issued by both, German and non-German issuers, not only to bonds issued by issuers located in Germany. Further, it does not only apply to straight bonds (such as high-yield bonds), but also to convertible bonds (Wandelanleihen), bonds with attaching warrants (Optionsanleihen), commercial papers and derivatives that are certified as securities. Application . Governed by German law: The application of the German Bond Act requires that the bonds are governed by German law. Pursuant to a judgment of the regional court (Landgericht) of Frankfurt am Main dated 27 October 2011 of (“Pfleiderer”), the application of the German Bond Act is limited to bonds that are exclusively governed by German law, German i.e. it doesn’t apply to bonds which are only partly governed by German law. Bond Act . Excluded instruments: The German Bond Act does, however, not apply to: (i) covered bonds issued by mortgage lending banks (Pfandbriefe), (ii) bonds issued or guaranteed by the Federal Republic of Germany, a German Federal State, a German municipality or a German Special Fund (in particular the German Financial Market Stabilization Fund (Finanzmarktstabilisierungsfonds or SoFFin), (iii) to a certain extent German law governed bonds issued by an EU member state and (iv) German certified loans (Schuldscheindarlehen).
24 3. German Bond Act
A. General Overview on new German Bond Act cont‘d
. Opt-in: With respect to German law governed bonds which have been issued by a German issuer prior to 5 August Application 2009, the German Bond Act allows bondholders to “opt-in” with the consent of the issuer in order to make use of the of options that are available under the German Bond Act. To “opt-in” requires a resolution with a majority of 75 % of the German participating votes. However, pursuant to recent court judgements, an opt-in is not available to German law governed Bond Act bonds issued by non German issuers prior to 5 August 2009.
25 3. German Bond Act
B. Amendments to Bond Terms by Majority Resolution (“collective action clauses”)
. Majority resolutions possible: Subject to limitations set out below, bond terms can now provide that a majority of Important bondholders may in all respects pass resolutions resulting in amendments to the bond terms that are binding on all Principles bondholders. However, if amendments to the bond terms by majority resolution are not expressly permitted in the bond terms, amendments to the bond terms will require unanimous consent. . Material amendments: Resolutions resulting in material amendments to the bond terms require a majority of 75 % of the participating votes, unless the bond terms provide for a larger majority requirement. . Material per definition: The following amendments are defined by the German Bond Act as material amendments: Amendments to the due date of interest payments, interest rate reductions, the exclusion of interest and to the maturity date. Reductions of the principal amount. Majority Subordination of claims in insolvency proceedings over the issuer. Requirement Substitution and release of security interests or substitution of the issuer by another debtor. of Changes of bond currency. 75 % Waiver of the bondholders' termination right and its limitation. Conversion or exchange of the bonds in shares, other securities or other payment obligations. . Further material amendments: In addition, the following amendments to bond covenants should as well require a majority of 75 %, although not expressly stipulated by the German Bond Act: (i) amendments to bond covenants which limit the issuer's ability to create security interests over its assets, incur additional financial indebtedness, change its business or relocate its domicile, (ii) amendments to the bonds' denomination, or (iii) changes to the governing law and the place of jurisdiction. . Simple majority: Only technical amendments can be made with a simple majority of the participating votes (50 % + 1). Further Majority . Individual bondholder consent: Amendments which require bondholders to make additional payments or which do not equally apply to all bondholders require the consent of each individual bondholder. The same applies to a waiver of Requirements the entirety of principal claims. . Same bond issue: Amendments by majority resolutions are only binding on the holders of bonds from the same bonds issue, which are governed by the same bond terms. Other . No “aggregation clauses”: “Aggregation clauses” are not permitted i.e. bond terms may not provide that bond terms are amended by majority resolution of the holders of all bonds issued by the issuer. This may leave room for potential for hold-outs in restructurings which involve several bond issues.
26 3. German Bond Act
C. Bondholder Resolutions
. Meeting: Bondholder resolutions can be passed in a physical meeting of bondholders or by way of a vote in a virtual meeting. The bond terms can provide that resolutions can only be passed by one of these procedures. . Call of meeting: Bondholder meetings can be called by the issuer or the joint bondholder representative (see below). Bondholders Upon the request of bondholders representing 5 % of the outstanding bonds a bondholder meeting has to be called if: Meeting (i) the meeting shall resolve on the appointment or dismissal of a joint bondholder representative, (ii) the meeting shall resolve on the revocation of terminations by bondholders, or (iii) the bondholders have a special interest to call a meeting.
. Quorum requirements: At least 50 % of the nominal amount of the outstanding bonds are required to be present, (whereby bonds held by the issuer or its affiliates are disregarded for determination of a quorum). If there is no quorum in the first meeting of bondholders, a second meeting with the same agenda can be called which does not require a quorum, unless the agenda comprises items which require a majority of 75 %. In this case, there is only a quorum at the second meeting if 25 % of the nominal amount of the bonds are present or represented. However, the bond terms may provide for a higher quorum. . Majority requirements: In principle, resolutions require a simple majority of the participating votes, except for resolutions resulting in material amendments to the bond terms (which require a majority of 75 % of the participating votes (see above)). However, the bond terms may provide for a larger majority requirement. Quorum and Majority
27 3. German Bond Act
C. Bondholder Resolutions (cont‘d)
. Court challenge: Bondholders can challenge bondholder resolutions in court within one month from the publication of the resolution, unless they have voted in favor of the resolution. A challenge can particularly be based on: (i) a breach of any procedural rules under statutory law or the bond terms, (ii) the provision of inaccurate or incomplete information or (iii) the illegitimate content of a resolution, such as a breach of the principle that resolutions must apply equally to all bondholders. Further, a number of legal practitioners suggest that resolutions that have been passed with the requisite majority are not per se legitimate and that resolutions regarding amendments of bond terms must be in the interest of the bondholders and be suitable and appropriate for the intended purpose. As regards shareholder resolutions, German courts have frequently judicially reviewed shareholder resolutions in relation to intrusions into shareholder rights. However, the application of these principles to bondholder resolutions is doubtful and it is arguable that a judicial review should be limited to abusive resolutions by which the majority pursues purely self-serving objectives. . Blocking of implementation: A legal challenge of bondholder resolutions blocks the implementation of the resolution Bondholder until: (i) the challenge has been dismissed by final court judgment (this applies irrespective of whether the action is Litigation well founded and irrespective of the gravity of the asserted breach); or (ii) the competent appellate court issues an non-appealable implementation order in an expedited proceeding (Freigabeverfahren) initiated by the issuer, if certain requirements are met (e.g. if in the absence of a grave violation of the law, the disadvantages resulting from the non- implementation of the resolution for the issuer and bondholders outweigh the disadvantages for the claimant if the resolution is implemented). . Effect of litigation: (Abusive) bondholder litigation may compromise successful restructurings, unless appellate courts are not reluctant to issue implementation orders on the basis of the outweighing interests of the issuer and the bondholders within a shut time period (particularly in light of potential insolvency filing duties). . Successful challenge: If the bondholder resolution was not implemented on the basis of a successful implementation order, the resolution is retroactively void and does not have any legal effect. However, if the bondholder resolution was implemented on the basis of an implementation order, the issuer must compensate bondholders who have successfully challenged the resolution for any losses that have been caused by the implementation of the resolution.
28 3. German Bond Act
D. The Joint Bondholder Representative
. Appointment: The German Bond Act permits the appointment of a joint bondholder representative in the bond terms (contractual joint representative (Vertragsvertreter)) or through a resolution of bondholders (appointed joint representative (Wahlvertreter)). The appointment by resolution requires a simple majority of the votes cast. A 75 % majority is required if the representative is being granted the power to agree on the amendment of material bond terms. In the absence of provisions in the bond terms, bondholders can still appoint a joint representative if insolvency proceedings are opened. . Dismissal: Joint representatives can be dismissed by a bondholder resolution at any time without a reason and without appointing a new joint representative. The majority required for a dismissal is uncertain. According to the legislative records the same majority as for the appointment is being required (i.e. a 75 % majority may be required).
Important . Rights of Joint Representative: Under statutory law, the joint representative's rights are limited to certain procedural rights, including the right to: (i) call bondholder meetings, (ii) manage the passing of resolutions outside of physical Principles meetings, (iii) request administrative information from the issuer, or (iv) assert bondholders’ rights in the issuer's insolvency. Additional rights can be granted to the bondholder representative in the bond terms or through a resolution of bondholders; however, the right to agree on a waiver on bondholder rights can only be granted by bondholder resolution. . Exercise of bondholders’ rights: Bondholders are no longer entitled to exercise any rights that are granted to a joint representative (but can still issue instructions to the joint representative by a resolution of bondholders).
29 3. German Bond Act
Insolvency Proceedings
. Bondholders’ meeting: The insolvency court has to call for a bondholders’ meeting after opening of insolvency proceedings to facilitate the appointment of a joint representative, to the extent a joint representative has not yet been appointed by the bondholders. . Exercise of bondholders’ rights: Bondholders are no longer entitled to exercise any rights in an insolvency proceeding if a joint representative has been appointed (but can still issue instructions to the joint representative by a resolution of bondholders). The joint representative exercises all the voting rights of the bondholders in the creditors meeting and in connection with the class voting in an insolvency plan proceeding. If bondholders refuse to appoint a joint representative they may still exercise their (voting) rights independently. Although such view is not undisputed, even if the bondholders have not appointed a joint representative in an insolvency proceeding they may still adopt majority resolutions as permitted under the German Bond Act. . “One Euro, one vote” does not apply: Provided a joint representative has been appointed in the issuer’s insolvency, only the joint representative can exercise the rights of the bondholders and “speaks” for all bondholders, but will usually want to obtain their prior consent via a bondholder vote (there is some uncertainty if in an insolvency Important proceeding certain restructuring measures requiring a qualified majority decision under the German Bond Act could be adopted with simple majority of the claims according to the German Insolvency Code). As a result, the “one Euro, one Principles vote” principle is not applicable and the actual majorities may be distorted, i.e. in a voting of a creditors’ meeting (Gläubigerversammlung), which requires the majority of claims:
Total debt of the issuer under the bond: EUR 10m Other liabilities of the issuer: EUR 9m Voting results of the bondholders: Voting results of the other creditors: Yes EUR 4m Yes EUR 8m No EUR 6m No EUR 1m Total No votes: 7m Total Yes votes: 12m
As the joint representative representing the full bond claims speaks with one voice, the proposal is rejected by 11:8. . Par conditio creditorum: An insolvency plan has to offer equal rights to the bondholders. The joint representative may not vote in favour of an insolvency plan, which is in breach of this principle.
30 3. German Bond Act
F. Debt-to-Equity Swaps
. Permitted by the German Bond Act: The new German Bond Act expressly permits that the bond terms can allow the conversion or exchange of bonds into shares, other securities or other payment obligations, by a majority resolution of bondholders.
Important . Compatibility with German constitutional laws: Nonetheless, some practitioners question whether debt-to-equity swaps by majority resolution are compatible with German constitutional laws. However, these concerns should be Principles unfounded if the bond terms explicitly permit a debt-to-equity swap by majority resolution. . No Consent: While under the German Insolvency Code or the Bank Reorganisation Act basically no creditor may be forced to take equity, the German Bond Act provides for a forced equitisation, which applies even in connection with an insolvency plan procedure.
. Shareholders resolution: In most cases, a shareholder resolution on a capital increase with the requisite majority (not less than 75 %) will be required to allow the issuance of new shares, whereby the general subscription right of existing shareholders is excluded. . No issuance below par value: German corporate law requires that shares must not be issued below par value. Thus, the bonds to be converted into shares must have a certain minimum (market) value which has to be confirmed by an expert opinion. Otherwise, an additional cash payment will be required in connection with the issuance of shares. . Regulatory requirements: The issuance of new shares may trigger an obligation to prepare and publish a prospectus. Implementation In addition, the need for a mandatory take-over bid needs to be clarified. of . Subordination of claims: If a bondholder swaps part of its bonds into shares, as a result of which it holds (directly or Debt-to-Equity indirectly) more than 10 % of the shares in the issuer, any remaining claims of the bondholder against the issuer Swaps (under the bonds and otherwise) will be subordinated in the issuer’s insolvency pursuant to the provisions of the German Insolvency Code (see also above on shareholder subordination). It is unclear whether the statutory “restructuring privilege” applies to avoid German law shareholder subordination in this context. . Not applicable for partnership interests: Notwithstanding the broad wording of the German Bond Act, an exchange of bonds against a partnership interest, which results in a personal liability of bondholders, should not be permitted.
31 3. German Bond Act
G. Restriction of Individual Termination Rights
. No general exclusion of termination rights: Bond terms must not generally exclude the right of individual bondholders to terminate their bonds. . Possible restrictions: The bond terms can, however, provide that termination rights must be exercised in a “uniform manner” or that termination by individual bondholders will only take effect if termination rights (including termination rights for cause) are exercised with respect to bonds that represent a certain minimum percentage (not exceeding 25 %) of the nominal amount of outstanding bonds. . Disapproving resolution: Further, the bond terms can provide that terminations by the requisite number of Important bondholders shall not take effect if resolved upon by the bondholders, provided that the resolution disapproving the Principles termination is passed within three months from the termination taking effect. However, the majority requirements for such resolution are currently not clear but the wording of the German Bond Act suggests that the resolution requires a simple majority of all outstanding votes (irrespective of whether these votes participate in the vote) and must be approved by a number of bondholders (in contrast to the number of voting rights of these bondholders) exceeding the number of bondholders that have exercised their voting rights).
. Open issues: The limitation of termination rights raises a number of questions that are not sufficiently addressed by the German Bond Act: What does the requirement that termination rights must be exercised in a “uniform manner” mean? Does it mean that a bondholder must exercise termination rights with respect to all bonds from the same bond’s issue held by it? Is the issuer entitled to defer payments to terminating bondholders until either the three-months period has expired Other or a resolution revoking the terminations has been passed? Will a termination by the relevant majority of bonds affect all bonds under the relevant bonds issue (rather than the bonds that have actually been terminated)?
32
Mark W. Deveno Partner, Bingham McCutchen LLP
[email protected] T +1.212.705.7846 F +1.212.702.3654 New York T +1.212.705.7846 F +1.860.240.2800 Hartford
Mark Deveno is a partner in Bingham McCutchen’s financial restructuring group. Depending on the nature of his assignments, Mark splits time between the firm’s New York, Tokyo and Hartford offices. Regardless of the jurisdiction in which he is working, Mark’s practice focuses on the representation of financial institutions and commercial enterprises in complex workout and insolvency matters as well as general financial matters. Mark has extensive experience in a wide range of transactions, including international and domestic restructurings, debtor-in-possession financings, distressed mergers and acquisitions, out-of-court workouts, and related litigation.
Mark’s practice in Japan, in particular, capitalizes on the fact that Japan’s insolvency system is in a state of flux, with the system moving increasingly toward the use of a debtor-in-possession model and away from the use of independent court-appointed trustees. With that change has come a greater need for creditor oversight in insolvency situations despite a historic norm to the contrary. Mark’s practice, with the support of Bingham’s bengoshi, has centered on providing creditors with influence in insolvency situations as well as assisting a variety of entities in the development and implementation of distressed investment strategies. Representative matters include: (i) representation of Japan’s first-ever officially recognized creditors’ committee in the case of Spansion Japan, and (ii) representation of ad hoc bondholder groups in the corporate cases of Elpida Memory and Takefuji Corporation.
Consistent with his international focus and experiences, Mark is co-chair of the International Committee of the American Bankruptcy Institute.
Hideyuki Sakai Partner, Bingham McCutchen LLP
[email protected] T +81.3.6721.3111 F +81.3.6721.3112 Tokyo
Hideyuki Sakai has been practicing law for nearly 40 years and is one of Japan’s leading authorities in insolvency, financial restructuring and crisis management. He frequently represents prominent financial institutions and large creditor groups in complex debt restructurings and international insolvency matters. He has also frequently served as the court-appointed trustee in high-profile cases and as mediator in out-of-court ADR proceedings. He recently led the team representing Olympus Corporation in connection with its accounting irregularities and maintaining its listing on the Tokyo Stock Exchange.
Mr. Sakai was selected by Chambers Asia 2013 as a leading restructuring and insolvency lawyer in Tokyo with a stand-alone “Band 1” listing for the fifth consecutive year.
In addition to his active legal practice and role as Managing Partner of Bingham’s Tokyo office, he is frequently invited to speak at prestigious industry events including the Morgan Stanley Hedge Fund Forum (Tokyo) (Keynote Speaker, 2012), the Bank of America Merrill Lynch Japan Conference (2012 and 2013), the International Insolvency Institute’s Annual Conference (Paris, 2012 and New York, 2013) and the Inter-Pacific Bar Association Annual Meeting (Seoul, 2013).
Naomi Moore Partner , Bingham McCutchen LLP
[email protected] T +852.3182.1706 F +852.3182.1799 Hong Kong
Naomi Moore is a partner of Bingham McCutchen LLP based in the firm’s Hong Kong office. She focuses her practice on cross-border restructurings, insolvencies and workouts. With considerable experience gained in Asia, Australia and the United Kingdom, Naomi has a particular focus on solvent and insolvent schemes of arrangement. Recent engagements have included restructurings or distressed transactions in the PRC, India, Indonesia, Korea, Japan and Australia.
Naomi is recognised as a leading lawyer for restructuring and insolvency by IFLR1000 and Who’s Who Legal. She is a member of the board of the International Women’s Insolvency and Restructuring Confederation’s Hong Kong Chapter. Naomi is admitted to practice in Hong Kong, England and Wales, and New South Wales.
James Roome Partner , Bingham McCutchen LLP
[email protected] T +44.20.7661.5317 F +44.20.7692.5462 London
James Roome is managing partner of Bingham’s London office and co-head of the firm’s global Financial Restructuring Group (European head). An English lawyer who concentrates on UK and cross-border insolvency, workouts and restructurings, he also handles litigation and advises on a wide range of debt and equity investments on behalf of financial institution clients.
He has advised on numerous restructurings of distressed bonds, notes and loans in Europe, including representing noteholders of Atrium European Real Estate (formerly Meinl European Land), BAA, Concordia Bus, Damovo Group, Elektrim, Focus DIY, Head NV, Independent News & Media, Irish Nationwide Building Society, Kremikovtzi, Marconi Corporation, Petroplus, Phoenix Pharmahandel, Preem AB, Schefenacker, SwissAir, Truvo, Vantico International, Versatel Telecom International, Welcome Break, and Wind Hellas; representing lenders in LBO restructurings, including Alliance Medical, Arcapita, Bulgaria Telecom, Europackaging, European Directories, Findus, Gala Coral, Ineos, Mauser, Monier, Schieder Möbel, TMD Friction and Viridian; representing the mezzanine syndicate on the restructuring of Level One, a real estate securitisation vehicle; representing numerous financial institutions in relation to prime broking, derivative and bond claims following the collapse of Lehman Brothers; representing the junior debtholders on the restructuring of Queens Moat Houses; and representing the EGO BV bondholders in the administration of TXU Europe.
James is consistently named as a leading individual by Chambers UK, Chambers Global, Chambers Europe, the Legal 500, PLC’s Cross-Border Restructuring and Insolvency Handbook, Who’s Who Legal, and IFLR 1000, among others.
Sovereign Debt Restructuring
Presented by: Tim DeSieno, Bingham McCutchen (Moderator) Hung Tran, Institute of International Finance Arturo Porzecanski, American University Bruce Wolfson, Bingham McCutchen The role of markets in sovereign debt crisis detection, prevention and resolution
Hung Q Tran1
I would like to thank the BIS for inviting me to speak to you on an important and timely issue. Given the prospect of slow growth, large budget deficits and high public sector debt, the challenges of managing and resolving sovereign debt crises in many countries, including advanced economies, will be with us for some time to come. As part of the wide range of issues being discussed at this Seminar, I would like to focus my remarks on the role of markets and market infrastructure in sovereign debt crisis detection, prevention and resolution. I will consider briefly crisis detection and prevention, and will devote most of my remarks to the issues of crisis resolution and sovereign debt restructuring.
