,w^: ~_~ INTERNATIONAL INSOLVENCY INSTITUTE Sovereign Piracy G. Mitu Gulati and Kenneth N. Klee From The Kenneth N. Klee Collection in The International Insolvency Institute Academic Forum Collection http://www.iiiglobal.org/component/jdozunloads/viezucategori~/650.11tn~il International Insolvency Institute PMB 112 10332 Main Street Fairfax, Virginia 22030-2410 USA Email: [email protected] OO International Insolvency Institute 2011. All rights reserved. Admin`1584723.1 ~, y ~ ~~ ~ __. ~- ~s ~ x~ yr y , . `~ >(^ter£.'"~Y, -:S. ~E ~-rr er ';~ N. r _X ___—_._'_ ~_ :i,....3 s_:.,,,^ ~¢~i t +~ s '~---4 ?F ~ -`o~'a S'~ 5;?~~ ~ i f,,~: ~ '~'kae ~~ercY~~~~e~ Coy°~~rsc~.t~ F'i~~~ace ~x~~X~rrtt~~x~ ~ Lr~cima l~r~~e I3e1~L~lzirk <c~~d Daz~r'd I. I~l~celke~~ '~"~a~ ~:~e~~n~a~,~~~fcf~r T~~~~~~~ty ~~ t~aa~ "1'~'~~~~.1 I)~.~~~~ l~o~~Y ~ ~a~a~~lo~~~ ~b~ ~~~ix~~~ff~ g~ ~~ca~ritxe~ Cla~~ Acti.o~ ~,a~r~~~~~ I~ ~ Robe~~t rl. 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Goldnac~~~ X000 l~~I~~D~~ ~~~t~~~~ ~'I'LJI~~1~'~' ~TR~T'~I~T~ COS~1'~'~~'~' C I ~~~:~a~~,i~s~~~ ~~~a~t~,l .~.rrfl~~n~a~c~e 'I'lae ~as~~ .A.~c~~•d. ~ ~n~ ~~a~ I~T~v~ ~'x~rn~vvmrk R _ Hecatla Price Tarbert ~' ~~a~,~ k~,e~a~~w ~~'k'~~e~°~.1 ~eca~rxtae~ ~~g~a~~ta~xa r s ' ~Sicbcorrtntittee on tlae Ara~au~cl Peuieze~ ~ .__ _._ .,.___ Sovereign Piracy By G. Mitu Gulati and Kenneth N. Klee X INTRODUCTION In October X 995, Peru announced its Brady Plan debt restructuring of guaranteed Banco de la Nacion and Banco Popular del Peru bank loans.l Approximately four months later, Elliott Associates, LP (Elliott), a well- known vulture fund, purchased nearly $20.7 million face amount of loans from t~vo international banks for about $11.4 million.2 The restructuring went forward with Elliott holding out. Instead, Elliott filed suit in New York against one bank and Peru demanding full payment on the bank loans and guaranty. In June 2000, Elliott obtained a judgment against Peru for $55.7 million.3 The problem for Elliott, however, was the standard problem that arises ~vhen a creditor sues a sovereign. Often, especially if the state is the debtor, there is little in the way of assets that can be attached.4 Elliott's lawyers, however, came up with a creative solution. They intercepted and attached the payments that were about to be made to the other creditors, i.e., the ones who had agreed to the Brady Plan debt restructuring. * Mr. Gulati is an Acting Professor of Law at UCLA School of Law. Mr. Klee is air. Acti~~g Professor of Law at UCLA School of Law and Partner at Klee, Tuchi~z, Bogdanoff &Stern LLP. The views in this Article do not necessarily represent those of Professor Klee's law firm or any client. I. Elliott Assocs., L.P. v Banco de Ia Nacion, 194 Fad 363, 36G (2d Cir. 1999}. 2. See id. at 366-67; see also Joshua Chaffin, I~aaestor "Ijultures" G`ome Unde~~ Sc~~uEi~ay, Flzv. Ttrvt~s, Oct. 25, 2000, at 19. 3. See Elliott Assocs., L.P. v Banco de la Nacion, 2000 U.S. Dist. Lexis 14169, ae *2 (S.DN.Y. Sept. 29, 2000). For descriptions of these recent events involving Elliott and Peru, see ERIC LINDENBAUIvt & ALTCTA DURAN, MERRILL LYNCH & CO., DLB'I' RESTRUC- TUI2TNGS: L~sGAL CONSIDERATIONS (Oct. 30, 2000. See also GABRIELLE LIPWORTT-T & ENS NYS'I'LDT, INTERNATIONAL MONETAKY FUND, CRISIS RESOI..UTION AND PRIVA?'E SECTOR AIaAP'TA7"zON (paper presented at the First Annual IMF Research Conference, Nov. 9-10, 2000). 4. 'The reason for this is that generally oF~ly property used for the commercial activity in question inside the jurisdiction where the suit is brought may be aCtached. See, egg, 28 U.S.C. § 1610 (1994 & Supp. N 199£3). Given that most of tl~e sove~~eign's'assets relating to the borrowing are likely located within the sovereign's own boundariES, this leaves few assets for the creditors to reach. See MOODY'S INVESTOR SERV., SP~'CIAL COMMENT, HOW TO SUF A SOV[:REIGN: THE CASE OF PERU ~NOV. 2000; see aCso MQODY'S IIV'~CS'TOI2 S~RV.,SPECIAL COMMENT, SOVEREIGN DEBT: WHAT HAPPENS TF A SO~IEREIGN DEFAULTS {~uly 2000. 