Crisis detection
Market pricing has been viewed as being able to discount investors’ expectations of future events. In recent years, in addition to the cash markets for government securities, Credit Default Swap (CDS) markets have become more developed. Generally speaking, the deeper and more liquid markets become, the more efficiently they can reflect the collective views of numerous market participants. Indeed, in some instances, the markets for CDS have become much more liquid than cash markets, as CDS contracts can make it easier for investors to express their views on credit risk. In addition, ratings by Credit Rating Agencies (CRAs) can also reflect and influence market views, but the relationship between market prices and rating actions is complex. Usually, market prices are sensitive, quick-moving and tend to discount investor expectations well in advance. Ratings have tended to change more gradually and therefore are viewed as lagging market pricing on many occasions. If done in single notches and within the investment grade category, rating changes may not elicit much price reaction. However, multi-notch rating changes – particularly those moving across the investment grade borderline – can trigger more substantial price moves, mainly because many investment funds must observe eligibility requirements, such as those allowing them to invest only in investment grade securities. In principle, both market prices (for cash securities and CDS contracts) and rating actions can be expected to provide early detection of sovereign debt crises. A forensic analysis of the period leading up to the Greek sovereign debt crisis in early 2010 is useful to evaluate the effectiveness of the market’s role in crisis detection, especially
1 First Deputy Managing Director, Institute of International Finance (Washington D.C.). The views expressed here are personal and do not necessarily reflect those of the IIF. I would like to thank my colleagues for their helpful comments and suggestions, with particular appreciation to Thilo Schweizer for his assistance.
88 BIS Papers No 72 against the background of guidance and regulatory parameters set by policymakers and regulators. Greece joined the Euro Area on January 1, 2001, having missed being part of the first wave of those countries joining in 1999, due to non-compliance with the Maastricht criteria. Right from the start, celebratory statements were tempered with misgivings about Greece joining the monetary union, from both public and private sector observers. Wim Duisenberg, the inaugural President of the ECB, perhaps best reflected sentiment by noting just prior to Greece’s entry that: “…Greece has made great and commendable efforts in order to reach this stage. It shows the extent to which entry into Monetary Union and, therefore, complying with the Maastricht criteria have acted and are still acting as a catalyst for moves towards more sound public finance policies, an environment of low inflation and appropriate monetary policies...(However), it (Greece) still has a lot of further work to do.”2 Some investors worried that admitting Greece could send the wrong signal – that the Euro Area might accept weak members which would not fully comply with membership conditions. Nevertheless, the formal acceptance of Greece as the twelfth member of the Euro Area – against a background of enthusiastic statements by European leaders lauding the launch of the euro, as well as a very profitable track record of convergence trades on Italy, Spain, Ireland and Portugal in the years leading to EMU – unleashed strong investment and credit flows to Greece. A regulatory regime under which Greek government bonds (GGBs) were accorded zero risk weight (under the Basel capital framework), were encouraged to be held as part of banks’ liquidity pools, and were accepted at full face value at the ECB financing facility added allure to GGBs, particularly for Euro Area banks. Unsurprisingly, spreads between GGBs and Bunds collapsed from over 400 basis points in late 1998 (and 100 basis points just prior to joining EMU) to below 20 basis points in late 2001, staying in a low range around 15–40 basis points until well into 2008 – similar to developments seen in other periphery Euro Area countries. In 2004, Eurostat announced that it had audited Greece’s statistical releases from 1993 to 2004 and had fixed the deficiencies in their compilation. Statements from the official sector, including the IMF, continued to be mixed. While urging Greece to reduce its twin deficits, bring down inflation and continue to reform, official statements applauded Greece’s strong growth experienced since 2001, attributing it not only to low interest rates but also to the early fruits of structural reform and convergence. In fact, as late as March 2010, several European leaders, as well as Dominique Strauss-Kahn, then-Managing Director of the IMF, still maintained that Greece did not need financial aid from Europe, let alone from the IMF, and should just concentrate on cutting its budget deficit.3 In fact, by May 2010 the first EU-IMF program for Greece was launched, and the rest is history. In contrast to the muted reaction from the official sector, the CRAs had started to downgrade Greece, with Fitch downgrading Greece from A+ to A in December 2004, due mainly to its deteriorating fiscal position. After a period of stability over the subsequent several years, ratings downgrades resumed in early 2009 and became more pronounced after the Greek elections in October 2009 and the
2 Duisenberg (2000).
3 See e.g. Balmer (2010).
BIS Papers No 72 89 announcement by the new government of revised/corrected fiscal data showing larger than previously announced budget deficits and government debt. In the spring of 2010, Greece was downgraded to below investment grade (Chart 1, page 16). Greek yield spreads started to widen somewhat from low levels in spring of 2008, and rose further in late 2008 as the Lehman Brothers crisis hit. Following a period of relative stability at higher levels during most of 2009, the real blowout in spreads did not happen until early 2010. However, Greek CDS spreads seem to have lagged bond spread movements throughout 2007, afterwards moving more or less in tandem with bond spreads (Charts 2 and 3, page 16). It is important to note that the outstanding volume of CDS contracts on Greece during this time period was very small – around $9 billion (net), with infrequent trading (Chart 4, page 17). This contrasts sharply with the outstanding volumes in the GGB market at the time of some $400 billion. Hence there is little evidence to support the claim by some officials that the CDS market triggered turmoil in the GGB market.4 In summary, about a year before the crisis broke, spreads in the GGB market had started to widen, reflecting an expected increase in the probability of distress – which later materialized. In addition, rating agency commentary and market opinions began to focus on fiscal deterioration and debt sustainability, leading to gradual rating changes. While these market signals were rather modest prior to November 2009, in the next six months through May 2010, they worsened significantly in response to official data and policy announcements revealing the scale of fiscal imbalances amidst rapidly deteriorating economic conditions. As such, it can be said that market pricing and rating actions provided a measure of advance warning, by 3–6 months or so, of the impending sovereign debt crisis, with Greece’s ultimate loss of access to international capital markets amidst sharply widening spreads marking the sovereign debt crisis itself.
Crisis prevention
If markets exhibit signs of turmoil before a crisis erupts, they generally fail to prevent crises from happening. This is mainly because in many instances the authorities of the debtor country and others, including in regional groupings and international financial institutions, tend to ignore market signals. In some cases, authorities try to suppress market signals by “shooting the messenger” – including by banning short positions in securities markets or the purchase of “naked” CDS contracts on sovereign names. CRAs have also been subject to more scrutiny and regulation, including in the sovereign ratings arena, with official demands for regulation sometimes triggered by a downgrading action.5
4 As ISDA has noted, there was no surge in open interest in Greek CDS during 2009 and early 2010, and the relationship between government bond and CDS spreads was “essentially in line”, underpinning ISDA’s assertion that “the CDS market has had little or no impact on the government market”; ISDA (2010).
5 For example, against the backdrop of the European Commission’s ongoing amendments to existing CRA regulation, EU Internal Market Commissioner Barnier has indicated that CRAs could be banned from downgrading countries participating in the Eurozone’s bailout scheme. See e.g. Gow/Treanor (2011).
90 BIS Papers No 72 The rating agencies’ failures in other areas, notably subprime mortgage securitization, have contributed to demands for further regulation. However, this has confused the issue, as there is little indication that the deficiencies in rating subprime securitization had any bearing on sovereign or corporate ratings. A number of ideas have been advanced to improve the framework for crisis prevention. In particular, the Joint Committee on Strengthening the Framework for Sovereign Debt Crisis Prevention and Resolution was set up after the March 2012 Greek debt exchange to assess and draw lessons learned from the Euro Area’s recent experience with sovereign debt crisis management. It enhanced the guidelines contained in the 2004 Principles for Stable Capital Flows and Fair Debt Restructuring, a voluntary code of conduct between sovereign debtors and their private creditors that was endorsed by the G20 Ministerial meeting in November 2004 in Berlin. In its recommendations – issued as an Addendum to the Principles – the Joint Committee emphasized that effective sovereign debt crisis prevention is a shared responsibility, requiring – in addition to data and policy quality and transparency and open dialogue between creditors and sovereign debtors – sustained surveillance efforts by regional and international institutions and private sector groups, such as the IIF’s Market Monitoring Group. Effective crisis prevention also requires appropriate action by regulatory agencies, accounting and other international standard setters, as well as vigilance and enhanced risk management by private creditors and market participants in general. A concrete recommendation is that more structured fora for consultation between a sovereign debtor and its investor base can be useful, judging from the experience of several major emerging market countries that have adopted such practices. Regular and organized consultations, in the context of a regular investor relations program, can facilitate the ability of investors to share their concerns about perceived economic or financial imbalances and other policy deficiencies with relevant policymakers. This process can enable investors to better understand policymakers’ intentions, thus avoiding having to assume the worst-case scenario when the economy deteriorates. At the same time, feedback from investors can help galvanize timely actions by policymakers to avert potential crises.
Crisis resolution
Sometimes it becomes unavoidable that private creditors and investors need to be involved as part of crisis resolution. Private Sector Involvement (PSI) encompasses a rich menu of options, ranging from standstill to rollover (of maturing sovereign debt) to changing the terms and conditions of the debt, including extending maturities, lowering interest rates and reducing the face amount of the debt, or sovereign debt restructuring. This would relieve the cash flow and stock-of-debt burdens on the sovereign debtor, contributing to its adjustment and recovery process.
BIS Papers No 72 91 According to a recent IMF working paper6 there were 633 cases of sovereign debt restructuring in 95 countries over the last 60 years. The bulk of the restructuring (447 cases) was with bilateral official creditors in the framework of the Paris Club, while only 186 cases were with private creditors. Of the latter, the lion’s share was for bank loans, until recently, when sovereign bond restructuring has become more frequent, with 16 cases to 2010. To that list we can add the Greek debt exchange; St. Kitts and Nevis in 2012; and the second Belize Super Bond exchange (agreement in principle likely in 2013). Based on this body of experience, I would like to make several observations, highlighting instances where market mechanisms have worked relatively well and where they were weak and needed strengthening. These are key components of market-based sovereign debt restructuring and the Report of the Joint Committee includes recommendations to enhance their efficacy.
Fair burden sharing through good-faith negotiation
First and foremost, it is essential to keep in mind that sovereign debt restructuring means asking private creditors, especially long-term investors, to give up parts of their property rights and agree to debt forgiveness for the sake of the greater good – helping the recovery of the sovereign debtor and restoring financial stability – from which they benefit only indirectly as market participants. Understandably, an incentive for creditors to behave cooperatively is the threat of default, in which case creditors could stand to lose more. However, a defaulting sovereign debtor also pays a heavy price in terms of reputation damage and being shut out of international capital markets until the default is cured. Moreover, as the severity of haircuts in sovereign debt restructuring has shown a tendency to increase over time, the difference between the residual value in restructuring and the expected recovery value after default could diminish, weakening the potency of the threat of default. All things considered, a balanced approach is important in achieving voluntary agreement to a fair burden sharing among the three key partners in the adjustment program: the sovereign debtor country, the official sector and private creditors. Concretely, the debtor country has to implement meaningful fiscal and structural reforms to improve its economic performance and prospects. The official sector – traditionally meaning the IMF and other international financial institutions, but also the Eurogroup in the context of the Euro Area debt crisis – has to provide official financing to support the adjustment program because of its overall responsibility to maintain a stable international monetary system. In the case of the Euro Area, the financing is also to support a key policy objective – namely, sustaining the euro. In the context of the adjustment program, private creditors would agree to make their contributions in the form of debt relief to lighten cash flow and stock-of-debt burdens on the debtor. Given the different interests of the three partners, good-faith negotiation is obviously the only way to achieve a voluntary, orderly and effective debt restructuring – one which contributes meaningfully to the adjustment program, respects creditor rights, minimizes litigation risk and allows the sovereign to quickly regain access to international capital markets (without which debt is clearly not sustainable). Access to market
6 See Das/Papaioannou/Trebesch (2012).
92 BIS Papers No 72 financing is also necessary to allow the official sector to gradually unwind its adjustment lending exposure to the country. Improving market confidence and restoring good relations with private investors is therefore prudent and in the best interests of both the sovereign debtor and the official sector. Moreover, an agreement on fair burden sharing is not sufficient on its own. All three partners must perform their respective commitments within the “grand bargain” for the crisis to be resolved. For example, in the case of the second Greek program of February 2012,7 which offered a reasonable chance at that juncture for a gradual recovery of the economy (reaching a debt-to-GDP target of less than 120% by 2020 – considered by the official sector as essential to attain debt sustainability), private creditors and investors promptly performed their part of the bargain by participating in the March debt exchange. This debt exchange provided Greece with an unprecedented €107 billion of debt reduction, or a 53.5% nominal haircut and a 74% NPV reduction (at an assumed discount rate of 15%). However, Greece failed to implement the agreed reforms in full and on time and the official sector delayed the second disbursement for about six months – during which time the Greek economy collapsed further and its debt-to-GDP ratio jumped to 160% by the end of 2012. The actual sequence of events shows that it is erroneous to say that the March PSI was not “deep” enough to allow Greece to recover. In fact, given what has happened since March, even 100% debt forgiveness by private creditors would not have helped Greece. As a side note, with the debt buyback in December 2012, the share of private sector holdings of new GGBs has declined to less than 10% of total Greek public debt (estimated to be about €310 billion).
Assessment of debt sustainability
Central to an adjustment program is the assessment of how different configurations of fiscal and structural reforms, official financing and private debt relief would lead to debt sustainability in the medium term. The concept of debt sustainability is a matter of judgment and not “hard science”. It rests on numerous assumptions and is closely linked to the ability of the sovereign debtor to re-access international capital markets on reasonable terms. Traditionally, the assessment of debt sustainability was done on an iterative basis, with the IMF acting as an “honest broker”, providing the analytical framework and analysis for discussion between the sovereign debtor and its creditors. This approach has been more conducive to good-faith negotiations, which the Fund requires a sovereign debtor to conduct with its private creditors as part of the Fund’s Lending into Arrears policy. More recently, however, in the context of large fiscal imbalances, declining output, and fairly large and rising debt burdens, the IMF has espoused a medium-term target for the nominal debt-to-GDP ratio which has driven everything else to meet such a target. When combined with the fact that in some cases (such as the Greek debt crisis) both domestic reform measures and
7 “The Hellenic Republic today announced the key terms of a voluntary transaction in furtherance of the 26 October 2011 Euro Summit Statement, known as the Private Sector Involvement, and in the context of its economic reform programme that has been agreed with the European Union and the International Monetary Fund. The transaction is expected to include private sector holders of approximately EUR206 billion aggregate outstanding face amount of Greek bonds (excluding treasury bills)”; Hellenic Republic – Ministry of Finance (2012).
BIS Papers No 72 93 official financing from both the Fund and Euro Area countries appear to have been predetermined by political considerations, private debt relief has become the only free variable in the game. In other words, private investors have become the financier and debt relief provider of first, second and last resort! However, the more private investors are treated this way, the less likely the sovereign debtor would be able to regain access to international capital markets within a reasonable time frame. Generally speaking, the reluctance to reengage with such sovereign debtors might be expected to be stronger among long-term institutional investors, while some short-term investors may behave more opportunistically. Furthermore, the maturity and coupon as well as the ownership composition of sovereign debt are quite important to an assessment of sustainability. Debt of long maturity and low or concessional interest rates is much less of a burden than a similar nominal amount of medium-term debt at higher market rates. A focus on the nominal debt-to-GDP ratio misses this point completely. More importantly, if domestic financial institutions such as banks hold a significant share of outstanding sovereign debt, restructuring this debt would substantially impair the capital base of the domestic banking system. In many cases, this would necessitate a public recapitalization of domestic banks, raising sovereign debt levels. Furthermore, the economy could be weakened by the banking system coming under distress. The total economic cost could thus far exceed the benefit of a reduction in the nominal value of debt. Generally speaking, experiences from many emerging market countries exiting from sovereign debt crises show that sustained improvement in the debt-to-GDP ratio has largely resulted from a recovery of nominal GDP and not just a reduction in nominal debt. Given that assessment of debt sustainability could have a direct bearing on the severity of debt restructuring, it is even more important that private investors have an opportunity to engage with the official sector on a timely basis in a discussion about economic scenarios and key parameters of the adjustment program, including assessment of debt sustainability. Without private investors’ input and “buy-in” for the economic framework of the adjustment program, it is difficult to achieve a voluntary agreement on fair burden sharing and an appropriate debt restructuring.
Creditor coordination problem – role of the creditor committee
One of the most important sources of skepticism about the feasibility and efficacy of market-based sovereign debt restructuring is the coordination problem, both in the sense of the difficulty of getting thousands of bondholders to coalesce in a timely fashion into a representative creditor committee – as opposed to the ability of one or two dozen major international banks to quickly form such creditor committees in the sovereign bank debt restructuring of the 1980s and 1990s – and dealing with the free rider problem. Looking at the 19 or so cases of sovereign bond restructuring in the past 20 years, it is clear that coordination concerns have been exaggerated. In most if not all of these cases, a bondholder committee has been able to take shape within a reasonably short time frame, representing somewhere between 30 and 60% of the value of bonds outstanding. In addition, many institutional investors may decide not to formally join a bondholder committee for various reasons, but are prepared to
94 BIS Papers No 72 give serious consideration to the committee’s recommendations. Bondholder committees can also claim to be representative as they act in the interest of all bondholders in general. Reflecting the constructive role of creditor committees, market practices have evolved to include the sovereign debtor recognizing and negotiating with such committees as well as paying for their reasonable expenses, including for legal and financial advice. Recently, progress in communications technology and data retrieval, especially from bond depositary databases, has greatly facilitated the identification of and communication among major bondholders, accelerating the formation of bondholder committees. The IIF has contributed to this process, mainly through the work of the Principles Consultative Group (PCG) – a unique public-private sector group charged with monitoring implementation of the Principles. The PCG monitors and discusses all sovereign restructuring cases (including potential ones) among its members, supplemented by observers invited from major stakeholders in particular cases. As such, the PCG offers a natural base for concerned bondholders to come together to form a representative committee. In some cases, the IIF has also been invited by the official sector and bond-holding institutions to act as intermediary in a PSI process. This was the case with Greece – the IIF was asked by the Eurogroup Ministers in June 2011 to organize and represent private investors to engage with the official sector to discuss PSI for Greece. Concerns about the free rider problem have also been exaggerated. According to the IMF, of the 16 cases of sovereign bond restructuring it has examined, only two saw holdout creditors representing more than 10% of the value of outstanding bonds, and only one resulted in persistent litigation. This is the case of Argentina, which hopefully should remain a unique example of a sovereign debtor pursuing a unilateral and coercive approach to debt restructuring, willfully ignoring its own obligations to official creditors and international financial institutions such as the IMF and the World Bank’s International Centre for Settlement of Investment Disputes. In fact, a more serious obstacle to the smooth functioning of creditor committees as an essential part of an orderly sovereign debt restructuring has in some cases been the approach taken by particular sovereign debtors. Some have refused to recognize the creditor committee and in some instances have worked to undermine it, preferring to talk bilaterally with selected investors to market their unilaterally-determined debt exchange plans. While a sovereign debtor can and should talk directly to any and all investors, doing so as a pretext to avoid good- faith negotiations with a representative bondholder committee is equivalent to pursuing a unilateral and coercive approach to debt restructuring. Such an approach has been resisted by private creditors, and has led to a low participation rate in debt exchanges and high litigation risk – basically failing to achieve an orderly and effective debt restructuring.
Collective action clauses – pari passu clause
To address coordination problems, Collective Action Clauses (CACs) were first proposed by major advanced countries (and endorsed by the G10) in the early 2000s as an alternative to the top-down administered sovereign debt restructuring mechanism (SDRM) suggested by the IMF. CACs were first included in their modern
BIS Papers No 72 95 form in the prospectus of a global bond issue by Mexico in March 2003.8 Since then, most new sovereign bonds issued on global capital markets have included CACs. It is important to keep in mind the fact that CACs also represent a weakening of creditor and property rights, in the sense that investors agree on an ex-ante basis to be bound by the decision of a qualified majority of fellow bondholders to change the terms and conditions of their bond investments to their detriment. By comparison, creditors to corporations undergoing U.S.-style bankruptcy proceedings at least have the comfort of the process being supervised by an impartial judge, otherwise any substantial modification of the terms of the debt requires the unanimous consent of creditors. As such, it is only fair that when unavoidable, CACs should be used in a comprehensive way, meaning that the sovereign debtor recognizes and engages in good-faith negotiation with a representative bondholder committee to reach a voluntary debt restructuring agreement. The agreed plan would then be submitted to bondholders for a vote – an affirmative decision by a qualified majority would bind the minority to the proposed changes in terms and conditions of the bonds. (Incidentally, this imposition on minority bondholders constitutes a credit event in CDS contracts on sovereign names, triggering a settlement of outstanding contracts. A completely voluntary restructuring would not constitute a credit event in the sovereign CDS market.) In this context, an attempt to use only the voting mechanism specified in CACs to implement unilaterally-determined debt exchange offers or liability management plans would be abusive and likely to encounter investor resistance. In essence, using CACs only as a voting mechanism is similar in spirit to the use of “exit consent” in an attempt to impose a debt exchange plan on non-participating investors. If the terms are deemed to be onerous and punitive, investors can now appeal to the courts, based on a recent ruling of the London High Court.9 Overall, it is to be welcomed that sovereign bonds issued by Euro Area member countries will carry model and identical CACs from the beginning of 2013, implementing the ESM Treaty. In addition, the Euro Area CACs contain an aggregation clause for cross-series modification – which was also recommended by the Joint Committee in the Addendum to the Principles to facilitate the orderly implementation of an agreed debt exchange by making it more difficult for non-participating investors to build blocking positions in individual bond series. However, it is regrettable that the Euro Area CACs deviate from market practices –as reflected in guidelines set out by the International Capital Market Association (ICMA) – in two areas: lower thresholds for qualified majority (66.6% instead of 75%) and no coverage of bondholder committees.
8 On March 3, 2003 Mexico successfully issued its 6.625% Global Notes due 2015, governed by New York law that included both majority restructuring and majority enforcement provisions. The spread at issue was in line with the Mexican yield curve, suggesting that any premium paid for CACs was negligible. The bond continued to trade well in the secondary market. Although this was not the first bond issue governed by New York law to include majority restructuring provisions, this issuance is of particular significance because the existence and design of these clauses was the subject of extensive discussion at the time the bonds were issued; see IMF (2003), SEC (2004), p.2, Fn.3.
9 Assénagon Asset Management S.A. v. Irish Bank Resolution Corporation Ltd., July 2012. [2012] WLR(D) 243, [2012] EWHC 2090 (Ch).
96 BIS Papers No 72 More recently, the issue of pari passu clauses has received a lot of attention following the decisions of the District Court of the Southern District of New York in the case of Argentina v. NML Capital Ltd. (February and November 2012),10 and the U.S. Court of Appeals for the Second Circuit (October 2012).11 The concept of pari passu is more meaningful and clear-cut in the context of corporate bankruptcy, where the proceeds from the liquidation of corporate assets are distributed equally to unsubordinated debt holders before any residual amount can be used to pay more junior claims. For many years prior to the 1990s, the pari passu clause in the context of sovereign bank loans and bonds had the formal meaning of the sovereign debtor promising not to proclaim any new debt or parts of its outstanding unsubordinated debt as senior to other unsubordinated debt. However, since the 2000s, the pari passu clause in sovereign debt contracts has evolved to contain a second sentence referring to “equal ranking of payment obligations” among the debtor’s unsubordinated debts. By now, about half of the sovereign bonds in international capital markets contain both the first sentence about formal ranking and the second sentence about “equal ranking of payment obligations” in their pari passu clauses. Under such an extended pari passu clause, and in the opinion of the U.S. Circuit Court of Appeals for the Second Circuit, a sovereign debtor has an obligation as a bond issuer not to create any debt senior to the outstanding stock of unsubordinated debt. The debtor also has the obligation as a bond payor to refrain from paying some holders of unsubordinated debt while not paying others. Using this argument, the Second Circuit reaffirmed the decision of the District Court that Argentina had violated the pari passu clause in its bond contract in both senses, by passing the Lock Law and by not honoring its “equal ranking of payment obligations” to all bondholders. However, having a sovereign debtor judged to have violated its bond contract is one thing, how to remedy the situation is quite another. At present, it is not clear how this can realistically be done. The payment instruction specified by the District Court in November 2012 (namely, that Argentina must pay holdout claims in full when it makes payments on restructured bonds; that the injunction applies to the intermediaries such as trustee banks and clearing organizations in the payment process; and that Argentina must deposit $1.33 billion in an escrow account pending appeal) is being stayed, pending review by February 2013. This payment instruction – especially extending the injunction to intermediaries in the payment process – has given rise to concern about possibly incentivizing holdouts in future sovereign debt restructuring, even within the context of activating CACs, and disrupting payment systems in general. The outcome will very much depend on how the Second Circuit decides, and if its ruling is presented specifically for the unique case of Argentina and not to be interpreted more generally. Generally speaking, investors have found it quite difficult and costly to recover court judgments in their favor against sovereign debtors determined to exercise their sovereignty and ignore foreign court orders. Clarification of the payment sentence of pari passu clauses and a strengthening of the Waivers of Immunity
10 NML Capital, Ltd. v. Republic of Argentina, United States District Court for the Southern District of New York, Dec. 14, 2011, No. 03-cv-8845, ECF No. 452.
11 NML Capital, Ltd. v. Republic of Argentina, United States Court of Appeals for the Second Circuit, August 20, 2012, No. 11-4065-cv (L).
BIS Papers No 72 97 clauses could offer opportunities to address the difficulty in enforcing court judgments against a sovereign debtor – which is an important deficiency in sovereign debt markets.
Subordination – the Securities Market Program (SMP) and Outright Monetary Transactions (OMT)
The Euro Area sovereign debt crisis and in particular the Greek debt exchange have resulted in yet another erosion of the rights of private investors in the sovereign bonds of those countries: de facto subordination. Specifically, the GGB holdings of the ECB and the Euro Area national central banks were exempted from the Greek debt exchange, on the grounds that participation in the exchange would have been tantamount to “monetary financing”, which is prohibited by the Treaty on the Functioning of the EU. Unfortunately, such subordination meant that private holders of identical GGBs were put under more pressure to come up with a more onerous haircut to achieve the targeted debt relief for Greece. In addition, one of the recitals in the ESM Treaty also claims seniority for ESM loans, second only to the preferred creditor status of the IMF. In other words, when a problem member country receives such ESM loans, its sovereign bonds in the hands of private investors and other official creditors outside the Euro Area will become subordinated instead of unsubordinated, as specified in outstanding bond contracts – a possible violation of the pari passu clause of existing sovereign debt. The subordination problem is a serious concern for international investors (including both private sector firms and public sector entities such as foreign central banks and sovereign wealth funds). Specifically, it adds another complication to the assessment of credit risk for those Euro Area countries under fiscal stress and can make it more difficult for some of them to access capital markets on reasonable terms. Aware of this problem, the Euro Area authorities have taken some steps to assuage investor concerns. When launching the OMT scheme to buy short-term sovereign bonds on secondary markets, the ECB emphasized that bonds purchased under the OMT will be treated equally with those held by private investors. This clarification is welcome. However, it still leaves standing the preferred creditor status claimed for sovereign bonds held in the SMP, as was the case in the Greek debt exchange. Going forward, it is important that the Euro Area authorities clarify this important source of uncertainty so as to help restore normalcy to their sovereign bond markets.
Litigation and “vulture funds”
Against the backdrop of sovereign actions to impose de facto subordination on private holders of sovereign bonds and some attempts to pursue a unilateral approach to debt restructuring, it is important to realize that litigation is crucial to defend creditor rights and to help achieve a balanced approach to sovereign debt crisis resolution. Otherwise, allowing creditor rights (including litigation rights) to be weakened, even under the exigencies of crisis resolution, would have long-term negative effects on credit markets to the detriment of all market participants, mainly
98 BIS Papers No 72 by undermining the legal certainty of sovereign securities, especially in mature markets. In this context, it is important to put the debate about litigation by distressed debt funds, or so-called “vulture funds”, into perspective. According to research notes prepared by the Emerging Markets Trade Association (EMTA) and the IIF for the Paris Club-IIF Annual Meeting in June 2010, incidents of litigation against emerging markets, as well as low-income/HIPC sovereign borrowers have been relatively few in number and covered a small share of the outstanding value of restructured sovereign debt.12 According to EMTA, since the early 1980s, 59 emerging market and non-HIPC countries have defaulted and/or restructured their sovereign debt, worth more than $600 billion in total. Of this sample, nine countries were identified as being subject to litigation by one or more of their creditors. Excluding the unique case of Argentina, which defaulted in 2001, the face value of debt subject to litigation has amounted to about $1.5 billion and resulted in recoveries totaling about $230 million. Creditor plaintiffs have tended to be successful in asserting their claims and obtaining judgments in U.S. courts under basic principles of contract law, including waivers of sovereign immunity. However, actual recoveries appear to have been difficult and time-consuming – a trend which has become more pronounced over the past decade. According to the IIF review of litigation in low-income and HIPC countries, out of the 47 lawsuits identified by the 2008 HIPC Initiative and MDRI Status of Implementation Report by the IMF/IDA, 32 cases have been settled. Most of the remaining 15 cases have been brought by trade creditors such as suppliers to governments rather than by distressed debt or “vulture funds”, which now account for only three cases (two new cases involving the Democratic Republic of Congo and one old case involving Liberia). These facts should be kept in mind in the debate about possible legislation to deal with the perceived problem of litigation by “vulture funds”, especially in low- income/HIPC countries, so that a remedy to an exaggerated problem does not end up doing significant damage to the integrity of international credit markets, mainly by depriving investors of their legitimate recourse to litigation in case of disputes.
Debt buybacks
Sovereign bonds of a country in distress typically trade at a significant discount on secondary markets. Buying back such debt at current market prices (or with a small premium) crystallizes losses for participating investors, especially long-term investors, and precludes any chance of later recovery, while reducing the nominal value of debt for the borrower. As such, buybacks can have a role to play in the liability management toolbox to help a sovereign debtor manage its debt and provide an exit for investors in impaired markets. However, there are several considerations relating to the use of buybacks:
12 See IIF/EMTA (2009).
BIS Papers No 72 99 1. Most importantly, buybacks should be carried out on a voluntary basis based on market terms. Attempts to use CACs to impose a buyback at a specified price, especially if the price is below market, constitute a coercive approach to sovereign debt restructuring. Besides the fact that such tactics may encounter investor resistance, they represent an abusive use of CACs. 2. Secondly, the financing needed for such buybacks should be on substantially better terms than the debt being bought in terms of maturity and interest rates. 3. Thirdly, buybacks are best managed in a discreet and opportunistic fashion. Publicly announcing a buyback target and price, or even worse, making it a pre-condition for granting official financing to a debtor country (as was the case in the December 2012 Greek debt buyback) affords investors an almost one-way bet to push prices up. This results in a higher cost for buybacks and correspondingly less benefit in terms of nominal debt reduction for the borrower. 4. Last but not least, it is important to analyze the potential costs and benefits of alternative uses of official financing – a scarce resource for the sovereign debtor in distress. In the case of Greece, the buyback cost of €11.3 billion comes from squeezing the official financing package – precluding a more productive use of such financing to alleviate the acute liquidity shortage which has caused severe economic dislocation. Partly because of continued liquidity shortages, Greek nominal GDP is estimated in the program to shrink by another 5% in 2013, on top of the 20% decline since 2008. Such a decline in nominal GDP would increase the debt-to-GDP ratio by 9 percentage points, almost equivalent to the amount of debt (9.6% of GDP) retired by the buyback!
Credit enhancements and GDP-linked instruments
The Greek debt exchange has also provided concepts and techniques that can be used to enhance the credit quality of the exchange instruments so as to gain support from investors without increasing the upfront cost to the sovereign debtor or the official sector. Cash sweeteners, such as the €30 billion in short-term notes provided by the EFSF to participants in the March 2012 Greek debt exchange, are valued by investors for their lack of credit risk compared to collateral in the form of securities which may have equivalent costs to the official sector but whose value to investors varies according to market conditions. Co-financing structures such as that between the EFSF’s €30 billion loan to Greece and the new GGBs can give some protection to investors at no cost to the official sector or the sovereign debtor. The use of foreign law and jurisdiction in new domestic bond issues can minimize the risk of a sovereign debtor changing domestic law so as to alter unilaterally and retroactively the terms and conditions of its outstanding bonds, potentially subjecting private investors to significant haircuts. The use of GDP-linked instruments with proper safeguards to produce a win-win situation so that the sovereign will pay more when it can afford it, in cases of higher-than-anticipated output growth.
100 BIS Papers No 72 Conclusions
I would like to conclude by again drawing your attention to the conclusion of the IMF Working Paper cited above: “We find that most recent sovereign debt exchanges could be implemented quickly and without severe creditor coordination problems. Since 1998 only 2 out of 17 bond exchanges had a share of holdout exceeding 10% of the debt. Similarly, creditor litigation in the context of bond restructuring has been rare, with the exception of the default of Argentina after 2001. Overall the system of ad-hoc debt exchanges seems to have worked reasonably well for emerging market countries. These experiences may also prove useful to any distressed country, including advanced economies.”13 Given such a track record, the current “reasonably effective” system of ad-hoc sovereign debt exchanges should be further developed and enhanced by adherence to the Principles, in order to serve as the preferred framework for voluntary and good-faith negotiation to reach a fair burden sharing arrangement which – together with the use of CACs – can facilitate an orderly and effective debt restructuring. This in turn will contribute to sovereign debt crisis resolution and help restore financial stability. I appeal to you to lend your support to this endeavor. Thank you very much for your attention.
13 Das/Papaioannou/Trebesch (2012), p.96.
BIS Papers No 72 101 Appendix
Chart 1:
Chart 2:
Chart 3:
102 BIS Papers No 72 Chart 4:
Sovereign Bond Restructurings Table 1
Country Year Participation Rate Pakistan 1999 99% Ecuador 2000 98% Russia 2000 99% Ukraine 2000 97% Moldova 2002 100% Uruguay 2003 93% Dominica 2004 72% Argentina 2005 76% Dominican Republic 2005 97% Grenada 2005 >90% Belize 2007 98% Ecuador 2009 n.a. Seychelles 2009 89% Argentina 2010 93% cumulative (76% in 2005) Cote d’Ivoire 2010 99% Jamaica 2010 98% Greece 2012 93% St. Kitts and Nevis 2012 100% Belize 2013 Agreement in principle; announcement of terms and debt exchange offer pending.
Sources: IIF, Das/Papaioannou/Trebesch (2012), Cruces/Trebesch (2011).
BIS Papers No 72 103 References
Balmer, Crispian (2010), IMF working perfectly with EU on Greece – Strauss-Kahn, 29 March 2010, http://www.reuters.com/article/2010/03/29/imf-strausskahn- greece-idUSLDE62S0Z920100329. Cruces, Juan J. / Trebesch, Christoph (2011), Sovereign Defaults: The Price of Haircuts, CESifo Working Paper No. 3604. Das, Udaibir S. / Papaioannou, Michael G. / Trebesch, Christoph (2012), Sovereign Debt Restructurings 1950–2010: Literature Survey, Data, and Stylized Facts, IMF Working Paper (WP/12/203). Duisenberg, Wim (2000), Duisenberg comments on Greek EMU entry at ECB press conference, 14 December 2000, http://www.centralbanking.com/central- banking/news/1429133/duisenberg-comments-greek-emu-entry. Gow, David / Treanor, Jill (2011), Downgrading countries in bailout could be banned, says EU, 20 October 2011, http://www.guardian.co.uk/business/2011/ oct/20/downgrading-countries-in-bailout-ban. Hellenic Republic – Ministry of Finance (2012), PSI Launch Press Release, 21 February 2012, http://www.minfin.gr/portal/en/resource/contentObject/id/7ad6442f -1777-4d02-80fb-91191c606664. Institute of International Finance (IIF) / Emerging Markets Trade Association (EMTA) (2009), Creditor Litigation in Low-Income Countries Benefiting from the Enhanced-HIPC and MDRI, June 2009, Preliminary Analysis, http://www.clubdeparis.org/sections/communication/evenements/rencontre-avec- secteur/secteurprive2009/rencontre-avec-secteur/document-iif-emta/downloadFile/ file/IIF-EMTA_Study_on_Creditor_Litigation_against_Sovereigns.pdf?nocache= 1265362021.63 International Development Association (IDA) / International Monetary Fund (IMF) (2011), Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI) – Status of Implementation and Proposals for the Future of the HIPC Initiative. International Monetary Fund (IMF) (2003), Public Information Notice (PIN) No. 03/53, April 18, IMF Continues Discussion on Collective Action Clauses in Sovereign Bond Contracts, http://www.imf.org/external/np/sec/pn/2003/pn0353.htm. International Swaps and Derivatives Association (ISDA) (2010), ISDA Comments on Sovereign CDS – News Release, 15 March 2010, http://www.isda.org/media/press/ 2010/press031510.html. United States Securities and Exchange Commission (SEC) (2004), Order Granting Application for Exemption: Petroleos Mexicanos and the Pemex Project Funding Master Trust, October 13, 2004 (File No. 22-28755), http://www.sec.gov/ divisions/corpfin/cf-noaction/pemex101304.pdf.
104 BIS Papers No 72
WHEN BAD THINGS HAPPEN TO GOOD SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR
ARTURO C. PORZECANSKI*
I INTRODUCTION Multinational corporations were meant to be reassured by the protections incorporated into bilateral and regional investment agreements. However, judging from the growing number of claims filed with the International Centre for Settlement of Investment Disputes (ICSID) and other arbitration vehicles— more than three hundred and fifty treaty-based, investor–state disputes as of the end of 2009—it is evident that many corporations have found out the hard way that sovereign states are not always suitably restrained by the international treaties they have signed and ratified.1 Likewise, private-sector commercial-bank creditors, bondholders, and suppliers—even official bilateral and multilateral lenders—have come to learn by repeat experience that financial contracts entered into by sovereign borrowers, no matter how airtight and well-intentioned at the time they were crafted and signed, can be perverted or ignored by governments lacking in ability or willingness to pay. This article illustrates this point by focusing on the case of Ecuador, a country whose governments have defaulted nine times on foreign-currency bonds and numerous times to foreign commercial-bank creditors and others, such that the sovereign has been in default for at least 109 out of the last 184 years—sixty percent of the time from 1826 through 2010.2 By its own reckoning, the government has been in arrears on interest payments to some foreign creditor or another in each and every year starting in 1987.3 The lesson from
Copyright © 2010 by Arturo C. Porzecanski. This article is also available at http://www.law.duke.edu/journals/lcp. * Distinguished Economist in Residence, American University. 1. See United Nations Conference on Trade and Development [UNCTAD], Geneva, Switz., 2010, World Investment Report, at 83. 2. Ecuador’s first default took place when it was part of the Republic of Gran Colombia, which became the nations of Ecuador, Colombia, and Venezuela in 1830. See generally David T. Beers, Commentary, Sovereign Defaults At 26-Year Low, To Show Little Change in 2007, STANDARD & POOR’S, Sept. 18, 2006, at 18. 3. BANCO CENTRAL DEL ECUADOR, 80 AÑOS DE INFORMACIÓN ESTADÍSTICA ch. 2 tbl.2.12 (2007), available at https://www.bce.fin.ec/documentos/PublicacionesNotas/Catalogo/Anuario/80anios/ indice.htm; Banco Central del Ecuador, Movimiento de la Deuda Externa Pública, INFORMACIÓN 252 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 abundant history is that, despite decades of innovations in international-loan and bond contracts involving sovereign financial obligations—courtesy of some of the best minds in New York, London, and beyond—lawyers, bankers, analysts, and investors are best advised to operate under no illusions: sovereigns are indeed sovereign, independent of the laws of other nations. Those who harbored the hope that Argentina’s bad behavior as a sovereign debtor was a major exception that would not soon be repeated should be persuaded by the case of Ecuador that, although the absence of sovereign willingness to pay remains rare, it is not rare enough. Notwithstanding the best of legal contracts and the surrender of sovereign immunities under New York, English, or other foreign law, in actual practice, rogue sovereign debtors can be held accountable or effectively restrained only by the forceful actions of other sovereigns.4 During the nineteenth century, this was sometimes accomplished by the successful exercise of military force and, during the twentieth century, through the application of diplomatic, trade, and financial sanctions or incentives, both unilaterally and through multilateral organizations.