635 636 The Business Lawyer; X101. 56, February 2001 Elliott did two things to put this strategy into effect. rirst, it obtained a restraining order against The Chase Manhattan Bank in New York (Chase), the New York fiscal agent for the Brady bonds, after successfully arguing that the funds were still the property of Peru (Chase being the agent far the debtor),5 This tactic was thwarted temporarily because Peru got word of the order just in time to stop the transfer of funds to Chase. Elliott next sought ex pane, but did not get, an order from a Brussels Com- mercial court restraining Euroclear from either accepting money from Peru or paying it to the other ereclitors. Elliott quielcly appealed ex~iarte to the Court of Appeals of Brussels, which issued the restraining order the next day.6 By this time, Peru was getting close to defaulting on its Brady payments---the thirty-day grace period was close to ending—and it chose to settle by paying Elliott X56.3 million. Central to Elliott's victory in Brussels was its success in arguing that Peru was contractually barred from paying one group of creditors (here, the creditors who had agreed to the restructuring) before paying it the holdout). The basis for the argument was a device called the pari passu clause$—a standard clause found in almost all sovereign bond indentures.9 The clause typically states (as it did in this case) that the debtor represents and warrants that "[t]he obligations of the Guarantor here- under do rank and will rank at least pari passu in priority of payment ~cvith all other External Indebtedness of the Guarantor, and interest thereon."la Professor Andreas Lowenfeld of New York University explained Elliott's argument in a declaration to the court.l l Elliott argued that the meaning of the payi ~iassu clause was clear.12 What the clause says, according to Lowenfeld's opinion, is that if the debtor does not have enough money to pay its creditors in full,13 they all have to be paid their pro rata 5. S'ee Elliott Assocs., L.P., General Docket No. 2000/QR/92 (Court ofAppeals of Brus- sels, 8th Chamber, Sepe. 26, 2000) (unofficial translation on file with The Business Lawyer, University oFMaryland School of Law) [hereinafter Brussels Opinion]. 6. Id. 7. The settlement includes postjudgment inCerest. See Lr1vD~N13nuM & DurtAN,supra note 3, at 2. 8. "[T]he term `part ~iassu' is adopted from the Latin £or `with equal step,' or `side by side."' Carl S. Bjerre, Secu~•ed TransacCions Insede Out: Negatiae Pledge Covenants, Pro~ierty and Pe~c- tion, 84 CoRivlsLt, L. REV. 305, 309 n.6 (1999). 9. See Brussels Opinion, supra note 5. 10. See Declaration of Professor Andreas Lorvenfeld at 8, Elliott Assocs., L.P. v Banco de la Nacion, 2000 U.S. Dist. I~EXIS 19.169 (S,D.N.Y. Sept. 29, 2000}; Elliott Assocs,, L.P, v. Republic of Peru, 2000 U.S. Dist. LEXIS 3G8 (S.D.N.Y, Jan. lfi, 2000)(executed Aug. 31, 2000)(on file with The Business Lawyer, University of Maryland School of Law). 11. Id. 12. As noted in footnote 10, we have a copy of Professor Lowenfeld's opinion that was submitted in the New York cases. We are advised that the same memorandum was suhmitCed in the Brussels case. 13. Professor Lowenfeld limits his opinion to the context whexe there is "not enough money to go around," or the debtor is insolvent in the equity sense of inability to pay debts Sovereig~~ Piracy 6~7 shares.~~ The debtor is not allowed to pay one creditor in full and leave the others unpaid. In vivid, Tom-Dicl~-Harry terms, Lowenfeld explains: A borrower from. Tam, Dack, and Harry can't say "I will pay Tom and Dick in full, and if there is anything left over I'll pay Harry." If there is not enough money to go around, the borrower faced with a sari passu provision must pay all three of therx~ on the same basis: Suppose, for example, the total debt is $50,000 and the borrower has only $30,000 available.