II THE GOOD INTENTIONS After repeated refinancings and deferrals of debt-service obligations to foreign commercial banks, and the accumulation of sizeable interest arrears (particularly from 1987 through 1994), the government of Ecuador finally reached a comprehensive debt-forgiveness and restructuring deal in 1995, under the aegis of the Brady Plan. The terms agreed to reflected creditor concessions that were more generous than those granted to any other Latin American government up to that moment; in particular, the discount bond—accepted by creditors willing to give up claims on principal owed—involved a forty-five percent “haircut” rather than the usual thirty-five percent.5 As in other Brady Plan applications, the various securities issued in exchange for old defaulted loans (in this instance the par, discount, past-due-interest, and interest- equalization bonds) incorporated a number of legal innovations designed to make them virtually inviolable in any future economic emergency. First, they were freely transferrable bonds listed on the Luxembourg Stock Exchange, precisely so their ownership could change over time and so they would not be easily traceable for the purpose of getting them restructured again. Second, the bonds that involved debt forgiveness or concessional interest rates and that had very long grace periods and maturities (the pars and discounts) were backed in
ESTADÍSTICA MENSUAL, Sept. 2010, at tbl.3.3.1, available at http://www.bce.fin.ec/home1/estadisticas/ bolmensual/IEMensual.jsp. 4. See Arturo C. Porzecanski, From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default, 6 CHI. J. INT’L L. 311, 331 (2005) (asserting that rogue debtors are a threat to the international financial architecture). 5. Lee C. Buchheit, How Ecuador Escaped the Brady Bond Trap, INT’L FIN. L. REV., Dec. 2000, at 17, 17. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 253 part with good collateral (U.S. government zero-coupon bonds), so future governments would not be tempted to default merely to avoid servicing them. And, third, the new bonds contained “exit covenants” by which the obligor pledged neither to ask for a future restructuring of the securities nor to request additional funding from the holders of the bonds.6 In addition, the Ecuador and other loan-for-Brady-bond exchanges were accompanied by concrete steps and pledges of improved macroeconomic policies and market-friendly structural reforms that would enhance the ability of governments and their successors to service the new financial obligations until their eventual maturity. In Ecuador’s case, good progress in terms of economic stabilization and structural reforms was made ahead of the Brady Plan’s implementation, with the support of the Washington-based multilateral agencies, moving the International Monetary Fund (IMF) twice (in 1992 and 1994) to endorse a rescheduling of debts owed by the government of Ecuador to the official foreign-aid and export-financing agencies represented at the Paris Club. However, in 1995, the debt relief obtained in these reschedulings was squandered via increased military spending following a brief border war with Peru; and what had been a duly balanced government budget from 1993 through 1994 became a string of deepening fiscal deficits—and renewed foreign indebtedness, including for armaments. Battered also by drought-related power shortages and the adverse repercussions of the financial crisis in Mexico, the economy stagnated that year, and the country’s vice president, who had been the driver of market-friendly economic reforms, fled Ecuador to evade arrest on charges of corruption.7 Notwithstanding the good intentions incorporated into the 1995 debt-relief operation, by 1999, Ecuador was in very serious—indeed far more serious— financial trouble. A decline in world oil prices, damaging floods occasioned by the El Niño weather phenomenon, a drop in capital inflows in the wake of the Asian and Russian financial woes, a major domestic banking crisis, and loose fiscal and monetary policies all combined to push the economy to the brink of ruin. During the second half of that year, Ecuador became the world’s first government to default on its Brady bonds. Ecuador defaulted as well on two Eurobonds that had been issued in better days (1997) and on dollar- denominated domestic obligations maturing in the short run. In a desperate move, the government officially dollarized the economy in January 2000, but soon after, the president was deposed and was replaced by his vice president. As financial stability and improved macroeconomic policies took hold, the IMF
6. Lee C. Buchheit, The Evolution of Debt Restructuring Techniques, INT’L FIN. L. REV., Aug. 1992, at 10, 12. 7. Stanley Fisher, First Deputy Managing Dir., Int’l Monetary Fund, Remarks at the Hoover Institution Conference on Currency Unions: Ecuador and the IMF (May 19, 2000), available at http:// www.imf.org/external/np/speeches/2000/051900.htm. 254 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 offered its financial support in April of that year—provided that substantial debt relief was obtained from foreign private creditors.8 In July of 2000, with the IMF’s backing, the government sought and obtained a second round of principal forgiveness from its creditors, estimated at around forty percent of face value. Bondholders were presented with a take-it- or-leave-it exchange offer whereby they would get new, uncollateralized obligations due in 2030 that paid very little interest, at least in the initial years, in exchange for their long-dated Brady bonds, to which a heavy discount was applied, and for their short-dated Eurobonds, to which no discount was applied. If creditors had opted instead for a bond paying a high interest rate and maturing in 2012, they would have had to concede an additional thirty-five percent “haircut” on the principal owed by Ecuador. Some ninety-seven percent of all bondholders accepted the exchange offer, which gave Ecuador substantial debt reduction as well as significant cash-flow relief in the initial years.9 The new bonds incorporated contractual innovations meant to reassure investors that the risk of future losses would be minimized and that the new securities had upside potential. As the venerable Lee Buchheit, New York counsel to the Republic of Ecuador, recounted, “A deliberate effort was . . . made to include structural features in the new bonds that would reduce the likelihood that the debt stock would become the subject of a third round of debt relief in the future.”10 The first legal innovation was to incorporate a pledge that, if there should be a default that was not cured within one year on the 2030 bonds during the first decade after issuance, Ecuador would compensate bondholders: it would grant them additional 2030 bonds under a sliding scale, starting with an extra thirty percent of bonds if the default took place in the first four years after their original issuance. This principal-reinstatement provision sought not only to reassure those investors who had granted debt forgiveness that a meaningful portion of their original claims against Ecuador would be restored in case of a default, but also to discourage future Ecuadorian governments from defaulting by making it expensive for them to do so. The second legal novelty was to include a binding commitment that Ecuador would repurchase a specified percentage of both the outstanding 2012 and 2030 bonds in each year starting six and eleven years after their issuance, respectively. These mandatory buybacks (at secondary-market prices) were
8. Id. (“The country needed both cash flow relief and debt reduction to secure a sustainable external and fiscal position for the medium term.”). 9. Lee C. Buchheit, supra note 5, at 18–19. A ceiling was placed on the overall issuance of 2012 bonds and a cash payment was made on past-due interest and principal, funded by the collateral set aside when the Brady bonds had originally been issued. There was also an innovative, aggressive use of “exit consents” to penalize bondholders who might choose to retain their existing bonds; they would be rendered substantially inferior by the consent to various prejudicial amendments granted by bondholders entering into the debt exchange. The application of these exit consents surely helps to explain the high bondholder participation rate. Id. at 19–20. 10. Id. at 19. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 255 intended to set investors’ minds at rest that the aggregate amount of Ecuador’s bonded debt would be gradually reduced to a smaller, more manageable size before the bonds matured and to reassure them that, by its actions, the government of Ecuador would help bolster the price of these securities in the secondary market. Ecuador’s failure to meet the debt-reduction targets in any one year would trigger a mandatory partial redemption of the bonds at par. However, this novelty was potentially quite advantageous also for Ecuador because it allowed the government to satisfy its amortization commitments by purchasing the bonds and retiring them whenever they traded at a discount in the secondary market—which they usually did, at prices in the range of fifty to sixty cents on the dollar. If the 2012 or 2030 bonds were ever to trade above par, the government could always make the amortization payments at par.11 With the IMF’s blessing, the Paris Club subsequently refinanced accumulated arrears and maturities through April 2001. It did not grant any debt forgiveness, however, just as it had not done in the early 1990s. And yet Ecuador’s interest and principal arrears to official creditors were more than twice as large as they had been to commercial banks and bondholders before the refinancing.12 Evidently, while Ecuador was deemed (by the United States and European governments, as well as by the IMF’s management) to be insolvent enough to deserve major write-offs from private creditors twice in five years, it was considered solvent enough not to deserve write-offs from official creditors even once—despite being in the midst of the country’s arguably worst economic crisis. This was one of several instances in which the Paris Club’s principle of “comparable treatment” proved to be a highly discretionary one- way street.13 It would take less than a decade for investors in vintage-2000 Ecuador bonds to come to regret ever owning the new, and supposedly much- improved, securities.
11. Id. at 19–20. This was one of the motivations for the government to set up a fund known as the Stabilization and Investment Fund for Petroleum Resources (FEIREP), infra p. 259, to provide a pool of cash to repurchase the 2012 and 2030 bonds opportunistically whenever they would trade at a deeper than usual discount. The government could also achieve the promised reduction in the stock of outstanding bonds by other means, such as debt for equity exchanges. 12. INT’L MONETARY FUND, ECUADOR: SELECTED ISSUES AND STATISTICAL ANNEX 141 tbl.47 (2000), available at http://www.imf.org/external/pubs/ft/scr/2000/cr00125.pdf (demonstrating that as of May 2000, Ecuador’s arrears to bilateral agencies had reached $742 million, versus $311 million to commercial banks and bondholders). 13. Arturo C. Porzecanski, Debt Relief by Private and Official Creditors: The Record Speaks, 10 INT’L FIN. 191, 204 (2007) (observing that during the 1990s, the Paris Club never granted debt relief to several governments in Asia and Latin America that did obtain debt relief from private creditors, and then in 2005–2006, the Paris Club benefited from debt prepayments made by Nigeria, Peru, and Russia, but did not insist that private creditors likewise receive prepayments). 256 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251
III THE BAD OUTCOMES In late 2008 the current populist government of Ecuador, headed by President Rafael Correa, defaulted on the 2012 and 2030 sovereign bonds, claiming they were immoral and illegitimate obligations.14 At no point before or after the default—when Ecuador was repurchasing the bonds both indirectly (through the secondary market) and directly (through a buyback for thirty-five cents on the dollar)—did the government assert that servicing these obligations posed a financial hardship. There was no objective basis for doing so: in 2008, the public external debt was the least burdensome it had been in over three decades, relative to government revenues or to the gross domestic product (GDP). Moreover, the country’s central bank held more freely disposable international reserves ($6.5 billion) than it had ever accumulated before.15 The United States and Europe were in a financial crisis and world oil prices had plunged, but the Ecuadorian economy was unusually well positioned to withstand these exogenous shocks, which proved temporary anyway. Therefore, this default was not the consequence of a sovereign’s inability to pay.16 It was also out of character with Ecuador’s many prior defaults, which had taken place during major fiscal and economic emergencies. During the period from 2000 through 2005, the government’s external public indebtedness remained fairly steady averaging $11.25 billion, then declined to $10.1 billion by the time of the default, as repayments exceeded new disbursements because rising world oil prices provided a fiscal windfall that minimized Ecuador’s borrowing needs. The economy expanded steadily and the market value of Ecuador’s GDP ballooned from an abnormally depressed $16 billion in 2000 to $54 billion by 2008. Consequently, by the time President Correa announced the default, the ratio of external public debt to GDP had dropped sharply from seventy percent in 2000 to a very manageable proportion of under twenty percent in 2008 (see Figure 1 below).
14. Simon Romero, Ecuador: President Orders Debt Default, N.Y. TIMES, Dec. 13, 2008, available at http://www.nytimes.com/2008/12/13/world/americas/13briefs-PRESIDENTORD_BRF.html. 15. BANCO CENTRAL DEL ECUADOR, supra note 3, at tbl.1.2.1. 16. Fifteen months later, the finance minister would confirm that the December 2008 default was not triggered by any economic difficulties. See Press Release, Ministerio de Finanzas del Ecuador, La Moratoria de los Global 2012 y 2030 Fue por Ilegitimidad y No por Falta de Recursos (Mar. 4, 2010), available at http://mef.gov.ec/pls/portal/docs/PAGE/MINISTERIO_ECONOMIA_FINANZAS_ ECUADOR/ARCHIVOS_INFORMACION_IMPORTANTE/TAB138898/TAB190900/TAB203179/ BOLETIN07_04_03_2010.PDF. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 257
Figure 1: Ecuador’s External Public Debt as a Percentage of GDP (including any interest or principal arrears)17
Servicing this external indebtedness imposed an increasingly lighter burden on the country and its public finances, especially given the rapid growth of government revenues during the intervening years, from $4.2 billion in 2000 to $21.4 billion in 2008. The interest bill averaged $1 billion in 2000 and 2001, but it started to drop and settled at less than $700 million per annum in 2002 through 2008. As a proportion of government revenues, interest payments dropped from over twenty-six percent in 2000 to under four percent in 2008, and in relation to GDP, they fell from seven percent to nearly one percent (see Figure 2 below).
17. Author’s calculations based on BANCO CENTRAL DEL ECUADOR, supra note 3. 258 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251
Figure 2: Interest Payments on Ecuador’s External Public Debt (including any interest arrears)18
In particular, the 2012 and 2030 bonds, which accounted for nearly one-third of the external public debt as of the end of 2008, required annual interest payments of $331 million, which is the equivalent of a mere 1.9% of 2008 government revenues and 0.6% of 2008 GDP—a relatively insignificant amount by any standard. Even though revenues and GDP dropped somewhat in 2009 in the aftermath of the global recession, the burden of interest payments on the 2012 and 2030 bonds would not have increased appreciably in the absence of a default. To understand the genesis of this decision to default out of unwillingness rather than inability to pay, it is necessary to paint a brief profile of President Correa. He was born in 1963 in the coastal city of Guayaquil to a family of modest means. Throughout his formative years—until age twenty-eight, in fact—he attended or was otherwise affiliated with Catholic schools and universities, mostly run by the Salesians, one of the world’s largest Catholic missionary orders. This upbringing included spending one year on a mission at a social center run by the Salesians in the Cotopaxi province, where Correa gained empathy for the native population by seeing their extreme poverty up close. In a speech delivered recently at Oxford entitled My Experience as a Leftist Christian in a Secular World, President Correa stated that his “economic principles are based on the Social Doctrine of the Catholic Church and on
18. Author’s calculations based on BANCO CENTRAL DEL ECUADOR, supra note 3. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 259
Liberation Theology.”19 He denounced the very unequal distribution of income in Latin America and said, “As a practicing Catholic, I will always believe in the importance of charity and solidarity,” and he pledged to keep ruling “with a clear preferential option for [helping] the poorest and the forgotten; and [for] prioritizing human beings over [the owners of] capital.”20 Vice President Alfredo Palacio, a cardiologist with no business experience, “discovered” Correa in 2003, when Correa was an economics professor and consultant. Palacio retained Correa as his economic advisor on the issue of how to set up and pay for a universal health-care system, which had been one of Palacio’s campaign promises.21 At the time, funding for social programs was limited, and resources that might otherwise be available were not within reach because a portion of oil-related revenues was being deposited into a government fund known as the Stabilization and Investment Fund for Petroleum Resources (FEIREP).22 The fund was set up in 2002 largely to generate the fiscal savings necessary to pay for the buybacks required by the debt restructuring of 2000. Palacio and Correa tried to tap into the FEIREP to help fund a universal health-care system, but were unsuccessful. In March 2005, Correa presented a foreboding paper at a meeting sponsored by a regional council of Christian churches held to discuss Latin America’s foreign-debt problems. It was entitled Debt Exchange: It’s All About the Creditors, and in it, Correa denounced the 2000 restructuring as having delivered insufficient relief. To begin with, he wrote, Ecuador’s obligations should have been written down to then-prevailing prices in the secondary market—precisely the kind of massive forgiveness that Argentina was rightly demanding, he felt, from its creditors. Correa went on to denounce the FEIREP for starving the country of funds for social programs and for enriching bondholders by boosting the market price of Ecuador’s debt.23 A few weeks later, on April 20, 2005, Palacio was appointed to the presidency when the legislature removed the incumbent, Lucio Gutiérrez. This followed a week of growing popular unrest and was done as political retribution against what was perceived as dictatorial decisions made by President Gutiérrez in prior months.24 Palacio, in turn, appointed Rafael Correa as his finance minister. Correa wasted no time in proposing to the legislature the abolition of
19. Rafael Correa, President of Ecuador, Address Before the Oxford Union Society: My Experience as a Leftist Christian in a Secular World 6 (Oct. 26, 2009), available at http:// www.presidencia.gov.ec/pdf/Discurso%20ingles.pdf. 20. Id. at 4, 11. 21. See Vida Política, DR. ALFREDO PALACIO, http://www.dralfredopalacio.org/actividades.htm (last visited Nov. 9, 2010). 22. Id. 23. Rafael Correa, Canje de Deuda: Todo en Función de los Acreedores, LA INSIGNIA, June 20, 2005, available at http://www.lainsignia.org/2005/junio/econ_008.htm. The sponsoring regional council was Consejo Latinoamericano de Iglesias. 24. Monte Reel, Ecuadoran Congress Ousts President, WASH. POST, Apr. 21, 2005, available at http://www.washingtonpost.com/wp-dyn/articles/A5002-2005Apr20.html. 260 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 the FEIREP, which it did in June while setting up an alternate fund (CEREPS), largely to underwrite social spending.25 This was done even though the FEIREP, which had accumulated $1.1 billion during its nineteen months of existence, had not spent a single dollar to buy back any foreign debt. According to the World Bank, the fund had been turned into “the piggy bank to finance the liquidity needs of the central government.”26 Correa also denounced the prior administration’s supposedly secret consent to various policy conditions imposed by the IMF and the World Bank, threatened to withhold debt-service payments to the multilateral agencies if they did not fulfill their loan commitments, and raised the possibility of bypassing the multilateral agencies altogether and selling bonds to Venezuela instead.27 In late July, the World Bank made it known to Minister Correa that it would not authorize the disbursement of a $100-million loan he was counting on. Correa fired off an angry letter to World Bank President Paul Wolfowitz, telling him the Bank had offended Ecuador by reneging on the loan and demanding to know precisely why the disbursement had been cancelled.28 A couple of days later, having set himself proverbially ablaze, Minister Correa tendered his resignation at the request of President Palacio, whose office let it be known that the minister had failed to keep his superior properly informed of his (inflammatory) activities.29 During his 106 days in office, Correa had managed to ruin the government’s access to external funding, but by wrapping himself in the national flag to confront the Washington multilateral agencies, supposedly on behalf of the dispossessed of Ecuador, he had also succeeded in gaining national name recognition—thereby setting the stage for his candidacy in the next presidential election. Upon departure, Correa’s popular approval rating was fifty-seven percent, the highest among cabinet members and nearly twenty percentage points higher than President Palacio’s own.30 Rafael Correa would go on to win the presidential election held in November 2006, and his inaugural address on January 15, 2007, presaged his get-tough attitude toward foreign bondholders. He stated that one of the main challenges facing Ecuador was to overcome a culture of issuing debt abroad, which had left the country saddled with “a very costly overindebtedness”—a
25. WORLD BANK, REPORT NO. 00000-EC, ECUADOR COUNTRY ECONOMIC MEMORANDUM: PROMOTING STABLE AND ROBUST ECONOMIC GROWTH 33 (2005), available at http://siteresources .worldbank.org/EXTEXPCOMNET/Resources/2463593-1213987636514/02_Ecuador.pdf. 26. Id. at 34. 27. Rafael Correa Renunció al Ministerio de Economía, EL UNIVERSO, Aug. 5, 2005, available at http://www.eluniverso.com/2005/08/05/0001/9/A99FF2FCCCAE4D70BE0A1E92B2AC69D1.html. 28. La Renuncia de Rafael Correa, Ministro de Economía de Ecuador: ¿Un Ejemplo de la Influencia de las IFIs?, CHOIKE, Aug. 16, 2005 [hereinafter La Renuncia], available at http:// ifis.choike.org/esp/informes/134.html. 29. Gobierno Niega Que Cambios en Áreas Económica y Petrolera Sean por Presiones, EL UNIVERSO, Aug. 5, 2005, available at http://www.eluniverso.com/2005/08/05/0001/9/0C25A623318045 EBB1606CD1656A467B.html?p=9A&m=2349. 30. La Renuncia, supra note 28. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 261 gross factual misrepresentation. He said a country’s debt service should be subject to a sustainability criterion; for example, debt-service burdens should not be incompatible with the achievement of the United Nations’ Millennium Development Goals. He also stated that part of Ecuador’s foreign debt was illegitimate, had been acquired under dubious circumstances, was not used for its intended purposes, and had been “repaid several times” already.31 Ideally, President Correa acknowledged, governments should be able to appeal to an impartial and transparent international tribunal that would determine which obligations should be serviced and a country’s objective capacity to pay. He noted, however, that such an impartial third-party forum does not exist; there is only the IMF, “the creditors’ representative.”32 This is why, Correa concluded, his administration would engage in a “firm and sovereign renegotiation of the external debt, above all of the inadmissible conditions that were imposed on us in the debt exchange of 2000.”33 Nearly six months later, on July 9, 2007, President Correa issued a decree authorizing the creation of an Integral Auditing Commission for the Public Credit (CAIC) and charged it with determining the “legitimacy, legality, transparency, quality, efficacy and efficiency” of the domestic and foreign public debt contracted between 1976 and 2006, taking into consideration “the legal and financial aspects, and its economic and social impact on regions, the ecology and various nationalities and peoples.”34 The CAIC was to analyze not just each bond issued at home and abroad, but also each and every loan contracted with official bilateral and multilateral agencies, as well as with commercial banks and suppliers, during the past three decades. It was to determine who had authorized the indebtedness in question, whether the requisite feasibility studies had been conducted, what conditions had been imposed, to what purpose the funds had been allocated in actual practice, and the comprehensive (“integral”) impact of each project thus underwritten, among other matters.35 And it was to accomplish this mission within one year, although later on the CAIC was given an extra couple of months—until the end of September 2008—to achieve what any reasonable observer would regard as a “Mission Impossible.” The CAIC was not even allocated any funding to hire a
31. Rafael Correa, President of Ecuador, Discurso de Rafael Correa Presidente de Ecuador [Inaugural Address] 4–5 (Jan. 15, 2007), available at http://www.coberturadigital.com/wp-content/ uploads/2007/01/DISCURSO%20de%20Rafael%20Correa%20Presidente%20del%20Ecuador.doc (author’s translation). 32. Id. 33. Id. at 6. 34. COMISIÓN DE AUDITORÍA INTEGRAL DEL CRÉDITO PUBLICO [CAIC], INFORME FINAL DE LA AUDITORÍA INTEGRAL DE LA DEUDA ECUATORIANA: DECRETO EJECUTIVO 472, arts. 2, 3(a) at 156 (2007) (Ecuador) [hereinafter CAIC REPORT]. The Spanish version of the CAIC REPORT is available at http://www.auditoriadeuda.org.ec/images/stories/documentos/Libro_CAIC_Espanol.pdf .zip. The CAIC produced an English version of this report, which is available at http://www .auditoriadeuda.org.ec/images/stories/documentos/Libro_CAIC_English.pdf.zip, but the translation is so poor that all quotes from the report are translations by this author from the Spanish original. 35. Id. art. 3(b). 262 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 staff until December 2007. Nevertheless, it managed to deliver a preliminary report in February 2008, a second draft in July, and its final report in November 2008.36 The CAIC’s designated members were four representatives of the Correa Administration, including the then finance minister plus six other Ecuadorians and three foreigners from social organizations who had worked on debt issues in Ecuador or elsewhere.37 However, none were professional auditors, and all had a long history of militancy in the debt-forgiveness or debt-repudiation movement.38 The CAIC was chaired by Ricardo Patiño, an extreme leftist who in his early years had joined the Sandinista revolution in Nicaragua and had later held a post in the Sandinista government’s land-reform agency. Upon returning to Ecuador, Patiño set up the country’s Jubilee 2000 office, part of the international-coalition movement that called for the cancellation of third-world debt by the year 2000.39 He was appointed finance minister in January 2007, but a couple of weeks after being named to chair the CAIC, he stepped down from this cabinet post because of a scandal involving the alleged manipulation of Ecuador’s bonded debt. He was immediately given another cabinet post by Correa,40 and despite the appearance of impropriety and of a conflict of interest, Patiño was kept as the chairman of the CAIC.41 The CAIC’s report was written in great haste, without the benefit of having hired professional auditors; interviewing public credit officers, finance ministers, or living presidents from 1976 through 2006; or obtaining access to many important documents.42 The report’s authors reveal that they requested
36. Hugo Arias Palacios, La Deuda Ecuatoriana y la Auditoría, in SOBRE LA DEUDA ILEGÍTIMA: APORTES AL DEBATE 129 (Gabriela Weber ed., 2008), available at http://www.flacsoandes.org/biblio/ shared/biblio_view.php?bibid=111618&tab=opac. Arias Palacios was a member of the CAIC. 37. Id. at 127. 38. For example, Jubilee, Eurodad, and LATINDADD. Id. Comisionados con Historial Antideuda, EL COMERCIO, Nov. 22, 2008 (on file with author). 39. Funcionarios “Clave” Están Más Cerca de Correa, DIARIO HOY, Dec. 16, 2007, available at http://www.hoy.com.ec/noticias-ecuador/funcionarios-clave-estan-mas-cerca-de-correa-284778-284778 .htm. 40. As of this writing, Patiño in fact is holding his fourth cabinet post, as the country’s minister for foreign affairs. See Ricardo Patiño Es el Nuevo Canciller del Ecuador, EL UNIVERSO, Jan. 21, 2010, available at http://www.eluniverso.com/2010/01/21/1/1355/ricardopationuevocancillerrepublica.html. 41. A month after becoming finance minister, Patiño had said he might delay a $135-million interest payment on the foreign debt, but then did not. This led to “wild swings in the value of Ecuador’s bonds and derivatives linked to them, raising suspicions of a deliberate market manipulation.” In May 2007, a video surfaced of a meeting between Patiño and three others in which the minister appeared to discuss a plan that would enable certain investors to make a great deal of money from the bond price swings. Minister Patiño denied any wrongdoing, but after the Ecuadorian congress censured him in July 2007, another video surfaced showing him arranging a backroom deal with the head of Ecuador’s congress, whereupon he moved to another cabinet post. See Caught on Camera, ECONOMIST, July 26, 2007, available at http://www.economist.com/node/9546462. 42. For example, former president Sixto Durán Ballén (1992–1996) said he was never contacted by the CAIC to hear his version of events surrounding the issuance of Brady bonds and that the CAIC report was full of inaccuracies. See Sixto Durán Ballén Indignado por Informe de Deuda, EL COMERCIO, Nov. 21, 2008 (on file with author). Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 263 information from eighteen government agencies, but never heard back from three of them, were given information that was not relevant by eleven of them, and obtained the documents they were seeking from just four agencies.43 In particular, the armed forces, known to have contracted many a foreign loan for the purchase of armaments (as confirmed by documents held by the finance ministry), had the audacity to issue a statement to the CAIC stating that they “had not found any documentation that details any loans received from foreign commercial banks during the period 1976–2006.”44 As was to be expected given the circumstances, the CAIC report is incomplete, biased, and inaccurate. For example, the first misdeed it identifies involves none other than the United States Federal Reserve, which is accused of “illegally raising interest rates,” thereby causing Ecuador’s debt to snowball during the late 1970s and early 1980s.45 The accusation of illegality is ridiculous, of course. Moreover, a factual analysis based on official Ecuadorian statistics, which are publicly available, reveals that the temporary hike in U.S. interest rates under Federal Reserve Chairman Paul Volcker may explain, at best, a small fraction of the debt buildup that took place in those years. Ecuador’s public external indebtedness grew to $5 billion as of the end of 1982 from less than $2 billion at the end of 1978, but only about one-third of this increase could be justified by the need to borrow to cover the higher interest payments.46 Besides, while U.S. interest rates were being hiked, Ecuador was simultaneously benefiting from a doubling in its oil-export revenues, such that the government should have been able to afford the higher interest bill without recourse to extra borrowing.47 Indeed, despite a near halving of U.S. rates between the end of 1982 and the end of 1987, the government’s external debt went on to double to $10 billion. In sum, there is no basis for pinning Ecuador’s debt snowball on the Federal Reserve. The other accusations of “illegality” made in the CAIC report target prior administrations, charging them with having violated either mostly unspecified Ecuadorian laws or “basic principles of international law.”48 Some examples of these transgressions are that prior administrations agreed to submit debt contracts to foreign jurisdiction (namely, New York and English law), to waive Ecuador’s sovereign immunity, and to accept conditions imposed by official multilateral agencies “in violation of basic principles of international law such
43. CAIC REPORT, supra note 34, RESUMEN EJECUTIVO 28 (2008). 44. Id. 45. Id. at 26. 46. If the average interest rate paid by the government on its external debt had remained at its 1978 level of 7.4%, the cumulative interest bill from 1979 through 1982 would have been $1.1 billion lower than it actually was; however, the stock of indebtedness during this period jumped by $3.2 billion. See BANCO CENTRAL DEL ECUADOR, supra note 3, at ch. 2 tbl.2.12. 47. In fact, the central government’s interest bill on foreign debt went up by $110 million between 1978 and 1981, but its oil-related revenues increased by $360 million. BANCO CENTRAL DEL ECUADOR, supra note 3, at ch. 3 tbl.3.5. 48. CAIC REPORT, supra note 34, at 34. 264 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 as the equality of sovereign states, the self-determination of peoples, the non- interference in the internal affairs of nations, the right to [economic] development, and the respect of human rights.”49 There are also multiple accusations of “irregularities,” like prior administrations’ prepaying debts (in the context of debt-refinancing agreements) when they were under no obligation to do so, and the government’s taking over private-sector obligations from 1983 through 1984 in the midst of a major economic crisis without auditing the beneficiaries to check whether their obligations were indeed still outstanding.50 The CAIC report also censures loans obtained from foreign bilateral and multilateral agencies on a variety of grounds. For example, funding from the World Bank and the Inter-American Development Bank (IADB) was used to purchase collateral to back the Brady bonds, “thereby aiding and abetting the reallocation of funds for purposes other than those contemplated in the lending programs previously agreed.”51 Prior administrations had also accepted various conditions imposed by official foreign creditors, had not prevented cost overruns in various projects funded by foreign loans, and had not carried out the necessary environmental and other impact studies.52 A number of specific projects are examined and sufficient objections raised about how they had been implemented to support the CAIC report’s recommendation of the repudiation of the multilateral loans involved.53 Ominously, the CAIC report criticizes prior administrations for having “overpaid” greatly when they restructured their foreign obligations, particularly during the two bond exchanges in 1995 and 2000.54 With a perspective surely inspired by Argentina’s harsh treatment of its own bondholders, the report points out the costly “mistakes” of recognizing and capitalizing interest arrears, and the failure to base their negotiation with creditors on prices for Ecuador’s defaulted debt as observed in the secondary market.55 Prior to the Brady bond exchange, the report noted, Ecuador owed $4.5 billion of principal plus $2.5 billion of past-due interest; but its obligations were trading in the secondary market at around twenty-five cents on the dollar, so that should have set the basis for the discount (seventy-five percent) applied during the debt-for-Brady- bonds exchange.56 Likewise, in 2000, the Brady bonds and Eurobonds were
49. Id. Prior governments are also accused of failing to register Ecuador’s bonds with the U.S. Securities and Exchange Commission—because they were issued under Rule 144A and Regulation S, in full compliance with U.S. securities laws. The CAIC took this type of bond issuance as evidence of a lack of transparency. Id. at 59. 50. Id. at 28, 38. 51. Id. at 151. 52. Id. at 151–52. 53. Id. at 104, 152. 54. See id. at 42, 46 (discussing the actual debt Ecuador had and the debt they incurred after the restructuring of the bonds). 55. See id. at 46–47. 56. Id. at 42. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 265 trading at around thirty cents on the dollar, so they should have been restructured on that basis (a seventy percent “haircut”), in which case only $1 billion of 2012 and 2030 bonds would have been issued instead of nearly $4 billion.57
IV THE DEFAULT AND ITS AFTERMATH The CAIC report was formally delivered to President Correa on November 20, 2008, but by then, he was well aware of its contents—he had been handed a preliminary draft on October 23—and had already ordered that an upcoming $31 million coupon payment on the 2012 bonds be skipped.58 A formal default on the foreign debt was declared on December 12. Starting that day, Correa would justify the country’s moratorium on the basis that Ecuador’s debt obligations were “immoral,” “illegal,” or “illegitimate”—preferably, all of the above. On December 15, it was announced that an upcoming $30.5 million coupon payment on a ten-year sovereign bond that had been issued in December 2005 would likewise not be made.59 Yet as the weeks and months passed, it became apparent that Ecuador’s default would be highly selective rather than indiscriminate, and that it would lead neither to a repudiation of obligations as odious60 or on other grounds, nor to a negotiated or even unilateral debt exchange (Argentine style) for the purpose of obtaining massive debt forgiveness.61 President Correa made clear on December 20 that all obligations to official bilateral and multilateral agencies would continue to be serviced in full and on time, notwithstanding the CAIC’s damning report and his own prior announcement that even debts deemed “legitimate” would be subject to restructuring.62 He and his finance minister, María Elsa Viteri, explained before and after the New Year that the default would be confined to the “commercial” debt, meaning Ecuador’s three sovereign bonds. In mid-January 2009, however, the government surprisingly decided to pay the coupon on the 2015 bond just before the grace period ran out, saying that its issuance was different from that
57. Id. at 46–47. 58. Press Release, Ministerio de Finanzas del Ecuador, Ecuador se Acoge a Período de Mora Técnica de Bonos Global (Nov. 14, 2008), available at http://mef.gov.ec/pls/portal/docs/PAGE/ MINISTERIO_ECONOMIA_FINANZAS_ECUADOR/SUBSECRETARIAS/DIRECCION_DE_ COMUNICACION_SOCIAL/PRODUCTOS_COMUNICACION_PRENSA/ARCHIVOS_2008_1/ 027.14NOVIEMBRE2008.PDF. 59. Ecuador Suspendió Pagos de Intereses de Global 2015, EL UNIVERSO, Dec. 15, 2008, available at http://www.eluniverso.com/2008/12/15/1/1356/C1E256567062492F936E2CA95EEE5F9A.htm. 60. See Lee C. Buchheit, G. Mitu Gulati & Robert B. Thompson, The Dilemma of Odious Debt, 56 DUKE L.J. 1201, 1216 (2007). 61. See generally Porzecanski, supra note 4. 62. Correa Promete Pagar Créditos a Organismos Regionales, EL UNIVERSO, Dec. 20, 2008, available at http://www.eluniverso.com/2008/12/20/1/1356/C1C7C6EF017C47FF8703BC700C78146B .html. 266 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 of the other two—even though the CAIC report had condemned the 2015 bond right along with the others.63 By February, it became clear that the government was really targeting only the two bonds Correa had been despising for years, so it came as no surprise when the government failed to pay $135 million in interest due on the 2030 bonds. The way the Correa Administration dealt with these undesirable obligations was to buy them back from intimidated investors, indirectly at first and then directly, paying cash for a fraction of their face value (or rather, their pre- default market value), for the purpose of extinguishing them. The government reportedly began to purchase the 2012 bonds in the secondary market after their price collapsed following the mid-November 2008 decision to default on them, using an Ecuadorian bank as the front man.64 It then continued repurchasing its securities after defaulting on the 2030 bond, such that by one estimate, the government picked up as much as half of the two bond issues in this manner.65 On April 20, 2009, the government announced a buyback offer to repurchase the 2012 and 2030 bonds through a modified Dutch auction with a base price of thirty cents on the dollar.66 A disclosure document was circulated by the deal’s manager, Lazard Frères, with an expiration date of May 15 for all offers. The document made plain that Ecuador had “no intention of resuming payments on these bonds following the [e]xpiration [d]ate.”67 Despite an attempt to organize resistance among bondholders, ninety-one percent of the bonds outstanding were tendered—presumably including those in government
63. The proceeds of that bond issue had been devoted by a prior administration to repurchase a portion of the 2012 bonds at par, in accordance with the commitment made at the time of the 2000 debt exchange. Because of this, the 2015 bond could have been regarded by President Correa as guilty of immorality, illegality, or illegitimacy by association—which was the view adopted by the CAIC. CAIC REPORT, supra note 34, at 47. 64. Ecuador Habría Comprado Su Deuda, EL COMERCIO, Dec. 11, 2008; Analytica Investments, ECUADOR WKLY. REP., Dec. 14–20, 2008 (on file with author). The bank was allegedly Banco del Pacífico, acting through a broker. 65. See Lester Pimentel, Ecuador Plays Bond Market for Fools, Aberdeen Says (Update2), BLOOMBERG NEWS, June 16, 2009, available at http://www.bloomberg.com/apps/news?pid=20601013 &sid=aQ7ZViOQQ4mI. The Correa Administration has yet to admit or deny the allegations of these back-door purchases, but if they did take place, that might help explain a portion of the precipitous drop in the central bank’s international reserves, from over $6 billion just prior to the November 2008 announcement that the 2012 bond coupon would not be paid, to less than $3.5 billion by March 2009 after the 2030 bond coupon went unpaid. However, capital flight in the wake of the default announcement probably accounts for most of this drop in dollar reserves. For data on said reserves, see BANCO CENTRAL DEL ECUADOR, INFORMACIÓN MONETARIA SEMANAL, No. 155, at tbl.IMS2 (2010), available at http://www.bce.fin.ec/home1/estadisticas/bolsemanal/Coyuntura.jsp. 66. See Lee C. Buchheit & G. Mitu Gulati, The Coroner’s Inquest, INT’L FIN. L. REV., Sept. 2009, at 22, 22 (“It was the first time in modern history that a sovereign debtor had demanded that its external commercial creditors write off most of their claims . . . without advancing a plausible argument that financial distress warranted such extraordinary debt relief.”). 67. Ministerio de Finanzas del Ecuador, Noteholder Circular, Apr. 20, 2009, at 15, available at http://blogs.reuters.com/felix-salmon/files/2009/04/noteholder-circular-goe-bond-offer.pdf; see also Buchheit & Gulati, supra note 66, at 4–5 (discussing why the bonds’ trustee did not exercise its discretion to accelerate either bond or to start an enforcement action, and the lessons learned about how a trustee indenture in sovereign documentation should read in the future). Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 267 hands—and were bought back at a discount of between sixty-five and seventy percent, thereby retiring nearly $3 billion in bonds for around $900 million in cash payments. Holdouts were then offered another chance to tender at thirty- five cents on the dollar, and in November 2009, an offer aimed at Italian investors was launched on identical terms. As a result, by the end of 2009, the government had successfully bought back about ninety-five percent of the 2012 and 2030 bonds.68 Obviously, this manner of dealing with a sovereign’s debt burden hinges on having more ample cash resources on hand than necessary to meet the interest payments falling due. It is neither an affordable strategy for a sovereign that is experiencing an acute liquidity crisis nor a smart strategy for a solvent sovereign able to refinance its obligations at lower interest rates—the far more common situations encountered in the practice of sovereign international finance. It also presupposes attaching little cost to damaging the issuer’s (already tattered) reputation as a debtor, as well as having no intention of regaining access to the international bond markets—at least not for many years. The government of Ecuador had been able to tap the international bond markets on one occasion (in December 2005), six years after its prior default, when the 2015 bond was issued. However, the Correa Administration soon made it known that it did not intend to return to the international private-capital markets. Its plan has been to rely on external financing from governments such as China, Iran, and Russia and from official multilateral agencies—preferably other than the IMF and the World Bank, regarded with long-standing animosity by President Correa.69 Evidently, the authorities did not care that their default would cause collateral damage, triggering capital flight and impairing the ability of Ecuadorian banks and corporations to access financing from foreign commercial creditors at a time of global financial turmoil. According to central- bank data, the private sector in Ecuador was able to borrow much less from abroad after the default than it had borrowed before, such that because repayments exceeded disbursements, the stock of its external-debt obligations
68. Ecuador Retiró Unos $50 Millones de Bonos Globales 2012 y 2030, EL UNIVERSO, Dec. 31, 2009, available at http://www.eluniverso.com/2009/12/30/1/1356/ecuador-retiro-unos-millones-bonos- globales.html. According to official statistics, the government’s principal due on 2012 and 2030 bonds dropped from a combined $3.21 billion at the end of 2008 to $223 million a year later, a ninety-three- percent reduction. See Ministerio de Finanzas del Ecuador, Boletines Deuda Externa, MÓDULO DE INFORMACIÓN DE FINANZAS PÚBLICAS, Dec. 2008, at tbl.1 [hereinafter Deuda Externa Dec. 2008], available at http://mef.gov.ec/stgcPortal/faces/uploads/bulletin/DE_DIC2008.htm; Ministerio de Finanzas del Ecuador, Boletines Deuda Externa, MÓDULO DE INFORMACIÓN DE FINANZAS PÚBLICAS, Dec. 2009, at tbl.1 [hereinafter Deuda Externa Dec. 2009], available at http://mef.gov.ec/stgcPortal/ faces/uploads/bulletin/DE_DIC2009.htm. 69. Press Release, Ministerio de Finanzas del Ecuador, Ministra de Finanzas Comparece a Comisión de lo Económico y Tributario (Nov. 18, 2009), available at http://mef.gov.ec/pls/portal/docs/ PAGE/MINISTERIO_ECONOMIA_FINANZAS_ECUADOR/SUBSECRETARIAS/DIRECCION _DE_COMUNICACION_SOCIAL/PRODUCTOS_COMUNICACION_PRENSA/BOLETINES_D E_PRENSA/BOLETINES_2009/BOLETINES/BOLETIN32_19_NOV_2009.PDF. In 2007, President Correa expelled the World Bank and IMF resident representatives from Ecuador. 268 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251 dropped by over fifteen percent between September 2008 and December 2009.70 Surveys of foreign banks’ exposure to banks and corporations in Ecuador reveal an absolute drop of twelve percent in the year after September 2008 versus a fall of six percent to these obligors throughout Latin America during the same period.71 The deplorable fact is that no leading government or any official multilateral agency based in Washington or Latin America went on record to express any dismay at Ecuador’s latest default and alleged bond-market manipulation. On the contrary, the local representatives of the regional development banks uttered words of moral support, and their headquarters provided an indirect blessing to the default and debt buyback by ramping up their lending to the government—despite an obvious deterioration in Ecuador’s creditworthiness and macroeconomic fundamentals in 2009. The Inter- American Development Bank’s representative in Ecuador, Carlos Melo, stated that “[t]he good results obtained [in the restructuring] will benefit all Ecuadorians during difficult times . . . . The IADB reiterates its predisposition to work alongside Ecuadorians to promote economic development.”72 Sure enough, the IADB stepped up its approval of new loans to Ecuador, agreeing to $515 million in new loans in 2009 versus a mere $50 million in 2008.73 The Colombia-based Latin American Reserve Fund (FLAR), for its part, made a general-purpose $480-million loan to Ecuador in July 2009; it had not lent anything to the government in the three prior years.74 And the Venezuela- headquartered Andean Development Corporation (CAF) approved $873 million in loans to the Correa Administration in 2009, an increase from $604 million in 2008.75 The CAF’s representative in Ecuador, Luis Palau-Rivas, said in May 2009 that the regional lender saw the defaulted-debt restructuring “positively because it’s a voluntary process [that is] helping to solve a difficult situation . . . and will benefit everyone.”76 The idea that Ecuador’s bondholders were participants in “a voluntary process” is ludicrous, of course. As one
70. Banco Central del Ecuador, Movimiento de la Deuda Externa Privada, INFORMACIÓN ESTADÍSTICA MENSUAL, Jan. 2010, at tbl.3.3.2, available at http://www.bce.fin.ec/documentos/ PublicacionesNotas/Catalogo/IEMensual/m1895/IEM-332.xls. 71. See Bank for Int’l Settlements, Consolidated International Claims of BIS Reporting Banks, CONSOLIDATED BANKING STATISTICS, 3d Quarter 2009, at tbls.9A:A, 9A:G, available at http://www.bis.org/statistics/consstats.htm. 72. Alexandra Valecia & Alonso Soto, Regional Lenders Back Ecuador in Debt Talks, REUTERS, May 18, 2009, available at http://www.reuters.com/assets/print?aid=USTRE54H58220090518. 73. INTER-AMERICAN DEVELOPMENT BANK, ANNUAL REPORT 2008, at 38, available at http://www.iadb.org/ar/2008; INTER-AMERICAN DEVELOPMENT BANK, ANNUAL REPORT 2009, 45, available at http://www.iadb.org/ar/2009/. 74. Economic Studies Division, FLAR, Member Countries: About Ecuador, FONDO LATINOAMERICANO DE RESERVAS [FLAR] (Sept. 27, 2010), at tbl. Loans Granted, https://www.flar .net/ingles/contenido/contenido.aspx?catID=216&conID=669. 75. CAF in Figures, ANDEAN DEVELOPMENT CORPORATION [CAF], at tbl. [Loan] Approvals, http://www.caf.com/view/index.asp?ms=19&pageMs=62012 (last visited Nov. 9, 2010). 76. Valecia & Soto, supra note 72. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 269 veteran financial reporter rightly commented at the time, since the bondholders had no say whatsoever in the unilateral destruction of the value of their investments, their only “choice” was whether to accept Ecuador’s risible offer or to hold onto defaulted Ecuadorian paper indefinitely.77 Beyond the supportive signals they sent to the government of Ecuador throughout the default, the multilateral agencies ended up disbursing nearly $860 million to the country in 2009, 152% more than the $340 million they had disbursed in 2008.78 The Correa Administration requested no loans or other support from the International Monetary Fund and World Bank in 2008 or 2009, and probably did not consult with them, either. But when a reporter asked the IMF about its attitude towards Ecuador’s default, the institution’s spokeswoman lamely said, It is longstanding [IMF] policy to encourage our members to, wherever possible, be current in servicing debt obligations, and when they are economically unsustainable to enter into productive negotiations [with their creditors]. We understand that Ecuador’s decision to default on these bonds is based on a dispute about [their] legal validity rather than [on] debt sustainability [grounds], and of course we don’t take sides on the merits.79 All things considered, the official community’s tacit approval of Ecuador’s default is deeply troubling.80 In practice, only governments and multilateral organizations, rather than any group of private-sector bondholders, banks, or suppliers, could have reined in a wayward sovereign debtor such as Ecuador in 2009—or Argentina from 2002 through the present, for that matter. As became evident in the 1980s, 1990s, and again during the recent global financial crisis, only the official community can exercise the kind of collective diplomatic pressure and put forth the financial incentives and disincentives necessary to motivate sovereigns to comply with their financial obligations—or at least to treat private creditors in a relatively responsible manner. This much was obvious even before bondholders obtained their many pyrrhic victories in New York and European courts in the wake of Argentina’s gigantic default. Legal precedents and plenty of indenture innovations notwithstanding, even the best of contract intentions cannot prevent investors from going through a hellish experience at the hands of a sovereign debtor unwilling to honor the spirit and the letter of its legal commitments.
77. Felix Salmon, Is the Obama Administration Condoning Ecuador’s Default?, REUTERS, May 18, 2009, available at http://blogs.reuters.com/felix-salmon/2009/05/18/is-the-obama-administration- condoning-ecuadors-default/. 78. Deuda Externa Dec. 2008, supra note 68; Deuda Externa Dec. 2009, supra note 68. 79. Caroline Atkinson, Dir. of External Relations, International Monetary Fund, Remarks at the Regular Press Briefing (Dec. 18, 2008), available at http://www.imf.org/external/np/tr/2008/tr121808 .htm. 80. Some would say that the United States and other leading governments, as well as the multilateral organizations, were too distracted and worried about the world financial crisis that erupted in September 2008 to concern themselves with Ecuador’s default. The international financial context may have played a role in explaining the lack of official reaction in December 2008, when the default was announced, but not throughout the first half of 2009, when the worldwide crisis eased and the Correa Administration could have been taken to task. 270 LAW AND CONTEMPORARY PROBLEMS [Vol. 73:251
Interestingly, just as Ecuador’s selective default and buyback attracted no opprobrium in official or multilateral circles, it did not gather any plaudits from the debt-cancellation movement either. From 2007 through 2008, virtually all national, regional, and international non-governmental organizations (NGOs), agitating for massive forgiveness of developing-country debt, hailed Ecuador’s decision to conduct a thorough “independent” audit of its external indebtedness. Dozens of such organizations sent an open letter to President Correa in 2008 expressing their support for the audit, and favorable declarations along the same lines were made by legal experts meeting in Quito that July as well as by participants in a symposium on illegitimate debt that gathered in Oslo in October 2008, among others.81 To our knowledge, though, not one of these organizations has expressed its approval of how Ecuador went about dealing with the results and recommendations of the CAIC audit. In fact, a November 2009 meeting of nearly thirty organizations—in Ecuador, of all places—made no mention in its Guayaquil Declaration of how the host country had dealt with its “immoral,” “illegal,” and “illegitimate” debt obligations.82 This deafening silence on the part of the advocates for across-the-board debt cancellation is understandable. The case of Ecuador does not fit the odious-debt doctrine or related grounds for repudiation. To begin with, the country has been under continuous civilian, constitutional rule since mid-1979. Though it has been mismanaged, it was not plundered by an egomaniacal dictator. The greatest build-up in foreign public indebtedness took place from 1980 through 1994, when the sum total of obligations (including arrears) skyrocketed from less than $3 billion to nearly $14 billion, tripling even in relation to rising government revenues and GDP.83 During this extended period, duly elected civilians were in charge, none of whom has been found guilty of any illegal conduct. Issues of state succession, war-related debts, widespread corruption, the absence of informed consent, or collusion on the part of creditors to divert funds for contrary purposes—none of these criteria seem applicable here. Nor are the charges of illegitimacy made by the CAIC and President Correa those usually offered as strong arguments for debt cancellation, such as obligations that involve predatory terms, that cannot be serviced without violating basic human rights, or that go against widely accepted legal, financial, or ethical standards. What is a supporter of debt cancellation to make of the very arbitrary manner in which the Correa Administration proceeded—accepting
81. CAIC REPORT, supra note 34, at 161–64. INTERNAL AUDITING COMM’N FOR PUB. CREDIT OF ECUADOR, FINAL REPORT OF THE INTEGRAL AUDITING OF THE ECUADORIAN DEBT 165–68 (containing declarations of support that do not appear in the Spanish version of the report). 82. Declaración de Guayaquil, RED LATINOAMERICANA SOBRE DEUDA, DESARROLLO Y DERECHO [LATINDADD] (Nov. 13, 2009), http://www.latindadd.org/index.php?option=com _content&view=article&id=552:declaracion-de-guayaquil&catid=37:pronunc&Itemid=115. Participating institutions included CADTM, CLAI, Jubilee, and LATINDADD. 83. Author’s calculations based on BANCO CENTRAL DEL ECUADOR, supra note 3, at ch. 2 tbl.2.12. Fall 2010] SOVEREIGN DEBT CONTRACTS: THE CASE OF ECUADOR 271 responsibility for every loan made to Ecuador by every official (bilateral and multilateral) foreign lender, even though the CAIC documented plenty of irregularities involving many of them? And what about the decision to default selectively on two bonds, but not on a third one that the CAIC had tarred and feathered just the same? How could someone from that camp express approval for a government that spent its “hard-earned money” buying back supposedly immoral, illegal, and illegitimate obligations, thereby validating them?
V CONCLUSION The story of Ecuador’s repudiation of its debt in this unprincipled way is the cautionary tale of the bad things that can happen to good sovereign debt contracts. It is one that even experienced international lawyers, bankers, analysts, and investors would be well advised to heed.
From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Arturo C. Porzecanski*
The past three decades have witnessed the rapid globalization of stock, bond, and currency markets, which has been facilitated by advances in telecommunications and the liberalization of previously sheltered, and often repressed, domestic capital markets. The process has been spurred by the search for higher yields and undervalued assets, wherever they may be located, on the part of individual and institutional investors; and also by the desire to mitigate asset-concentration risks via diversified, uncorrelated portfolios. This globalization has also been accelerated by the mushrooming of trade linkages and the spread of multinational corporations, which have put pressure on banks and other intermediaries to deliver all kinds of financial services—from old- fashioned trade credits to currency swaps and asset-backed finance—everywhere and around the clock. The birth of globalized capital markets has been painful, pockmarked by periodic crises spanning at times a multitude of countries: the industrialized nations in the 1970s, Latin America in the 1980s, and Asia in the 1990s. Governments have usually planted the seeds of those crises: first, by holding onto artificial exchange rate regimes even as their ability to control foreign exchange flows was fast diminishing; and second, by failing to set prudent limits on their own foreign indebtedness and on the mismatching of liabilities by their banks, even as the opportunities for financial mischief multiplied.1 Financial historians will recall Argentina in the 1990s as an extreme case: a country that pretended for a decade that its historically weak currency (the peso) could be as strong and stable as the US currency, at a fixed one-to-one exchange rate set by government fiat. To make matters worse, the authorities there literally
* Written while the author was Head of Emerging Markets Sovereign Research, ABN AMRO; Visiting Professor of Economics, Williams College; and Adjunct Professor of Economics, New York University. 1 See Morris Goldstein and Philip Turner, Controlling Currency Mismatches in Emerging Markets 63–76 (Inst Intl Econ 2004) (arguing that currency mismatches lie at the heart of many financial crises).
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“bet the ranch” by borrowing almost exclusively in dollars and other foreign currencies to finance a string of budgetary deficits, even though their revenues were due and collected only in pesos. 2 Once an erosion of export competitiveness, aggravated by fiscal and political indiscipline, undermined the regime’s credibility and led to a run on available dollars, bank deposits were frozen, capital controls were imposed, and soon after the peso had to be sharply devalued. A sinking currency rendered the government instantly insolvent: the net public debt, which at the one peso per dollar exchange rate was equivalent to nearly three times annual tax revenues and 50 percent of GDP, virtually tripled once the currency sank to around three pesos per dollar, becoming unaffordable to service.
I. DIFFERING PERSPECTIVES ON SOVEREIGN FINANCIAL CRISES Most academic economists, legal scholars, and policy gurus have focused their attention upon the alleged inefficiencies in international financial markets that supposedly lead to these periodic crises and complicate their resolution.3 They have argued that globalization has spawned increasingly diverse, diffuse, and unmanageable creditor and debtor communities that pose coordination and collective action problems. Gone are the days when a relatively small syndicate of commercial banks could gather quickly in New York or London, spurred into action by urgent telephone calls from their supervisory authorities, to deal with whatever financial emergency had erupted in some distant corner of the world. Nowadays, everything can be and is securitized and distributed widely around the globe, such that a financial “hiccup” in some corner of the world can affect a huge constituency half a world away—everyone from naïve retail investors to savvy hedge funds. As a result, governments that lose the confidence of their bank depositors, bondholders, or bank creditors, or fall victim to regional “contagion” effects, are claimed to be unable to work out constructive solutions prior to a major currency, banking, or debt crisis. After a crisis erupts, it is said, financial stability can only be restored by obtaining a massive package of loans from the G-7 governments acting through
2 By late 2001, only 3 percent of the total public debt, and a mere 2 percent of total government bonds, were denominated in Argentine pesos. See Arturo C. Porzecanski, Dealing with Sovereign Debt: Trends and Implications, in Chris Jochnick and Fraser Preston, eds, Sovereign Debt at the Crossroads (Oxford forthcoming). 3 Among the earliest contributors to the literature along this line (in the 1980s) were Christopher Oechsli, an attorney, and Jeffrey Sachs, the well-known economist. See Kenneth Rogoff and Jeromin Zettelmeyer, Bankruptcy Procedures for Sovereigns: A History of Ideas, 1976–2001, 49 IMF Staff Papers 470, 472–76 (2002) (describing the early literature, including the contributions of Christopher Oechsli and Jeffrey Sachs).
312 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski the International Monetary Fund (“IMF”)—the now classic “bailout.” And when sovereign liabilities need to be restructured or written down, the story goes, the absence of an orderly sovereign bankruptcy mechanism means workouts are delayed and their effectiveness is undermined by “free riders” and “rogue” (holdout) creditors. As Anne Krueger, the IMF’s second-highest- ranking official, expressed it in amazingly hypothetical fashion: [I]n the current environment, it may be particularly difficult to secure high participation from creditors as a group, as individual creditors may consider that their best interests would be served by trying to free ride . . . . These difficulties may be amplified by the prevalence of complex financial instruments . . . which in some cases may provide investors with incentives to hold out . . . rather than participating in a restructuring.4 This focus upon the alleged shortcomings of financial globalization, and the seeming repetition of currency and debt crises, spawned various concrete proposals earlier this decade to reform the “international financial architecture.”5 The so-called statutory approach argued for the creation of a supranational bankruptcy authority that would adjudicate financial claims on troubled sovereigns in an expeditious manner, overriding contracts written in national jurisdictions. The “contractual approach” called for the modification of boilerplate bond clauses (especially under New York law) in ways that would facilitate communication among creditors and with the sovereign debtor, restrain disruptive litigation, and facilitate restructuring decisions by a qualified majority rather than unanimous consent. Initially, consideration of both approaches was urged by several academic scribblers and favored by the G-7 governments; it was generally resisted by the financial industry and by many sovereign issuers in the emerging markets. In the end, however, the US Treasury sided with the contractual approach and persuaded the government of Mexico and its bankers to issue a bond, in early 2003, subject to New York law but incorporating innovative “collective action clauses.” The transaction was successful because investors did not demand a premium for the contractual innovation, and ever since, a growing number of sovereign bond issues have incorporated the said clauses at no obvious additional cost.6 The impetus to continue to reform the rules and practices of international finance has subsequently died down, especially since there has not been a major crisis in the past couple of years.
4 See Anne O. Krueger, A New Approach to Sovereign Debt Restructuring 8 (IMF 2002) (emphasis added). 5 See Barry Eichengreen, Restructuring Sovereign Debt, 17:4 J Econ Perspectives 75 (2003). 6 See IMF, Progress Report to the International Monetary and Financial Committee on Crisis Resolution (Sept 28, 2004), available online at
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Economists and lawyers working in the financial industry (on behalf of investors, issuers, and intermediaries) have looked mostly askance at this literature coming out of the universities and the G-7 policy gurus.7 After all, the international capital markets are exceedingly transparent and competitive when compared with most other markets for goods and services. What may look like inefficiencies viewed from the ivory tower are regarded as short-lived, arbitrage opportunities when viewed from the trading floor. Moreover, there is no evidence to suggest that the absence of a supranational bankruptcy procedure, or the dearth of contracts with collective action clauses, have impeded or even delayed sovereign debt workouts. Governments that have sought massive emergency financial aid from the IMF and the G-7 have probably done so not because they were unable to work things out cooperatively with their creditors, but because they did not want to face them. They would rather engage in what the economics literature has termed “gambling for [financial] resurrection.” Indeed, experience demonstrates that neither the threat nor the act of litigation, nor isolated instances of “rogue creditor” behavior, have thwarted the debt restructurings that needed to be accomplished. The governments of Ecuador, Moldova, Pakistan, Russia, the Ukraine, and Uruguay have all been able to restructure their bonded debt in recent years, despite the fact that their investor base was quite diverse and scattered and the debts in question were denominated in different currencies and were bound by contracts from several jurisdictions. With the exception of the Russia debt restructuring, which took more than a year, these transactions were completed quite smoothly within a matter of months, and creditor holdouts were not a significant problem. Three of these restructurings were even concluded prior to an event of default (Moldova, Pakistan, and Uruguay), and three others only afterwards (Ecuador, Russia, and Ukraine)—although not because of a lack of creditor cooperation. Three entailed the extension of maturities without any meaningful reduction in coupons (Moldova, Pakistan, and Uruguay); another involved the lengthening of maturities and cutting of interest payments (Ukraine); and the remaining two incorporated principal forgiveness plus debt service concessions (Ecuador and Russia). In earlier years, the bonded debt of Costa Rica (1985), Guatemala (1989), and Panama (1994) had likewise been successfully restructured. After examining the actual evidence, two international finance experts who are not on
7 See, for example, Sergio J. Galvis, Sovereign Debt Restructurings—The Market Knows Best, 6 Intl Finance 145 (2003) (providing the perspective of a practicing attorney); see also Arturo C. Porzecanski, A Critique of Sovereign Bankruptcy Initiatives, 38 Bus Econ 39 (2003) (providing the perspective of an economist in the financial industry).
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Wall Street’s payroll recently concluded: “Clearly, bond restructurings are possible in a wide range of circumstances.”8 It turns out that it is the official creditor community, represented by the Paris Club of foreign aid and export credit agencies, and the multilateral organizations (the IMF, the World Bank, and the regional development banks), which has been far less responsive to the needs of governments with solvency problems.9 The G-7 governments that have pointed an accusing finger in the direction of the private capital markets are the same ones that have dragged their feet again and again in terms of granting permanent debt relief even after the Highly Indebted Poor Countries (HIPC) initiative came into effect precisely for such purpose.10 The principle of “comparable treatment,” under which the Paris Club has often forced private creditors to grant debt relief, does not operate in reverse, as became clear during the Brady Plan era in the early 1990s, and again after the Ecuador and Russia workouts in the late 1990s.11 In sum, while bankers and bondholders have resolved expeditiously and even generously the sovereign debt crises in which they have been involved in various parts of the world, especially in recent years, the official development community cannot make the same claim. The prevailing view in the private capital markets is that, if anything, reforms should be aimed at facilitating the enforcement of claims against sovereigns, as well as the early and constructive involvement of private-sector creditors in addressing sovereign liquidity or solvency problems. 12 After all, despite the strong rights that creditors have on paper under New York, English, or other law, practical experience has long suggested that the enforcement of claims against sovereigns is a very difficult and protracted affair. Despite the usual surrender of sovereign immunity in standard loan and bond documentation, governments cannot, in fact, be compelled to deal with their underlying problems by changing management, restructuring operations, or
8 See Nouriel Roubini and Brad Setser, Bailouts or Bail-ins?: Responding to Financial Crises in Emerging Economies 167 (Inst Intl Econ 2004). 9 See generally Arturo C. Porzecanski, The Constructive Role of Private Creditors, 17 Ethics & Intl Aff 18 (2003). 10 See HIPC Debt Relief: Which Way Forward?, Hearing before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology of the House Committee on Financial Services, 108th Cong, 2d Sess (Apr 20, 2004). 11 For a perspective that puts the Paris Club in a more favorable light, see Roubini and Setser, Bailouts or Bail-ins? at 256–63 (cited in note 8). 12 See Institute of International Finance, Principles for Private Sector Involvement in Crisis Prevention and Resolution 4–5 (2001), available online at
Summer 2005 315 Chicago Journal of International Law mobilizing resources; moreover, their hard-currency assets cannot in practice be attached.
II. ENTER THE ROGUE DEBTOR: ARGENTINA The vast literature on the alleged defects of the international financial architecture does not dwell upon the possibility that one or more sovereign debtors will take purposeful advantage of their de facto immunity to walk away from legal and financial obligations. In contrast to all the hand-wringing about the potential dangers posed by “rogue creditors,” nary a drop of ink has been spent discussing the risk to the integrity and efficiency of international capital markets posed by “rogue debtors.” And yet, the world has definitely seen its share of deadbeats. Even preferred creditors such as the IMF and the World Bank have long had to provision against some sovereign nonperformers, and their write-off experience would be much heavier if it were not for the prospect of debt forgiveness dangled by the aforementioned HIPC initiative, which has encouraged many borderline-bankrupt governments to remain current.13 As concerns private creditors, their most meaningful encounter with a rogue debtor—before Argentina came along, that is—was Peru in the 1980s. The authorities there began to run arrears to banks and suppliers in 1984, but after President Alan García was inaugurated a year later, the running of payment arrears became an officially sanctioned policy. Negotiations with creditors were shunned, debt-service payments were capped at a certain level set in relation to export earnings, and the default soon widened to encompass obligations due to the multilateral agencies, including the IMF. Many of Peru’s commercial lenders pursued claims in New York and other jurisdictions, but they were not able to attach assets and collect on outstanding debts. It took many years and a new and very different government (under President Alberto Fujimori) for Peru to regularize its financial situation. In late 1991, the government paid off its arrears to the multilateral agencies (mainly thanks to bridge loans from friendly governments including the US), but it would take until 1997 for the country to complete a debt reduction and restructuring process (under the aegis of the Brady Plan) and become current with all private creditors. It was only in 2000 that a lone “rogue” creditor (Elliott Associates) was able to obtain full payment on a small amount of unrestructured obligations, on the basis of a New York ruling enforced in a somewhat unconventional way by a Brussels court, by threatening to attach payments to other creditors made through Euroclear.14
13 As of June 30, 2004, four countries (Iraq, Liberia, Seychelles, and Zimbabwe) were in arrears to the World Bank; as of April 30, 2004, four countries (Iraq, Liberia, Somalia, and Sudan) were in arrears to the IMF. 14 See Porzecanski, Dealing with Sovereign Debt 18–19 (cited in note 2).
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This brings us to the case of Argentina, by far the largest and potentially most complex default the world has ever known. It was declared unilaterally by an interim government to the cheers of legislators in the final days of December 2001. A unilateral restructuring offer was presented to bondholders three years later (January 2005), which was accepted by 76 percent of total bondholders. A settlement with the remaining bondholders, and with other creditors, including bilateral agencies represented by the Paris Club, will probably take several more years to achieve. The extent of the default first began to be revealed in February 2002, when the government (then led by President Eduardo Duhalde) issued a decree that was refined in four subsequent resolutions. Those rulings made it clear that the government would continue to service more than half of the total public debt, excluding arrears: loans from multilateral official lenders; bonds held by creditors who agreed to have their obligations redenominated in pesos; and holders of new bonds issued since the default, mainly to banks and their depositors, as well as to those who had financial claims on provincial governments now taken over by the central government. By residual, the debts that would eventually be subject to a restructuring were all remaining bonds (152 of them, denominated in six currencies and subject to eight legal jurisdictions); debts to official bilateral agencies, including but not limited to the Paris Club; and loans from commercial banks and suppliers. At the time, the principal entangled in the default exceeded $60 billion, but it would grow to around $105 billion by the end of 2004, including some $14 billion of past-due interest (at contractual rates) that for the most part the government would refuse to recognize. The government made one major executive decision that reduced the value of its debt obligations and two others that increased it, the net result of which was to augment the size of the performing debt to the detriment of its capacity to honor the nonperforming debt. The first decision decreed the forcible conversion of all government debt subject to Argentine law from foreign currencies into pesos at an exchange rate of 1.4 pesos per dollar—this at a time when the currency was free-falling toward two pesos per dollar, and several weeks before it touched bottom at four pesos, before finally settling at around three pesos per dollar. This measure minimized the impact of currency devaluation upon a portion of the stock of public debt, but obviously at the cost of disadvantaging the bondholders, who were mostly domestic pension and mutual funds, and insurance companies and banks, which had purposely hedged
Summer 2005 317 Chicago Journal of International Law themselves by investing in dollar-denominated securities. 15 Many of these investors then commenced litigation in Argentina against the government, so far without success. The second decision pertained to the assets and liabilities of the banking system denominated in dollars, which constituted the bulk of their balance sheets. Dollar loans to the private sector were forcibly converted into pesos at a one-for-one exchange rate, whereas dollar deposits in banks were to be recognized at 1.4 pesos per dollar. The former move was intended to fully protect households and companies with dollar debts from the currency’s devaluation, and the latter to limit the windfall that would have accrued to bank customers who had (by that time effectively frozen) dollar-denominated deposits. Understandably, this government decision was very popular among debtors but proved very unpopular among depositors, who staged loud protests and proceeded to jam the courts with lawsuits against the banks and the government. Thousands of these suits have resulted in lower court and appeals court decisions favorable to individual depositors, who have subsequently obtained restitution from their banks. The banks, however, have not obtained restitution from the government. By introducing a costly exchange-rate mismatch into the balance sheets of banks, however, this government decision—so-called asymmetric pesification— effectively rendered the banking system insolvent. Banks subsequently had to be recapitalized via the large-scale issuance of government bonds provided to them in compensation, thereby increasing the level of post-default public debt. A hefty amount of government bonds was also issued to compensate depositors for the freezing and subsequent rescheduling of their deposits, although at least these bonds generated an offsetting contingent asset for the government, because banks were obligated to gradually reimburse the government in lieu of meeting customer withdrawals. The third decision involved the central government’s takeover of liabilities incurred (including currencies issued) by provincial governments in prior years as part of a fiscal cleanup and consolidation process. This too led to a substantial post-default increase in the public debt, and likewise to an offsetting asset, because the provinces agreed to reimburse the central government over time. In a related move, government bonds were also issued in 2002–03 to settle previously contingent liabilities with pensioners, civil servants, victims of human rights abuses, and the like.
15 It also lowered the burden of debt-service payments, because the new peso-denominated bonds carried coupons of as low as 2 percent per annum, although principal was subject to adjustments for future inflation.
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Figure 1: Evolution of Argentina’s public debt during 2002–03 ($ billions) As of 31 Dec 2001 144.45
Forced debt conversion to pesos -22.09 Bonds issued to banks 8.30 Bonds issued to bank depositors 6.09 Bonds issued on behalf of provinces 12.11 Inflation adjustment of new bonds 7.33 Other assorted bonds issued 2.51 Subtotal 14.24
Interest arrears on defaulted debt 13.94 Other transactions 6.19
As of 31 Dec 2003 178.82 Source: Ministry of Economy of Argentina
The end result of these government decisions was that the stock of performing public debt, which could have fallen by $22.1 billion during 2002–03 in the wake of the forced currency redenomination, ended up being increased by $14.2 billion—a $36.3 billion difference equivalent to about half of the postdefault performing public debt, and to a whopping 31 percent of the 2002– 03 average GDP. In partial compensation, the government would accumulate $11 billion in financial assets by the end of 2003, derived from claims on banks and provincial governments on whose behalf the new debt had been issued. The banks and provincial governments are reimbursing the central government for these liabilities, and the provincial obligations are secured by a pledge of tax revenues that the provinces receive from the central government as part of the existing revenue-sharing scheme. The government’s financial assets would reach $21 billion by late 2004, and come to include more than $6 billion in cash (in foreign currencies) held by the National Treasury. However, the authorities would never offer to mobilize these assets, via their liquidation or securitization, for the purpose of improving the treatment of defaulted debt. In the aftermath of the devaluation and default, the authorities also made an important decision that would greatly enhance the government’s ability to service debt obligations. They imposed taxes upon exports, justifying them because exporters would otherwise reap too large of a windfall from the currency’s sharp devaluation—even though exporters had suffered financially throughout the 1990s, during the country’s hard-peso policy. The standard tax
Summer 2005 319 Chicago Journal of International Law for most products has ranged from 5 percent to 20 percent of FOB export values, with a supplement of 3–5 percent for certain commodities. These taxes on exports ended up yielding much more than initially envisioned because export earnings in dollar terms increased 15 percent in 2003 and an additional 16 percent in 2004, spearheaded by higher prices for fuel and soybean exports. Export earnings in 2004 reached a record of $34.5 billion, up from $26.6 billion in 2001, a 30 percent gain that translated into a 380 percent taxable increase in peso terms. Taxes on exports, which yielded a mere 50 million pesos in 2001 (equivalent to $0.05 billion), consequently generated more than 10 billion pesos by 2004 ($3.5 billion). The quantum increase in tax revenues from exports has been accompanied by a generalized recovery of tax collections in the wake of the economy’s strong upturn, with real GDP growth of 8.8 percent in 2003, and another 9.0 percent in 2004, following a cumulative GDP decline of 18.4 percent during 1999–2002. Indeed, tax revenues in 2004 were more than double their 2001 level, measured in pesos, although they were still more than one-fourth lower when translated into dollars at the managed exchange rate of 2.94 pesos per dollar on average for 2004. Indeed, the authorities have been keeping the peso purposely undervalued during the past couple of years to encourage the influx of dollars via a sizable foreign trade surplus. They have ensured its artificial weakness by purchasing excess dollars from the foreign exchange market through daily interventions, and to such an extent that official international reserves rose to $20 billion by the end of 2004, a near doubling from their 2002 year end level ($10.5 billion). Had the central bank allowed the exchange rate to be set by market forces, the Argentine currency would probably have traded closer to 2.50 pesos per dollar during 2004. Therefore, a less artificial currency regime would have allowed for swollen tax revenues in pesos to be worth almost 85 percent of their predefault levels, once translated into dollars at a realistic exchange rate.
320 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski
Figure 2: Evolution of Argentine tax revenues
60 120
50 100
40 80 30 60
20 40 10 20 0 0 2001 2002 2003 2004 2004*
$ billion Ps. billion (rhs) Note: “rhs” stands for right-hand scale. * At the likely market exchange rate of 2.50, rather than the managed average exchange rate of 2.94 pesos per dollar. Source: Ministry of Economy of Argentina, author’s calculations.
The very strong performance of Argentine tax revenues since the default means that the government’s ability to meet its obligations to bondholders and other creditors, which had been so seriously compromised by the peso’s devaluation, has been substantially restored. At the end of 2001, the public debt net of financial assets stood at $135 billion, and this was equivalent to about 270 percent of total revenues and 50 percent of GDP. One year later, it had declined to $130 billion, but because of the devaluation’s impact upon peso-based revenues and GDP, the net public debt had now surged to the equivalent of nearly 725 percent of revenues and 130 percent of GDP. By the end of 2004, however, even though the net debt had increased to $168 billion as a result of the aforementioned decisions made by the government, the debt was now equivalent to around 400 percent of revenues and less than 100 percent of GDP (at the likely market exchange rate), with official and private forecasts pointing to still lower ratios in 2005. If the government had not issued all the new debt that it did after the default, the net debt-to-revenues ratio at the end of 2004 would already have dropped below 350 percent, and the net debt-to-GDP ratio would be close to 80 percent.
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Figure 3: Evolution of Argentina’s net public debt*
900 150
750 120 600 90 450 60 300 30 150 0 0 2001 2002 2003 2004 2004** % of total revenues % of GDP (rhs)
* Including interest arrears at contracted rates. ** At the likely market exchange rate of 2.50, rather than the managed average exchange rate of 2.94 pesos per dollar. Source: Ministry of Economy of Argentina, author’s calculations.
These are very high but not necessarily unmanageable ratios, depending upon the maturity structure and interest burden of the debt. For example, countries ranging from Egypt and Israel to India, Indonesia, and Pakistan, all have ratios of net public debt to revenues of around 200–450 percent, and ratios of net debt to GDP within the range of 80–95 percent. Moreover, one of Argentina’s neighbors, Uruguay, faced a similar degree of over-indebtedness in 2002–03, following a ruinous recession and currency devaluation—plus a massive run on its banks—and yet it refused to dishonor its obligations to creditors. After holding informal consultations with many of its bondholders in early 2003, the government of Uruguay put forth a debt exchange solely for the purpose of extending maturities, which was agreed upon by more than 90 percent of bondholders. In the wake of a strong recovery of government revenues and real GDP, Uruguay’s net public debt has since dropped to the equivalent of 80 percent of GDP and 300 percent of revenues.16
16 The above statistics were obtained from Standard & Poor’s, Sovereign Risk Indicators: General Government Finance Data (Dec 30, 2004), available to subscribers of S&P’s RatingsDirect service (on file with author).
322 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski
The Argentine government’s overall approach to its default has been uncooperative, to say the least. While other sovereigns in financial trouble, including Argentina itself in the past, have actively sought to avoid an event of default or have acted promptly to cure any default, in this case the government has dragged its feet for more than three years and, adding insult to injury, has largely refused to recognize the interest arrears that its own delay generated. Traditionally, sovereigns needing debt relief have followed one of two paths. The first is the negotiated route, whereby governments sit down to hammer out a debt-restructuring deal with a representative committee of either bondholders or commercial bankers, depending upon which group holds a majority of the claims on the sovereign. This is the typical approach followed by dozens of governments in recent decades, from Argentina in the early 1980s to Vietnam in the late 1990s. They all negotiated with a Bank Advisory Committee (“BAC”) or so-called London Club (because most of the negotiating sessions took place either in London or in New York), in contrast to the so-called Paris Club of official creditors (which meets under the aegis of the French Treasury). The BAC would then recommend to other private creditors that they accept the terms agreed upon with the government in question, and most would usually do so.17 Those unwilling to participate (e.g., small regional banks) would generally be paid out but with the understanding that they would not be welcome to do new business in that country. The second route is the unilateral exchange offer, whereby governments engage commercial or investment banks to consult privately with a critical mass of lenders or investors about the possible shape of an acceptable settlement, which is then crafted and presented to all creditors on a take-it-or-leave it basis. These exchange offers are often accompanied by exit consents that encourage the participation of as many investors as possible by leaving nonparticipants in a disadvantageous position—for example, with less liquid securities. This approach has become more popular in recent years and was used successfully by Pakistan (1999), Ecuador (2000), Ukraine (2000), and Uruguay (2003). In recognition that the ideal should not become the enemy of the good, if necessary, governments will then quietly pay off any recalcitrant creditors when their original claims fall due. Argentina has followed neither path. The government appointed a financial advisor (Lazard Frères) in early 2003, but charged him solely with the task of developing a database of bondholders, presumably to enable them to be contacted in the future. Keeping bondholders informed, never mind engaged for the sake of a mutually agreeable solution, apparently was not a priority. The
17 See Lex Rieffel, Restructuring Sovereign Debt: The Case for Ad Hoc Machinery 95–131 (Brookings Inst 2003) (explaining the London Club process).
Summer 2005 323 Chicago Journal of International Law government dropped that firm in early 2004 and retained the services of three major investment banks (Barclays Capital, Merrill Lynch, and UBS) to become the eventual joint deal managers of its January 2005 debt-restructuring offer. It quickly became apparent that these firms would likewise not be engaging in a dialogue with the investor base on behalf of the Argentine government. The authorities also refused to follow the other, more historical approach of encouraging the formation of a bondholders’ committee with which to consult and negotiate a debt restructuring. Moreover, the government failed to recognize—never mind negotiate with—such a committee, the Global Committee of Argentina Bondholders (“GCAB”), once it was formed on the initiative of a large portion of disgruntled bondholders residing in Europe, Japan, and the United States. From time to time during 2003–04, the government held some perfunctory briefings for bondholders, but the outline of what would become its debt relief proposal, unveiled in Dubai in September 2003 (at the joint annual meeting of the IMF and World Bank), was developed unilaterally. This proposal, which called for what was estimated to be debt forgiveness equivalent to as much as 90 percent of contracted amounts on a net present value (“NPV”) basis and which ignored all past due interest, was widely denounced by bondholder representatives. The government justified it by making reference to a debt sustainability model it had developed that quantified ability to pay over a long period on the basis of multiple economic assumptions, including the fiscal savings it was willing to generate. The model would never be updated to reflect the overperformance of fiscal revenues and other crucial economic parameters in 2004, or to incorporate the government’s bulging financial assets, both at the National Treasury or at the Central Bank of Argentina. Indeed, it would never become part of its prospectus as filed with the Securities and Exchange Commission and its counterparts around the world. The Dubai proposal served as the basis for the concrete debt restructuring proposal put forth, likewise unilaterally, 15 months later (January 2005), which was estimated to involve debt relief of about 70 percent on an NPV basis. The major improvement made on Argentina’s part was the willingness to backdate to December 31, 2003 the new bonds to be issued in exchange for the defaulted ones, implicitly recognizing past due interest starting from that date, although recalculated at very low rates and capitalized in part. Interest arrears were not recognized at all for the preceding twenty-four months (2002–03), whether calculated at contractual or lower interest rates. The rest of the improvement was delivered exogenously by the financial markets, because an intervening rally in high yield and emerging-market bonds greatly narrowed the discount applied to similar “junk bonds,” thereby reducing the so-called exit yields used to calculate NPVs. Specifically, the government proposed that bondholders tender their existing 152 bonds, no matter their original maturity date, coupon, or currency
324 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski denomination, for any of three new securities. The first choice was a limited amount of Par bonds payable in dollars, euros, or Argentine pesos, involving no “haircut” on principal but a very low interest rate (as little as 1.33 percent on US dollar bonds for the first six years, rising to 5.25 percent after 25 years, and correspondingly less on euro and peso-denominated bonds, although the latter are adjusted for inflation); a long grace period (26 years); and a final maturity in 2038 (35 years). The second choice was a limited amount of Cuasi-Par bonds, issued to those willing to accept a 30.6 percent “haircut” on principal, that are payable only in Argentine pesos adjusted for intervening inflation through final maturity. They come with a low coupon (3.31 percent) also payable in pesos, a very long grace period (33 years), and a final maturity in 2046. And the third choice was an unlimited amount of Discount bonds, denominated in dollars, euros, or pesos, issued to those accepting a 66.3 percent “haircut” on principal, but paying a higher interest rate (part of it capitalized, beginning at 4 percent and rising to 8.28 percent on dollar bonds, less on euros and pesos, although the latter are adjusted for inflation). They have a long grace period (21 years) and a final maturity in 2034. Bondholders were also offered a free option on Argentina’s future growth outperformance via a security linked to the country’s real GDP, such that economic growth exceeding 3 percent in any one year after 2014, and somewhat higher between 2006 and 2014, would trigger a small, additional interest payment. Argentina’s demand for such massive debt relief was without precedent in its own checkered financial history. It can only be compared with the relief obtained by much poorer countries (for example, Albania in 1995, Bolivia in 1992, Guyana in 1999, Niger in 1991, and Yemen in 2001), but in these cases the sums involved have been far smaller and the creditors involved have been commercial bank lenders rather than bondholders. The proposed transaction was also unparalleled in various other respects. First, it did not recognize interest arrears nor treat them preferentially, as has always been the custom. Second, it failed to include an upfront payment to clear a portion of the arrears, a common “sweetener” to ensure success. Third, it was not accompanied by the usual reassuring endorsement—never mind backed with financial support—from the IMF or other multilateral agencies. Fourth, it did not aim for anywhere near 100 percent participation, which is the traditional objective, nor did it set a high level of participation (say, 85 percent or 90 percent) as a required minimum for the transaction to proceed. In fact, when launching the debt restructuring proposal, Finance Minister Roberto Lavagna went so far as to say that the government would regard any participation rate above 50 percent as having effectively cured the country’s default. The clear implication was that even if nearly half of all bondholders failed to accept the terms of the ruinous debt exchange, they would be ignored. To ensure the message was heard loud and clear, three weeks into the
Summer 2005 325 Chicago Journal of International Law transaction (in early February 2005) the government sent a draft law to the legislature forbidding the Executive from reopening the debt exchange in the future and engaging in any transaction with bondholders arising from any court order or otherwise.18 The law was passed within one week. Figure 4: Comparison of recent sovereign debt restructurings ARGENTINA ECUADOR PAKISTAN RUSSIA UKRAINE URUGUAY 2005 2000 1999 1998–2000 1998–2000 2003 Per Capita Income ($)* 11,586 3,363 1,826 6,592 3,841 8,280 Scope ($ Billions) 81.8 6.8 0.6 31.8 3.3 5.4 Number of Bonds 152 5 3 3 5 65 Jurisdictions Involved 8 2 1 1 3 6 Months in Default 38+ 10 2 18 3 None Minimum Participation Set No Yes Yes Yes Yes Yes Recognition of Interest Partial Yes Yes Yes Yes N/A Arrears Principal Forgiveness Yes Yes No Yes No No ‘Haircut’ on Discount 66.3 40 0 37.5 0 0 Bond (%) Lowered Coupons Yes No Yes No Yes No Extended Maturities Yes Yes Yes Yes Yes Yes Participation Rate (% of 76 97 95 98 95 93 Eligible) Note: N/A stands for not applicable. *Adjusted for purchasing power; latest (2003) data for Argentina, otherwise data corresponds to year(s) of debt restructuring as noted. Source: IIF, IMF, World Bank, author’s calculations.
III. DEALING WITH A ROGUE DEBTOR What is to be done in the case of a sovereign debtor who refuses to honor its debt obligations, even though a strong case can be made that it has regained the financial wherewithal to do so? In line with experience in decades past, the bondholders that within the past couple of years have filed suit against Argentina in various jurisdictions have found that seeking remedy in the courts against a sovereign is, for the most part, a fruitless endeavor.
18 The law also mandated the government to do everything in its power to delist all bonds not tendered into the exchange, and to unilaterally exchange all bonds tied up in litigation against Argentina into new Par bonds denominated in pesos and maturing in 2038.
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By the close of 2004, nearly 40 individual lawsuits had been filed in New York (specifically, before Judge Thomas P. Griesa in the US District Court for the Southern District of New York) seeking repayment of Argentina’s obligations, and judgments in favor of plaintiffs had been entered in seven cases entailing some $740 million. In addition, more than a dozen class action lawsuits had been filed against the Argentine government, and one of the plaintiffs had been granted the motion to certify its complaint involving two series of bonds with a face value of about $3.5 billion. The government, however, represented to the court that it had no assets in the United States used for a “commercial activity,” such as would provide a legal basis for an attachment or execution under the Foreign Sovereign Immunities Act. In Italy, there were a half dozen bondholder proceedings against Argentina pending in the courts, involving relatively small amounts, and while no final decisions had been rendered, some judges ordered payment and ordered the freezing of certain assets. However, the Argentine government was challenging these actions on the grounds that it enjoys sovereign immunity. In any case, under Italian law, any claims against Argentina would only be executable against assets not used for “public purposes.” In Germany, by late 2004, more than 100 legal proceedings had commenced claiming the euro equivalent of less than $100 million, and several prejudgment “arrest” (attachment) orders had been rendered against the Argentine government. Argentina was disputing each payment order claiming a “state of necessity,” and although some of the orders were enforceable, all cases had been suspended awaiting a decision by the German Constitutional Court on whether such a state indeed excused a deferral of debt service. Dealing with a rogue sovereign debtor requires, in actual practice, the political willingness of other sovereign states to confront the errant nation, whether directly or through a supranational body such as the IMF. It is only the international community that can exercise the kind of diplomatic pressure and put forth the financial incentives and disincentives to motivate a rogue sovereign debtor to come to terms with its private creditors in a fair and responsible manner. It is unfortunate that in the case of Argentina the G-7 governments for the most part have not been willing to stand up and be counted. To begin with, the international community has been providing a safe harbor for Argentina’s hard currency assets. Indeed, a sizeable proportion of the government’s and central bank’s foreign exchange holdings reportedly have been deposited at the Bank for International Settlements (“BIS”), the Basle-based central banks’ central bank, where they are out of attachment range. This is because the BIS has been granted various immunities in Switzerland and other jurisdictions, the main purpose of which, as the BIS itself proudly advertises in
Summer 2005 327 Chicago Journal of International Law its website, “is to protect central bank assets held with the BIS from measures of compulsory execution and sequestration, and particularly from attachment.”19 The welcome mat put out for a rogue sovereign debtor such as Argentina by the (exclusively sovereign) shareholders of the BIS thus stands in awkward contrast to the contemporary willingness of the international community to trace and recover the ill-gotten gains of Third World despots—even when they are on deposit in numbered Swiss bank accounts. Moreover, the international community has been supportive of Argentina via a series of new loans granted by the IMF, the World Bank and the Inter- American Development Bank, especially during 2003 and the first half of 2004. Indeed, in January 2003, the IMF agreed to extend a loan facility worth almost $3 billion to enable the Argentine government to cover debt service payments coming due to the Fund and, in September of that year, it opened another such window, but this time worth more than $13 billion, to help offset debt service payments during 2004–06. Simultaneously, the other multilateral development agencies opened up sizeable lines of credit for Argentina, and proceeded to disburse funds. All told, the multilateral agencies disbursed to the government of Argentina the sums of $600 million in 2002, $10.2 billion in 2003, and $4.1 billion in the first semester of 2004.20 This official financial support has been subject to a variety of conditions agreed to by the Argentine government, involving fiscal policy targets and structural reforms.21 Blatant failure to make progress on these reforms eventually prompted the IMF to stop disbursing funds in August 2004, whereupon the government has nonetheless continued to make debt service payments to the Fund. Whatever tough message the IMF’s halt to new lending was intended to deliver was blunted, however, by subsequent decisions on the part of the other
19 See BIS as a bank for central banks, available online at
328 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski multilateral agencies to continue to support Argentina financially. For instance, in November 2004, the board of directors of the Inter-American Development Bank voted unanimously to approve a multi year, $5 billion package of loans to the government; in December, the World Bank approved a $200 million loan for the upgrading of infrastructure in Buenos Aires province—in other words, business as usual. There are grounds for questioning the propriety, never mind the wisdom, of this post-default multilateral lending to Argentina. The IMF, in particular, has had a policy of lending to a government in default of financial obligations to private creditors only when it is pursuing “appropriate policies” and when it is making “a good faith effort to reach a collaborative agreement with its creditors.” Meeting in early September 2002 in the wake of Argentina’s default, the board of directors of the IMF reiterated and elaborated on this “good faith criterion,” spelling out that governments were expected to “provide creditors with an early opportunity to give input on the design of restructuring strategies and the design of individual instruments,” and that when a representative committee of creditors has been formed, that they would “enter into good faith negotiations with this committee.”22 In its negotiations with the IMF, in fact, the Argentine government openly committed to engage in a “collaborative dialogue with its creditors” (September 2003) and to begin “meaningful and constructive negotiations” with creditor groups, including with GCAB (March 2004). However, the government never engaged in any such dialogue or negotiations, as detailed in a position paper by GCAB, and the government’s eventual debt restructuring proposal did not reflect any input from this large bondholders’ group.23 Argentina also won an important gesture of political support in the US courts—specifically, in the form of amicus curiae briefs filed by none other than the US government and the Federal Reserve Bank of New York, in January 2004. The Argentine government had sought a declaratory judgment from Judge Griesa (of the Southern District of New York) to the effect that several of its creditors in pending cases should not be permitted to use a broad interpretation of the pari passu clause to enforce their judgments, for instance, by preventing the country from making payments to creditors such as the IMF. The plaintiffs had countered, among other things, that they had not sought and did not intend
22 IMF, IMF Board Discusses the Good-Faith Criterion under the Fund Policy on Lending into Arrears to Private Creditors, Public Information Notice No 02/107 (Sept 24, 2002), available online at
Summer 2005 329 Chicago Journal of International Law to seek such enforcement action, such that Argentina’s request was premature. However, the authorities in Buenos Aires were evidently successful in persuading high-ranking US authorities that there was a clear and present danger to the international payments system from the potential application of this clause, which had been used by creditors against the governments of Peru and Nicaragua.24 In any event, the plaintiffs prevailed on their procedural argument, but there is little doubt that the US and Federal Reserve “statements of interest” were interpreted in Buenos Aires as a green light to proceed with a hard line stance against bondholders. The willingness of US authorities to accommodate Argentina in 2004 stands in marked contrast to their willingness to confront a defaulting sovereign two decades earlier. At the time, Costa Rica had experienced a financial crisis, and because of the imposition of exchange controls prohibiting the servicing of obligations to foreign creditors, three state-owned banks had defaulted on a syndicated loan. A federal district court denied a motion for summary judgment against Costa Rica, and on appeal the Second Circuit initially agreed that the suit should not be heard on grounds of comity.25 However, the Justice Department submitted an amicus brief explaining that the unilateral imposition of exchange controls by Costa Rica was inconsistent with US policy and that the underlying obligations to pay remained valid and enforceable. Upon rehearing, the Second Circuit reversed itself,26 opening the door to limited creditor litigation against sovereigns and setting a standard that US courts would adhere to throughout the 1980s and 1990s.27 The most recent way that the G-7 governments have winked in Argentina’s direction is by failing to insist, either from the start or even late in the game, upon overwhelming acceptance of whatever debt restructuring proposal the country would put forth to its creditors. That would have put pressure on Buenos Aires to come up with a less punishing proposal, or to have added some last minute “sweeteners” to maximize bondholder acceptance. The IMF, in particular, carefully avoided setting a minimum participation rate it would consider acceptable for its own purposes, although privately it had earlier signaled that acceptance “in the high 80s” would be desirable. Evidently, its major shareholders have wanted to retain the right to recognize a restructuring
24 For an exhaustive background on this clause, authored by two attorneys with the firm that has acted as counsel to the governments of Peru, Nicaragua, and Argentina, see Lee C. Buchheit and Jeremiah S. Pam, The Pari Passu Clause in Sovereign Debt Instruments, 53 Emory L J 869 (2004). 25 Allied Bank International v. Banco Crédito Agrícola de Cartago, 733 F2d 23, 27 (2d Cir 1984). 26 See Allied Bank International v Banco Crédito Agrícola de Cartago, 757 F2d 516, 523 (2d Cir 1985). 27 See Jill E. Fisch and Caroline M. Gentile, Vultures or Vanguards?: The Role of Litigation in Sovereign Debt Restructuring, 53 Emory L J 1043, 1075–88 (2004).
330 Vol. 6 No. 1 From Rogue Creditors to Rogue Debtors: Implications of Argentina’s Default Porzecanski that was far less successful than all prior ones, possibly in order to resume the Fund’s lending program later this year and keep Argentina from defaulting on its obligations to the multilateral agencies. In so doing, however, the G-7 governments passed up an opportunity to show what Michael Mussa has called “principled leadership” in dealing with Argentina.28
IV. IMPLICATIONS The case of Argentina suggests that much of the academic and policy making literature has ignored the realistic possibility that rogue sovereign debtors, rather than rogue private creditors, are the ones that pose the greatest threat to the integrity and efficiency of the international financial architecture. The country’s actions in the wake of its gigantic default have also exposed the limitations of the customary Eurobond offering circulars, brimming as they are with legal clauses supposedly spelling out the enforceable rights of investors vis-à-vis sovereigns willing to waive their customary immunity. The fact remains that it is exceedingly difficult to collect from a sovereign deadbeat. The sad truth is that only other governments, rather than even the best organized group of bondholders, can hope to rein in a wayward sovereign debtor and persuade it not to walk away from its lawful obligations. And yet, as has been made clear in various ways, the G-7 governments, and particularly the George W. Bush administration, have not been willing to confront the authorities in Buenos Aires. The very harsh way that Argentina has dealt with its bondholders, despite the substantial recovery of its ability to service its contractual obligations, has set a troubling precedent for other sovereign debtors in future financial straits. While it is unlikely that emerging market governments will want to drive their economy into the ground any time soon in order to plead for debt relief on an Argentine scale, international financial conditions will not always be as benign as they are nowadays. There will surely be global liquidity and economic downturns in the future, and some governments will run out of cash. When they do, the precedent that Argentina is setting will surely come back to haunt the international financial community. As concerns the implications of Argentina’s stance for the country’s own economic future, chances are that the losses that foreign portfolio and direct investors have incurred there will poison the business climate for many years to come. This does not mean that the pace of economic activity will grind to a halt.
28 Michael Mussa, Statement to the Senate Banking Subcommittee on International Trade and Finance Hearing on the Argentine Financial Crisis (Mar 10, 2004, revised Mar 22, 2004), transcript available online at
Summer 2005 331 Chicago Journal of International Law
Just like it took many years for the nationalist, populist policies of General Juan Domingo Perón to reveal their insidious economic and social downside, it will probably take many years for the current, neonationalist, neopopulist policies to bear rotten fruit. After all, the tens of billions of dollars that foreign investors poured into Argentina during the 1990s did allow for a major modernization of the country’s infrastructure and productive base that will not be undone anytime soon.
332 Vol. 6 No. 1 Timothy B. DeSieno Partner
[email protected] T +1.212.705.7426 F +1.212.508.1458 New York
Tim DeSieno represents institutional investors in their global investments as well as in restructurings in cases of financial, political or other difficulty. These restructurings regularly include cross-border workouts and insolvency proceedings in one or more countries.
Tim is currently advising the ad hoc group of holders of notes secured by the OSX3 FPSO as well as the notes issued by a large Brazilian electricity distributor in connection with its Brazilian insolvency proceedings. He is also advising the offshore lenders in connection with the largest corporate insolvency in the history of Spain.
Other ongoing and recent engagements include advising holders of foreign law debt issued by the Hellenic Republic, advising the Icelandic Banks’ note holder committee in connection with debt restructuring and policy work in the wake of the financial crisis and the banks’ nationalization (Tim advised the creditors committee in the case of Straumur’s ground-breaking composition proceedings), and advising holders of bond debt issued by Irish banks in response to the government’s intervention. Tim recently advised the Petrozuata bondholders and the Fertinitro bondholders committees in connection with these Venezuelan projects’ nationalizations and the bondholders’ at-premium cash recoveries. He is currently, similarly advising the Sidetur bondholders.
During recent years, Tim has advised creditors and creditor committees in restructurings and debt recovery efforts in connection with financial institutions in the United Kingdom and corporates in Brazil, China, Indonesia, Malaysia, Mexico, Russia and Thailand.
In sovereign debt matters, Tim is advising the Grenada Sovereign Bondholder Committee, and he advises investors in connection with ongoing developments in Greece and Argentina. He also advised the Dominican Republic bondholders committee in connection with that country’s sovereign bond debt restructuring and has advised creditors of Belize and Ecuador. He has advised several governments and multilateral organizations in the design and implementation of corporate insolvency and rehabilitation systems, including the Government of Kazakhstan most recently. Tim is a member of the Working Group of the Institute of International Finance on the Role of Indenture Trustees in Sovereign Debt Restructuring.
In the U.S., Tim advises derivatives counterparties in connection with the Lehman chapter 11 proceedings, and he served as counsel to the Chapter 11 trustee of Refco Capital Markets in connection with the design and implementation of a settlement of massive intercreditor litigation as well as a Chapter 11 plan of reorganization for all the Refco entities.
Hung Q. Tran Executive Managing Director Institute of International Finance
Hung Q. Tran is the Executive Managing Director of the Institute of International Finance (IIF), assisting in the overall management of the IIF while also leading the Capital Markets and Emerging Markets Policy Department. Prior to his work at the IIF, Mr. Tran served for six years at the International Monetary Fund as Deputy Director, Monetary and Capital Markets Department, where his responsibilities included the overall management of the Fund’s semi-annual Global Financial Stability Report. He also served from 1998 to 2001 in London as the Managing Director, Chief Economist/Global Head of Research for Rabobank International.
He had spent the prior 12 years with Deutsche Bank with assignments in New York, Frankfurt and Singapore including serving as Director of Global Fixed Income Research from 1987-1990 and as Co-Founding Managing Director of Deutsche Bank Research from 1991-1995 and as Head of Equity Business for the Deutsche Bank Group in Asia-Pacific (1995-1998). Earlier in his career he had worked in international fixed income research for Merrill Lynch and Salomon Brothers in New York. Mr. Tran received his undergraduate and graduate degrees in Economics from California State University and completed the doctoral program in Economics at New York University.
Dr. Arturo Porzecanski American University
Dr. Porzecanski is an expert in international finance, emerging markets, and Latin American economics and politics. Since 2007, he has been on the faculty of American University in Washington, DC, as Distinguished Economist in Residence, and since 2012, serving also as Director of the International Economic Relations Program. He previously taught at Columbia University, New York University, and Williams College, but is a fairly recent arrival to academia, having spent most of his professional career working as an international economist on Wall Street. He was chief economist for emerging markets at ABN AMRO Bank (2000-2005); chief economist for the Americas at ING Bank (1994-2000); chief emerging-markets economist at Kidder, Peabody & Co. (1992-1993); chief economist at Republic National Bank of New York (1989-1992); senior economist at J.P. Morgan Bank (1977-1989); research economist at the Center for Latin American Monetary Studies in Mexico City (1975-1976); and visiting economist at the International Monetary Fund (1973).
Bruce Wolfson Of Counsel, Bingham McCutchen LLP
[email protected] T +1.212.705.7647 F +1.212.752.5378 New York
Bruce Wolfson recently joined Bingham McCutchen’s Corporate and Latin America Practice Groups. For more than 30 years, Bruce has been involved with financings and restructurings in the emerging-markets.
Before joining Bingham, Bruce was a partner and general counsel at The Rohatyn Group, an asset management firm specializing in emerging markets. Prior to joining The Rohatyn Group in 2004, he was a senior managing director in the legal department at Bear, Stearns & Co. Inc., where he was responsible for all legal work relating to trading, sales, capital markets, investment banking and wealth management in the developing world.
In addition to his work in the asset management and financial services sectors, Bruce has advised regulators in the emerging markets of Latin America and Asia concerning their foreign investment rules. He served as first chair of the documentation committee of EMTA, the association of the emerging market trade and investment community, which developed standard documentation for trading emerging-market assets. He served as a member of EMTA’s board of directors from 1994 to 2012.
Since 1999, Bruce has also been an adjunct professor of International Affairs at Columbia University School of International & Public Affairs. He is a frequent lecturer at universities and graduate schools.
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