Tabla para la Toma de Requerimientos

Associate Professor, University of Vienna

After the IMF’s proposal of a Sovereign Debt Restructuring Mechanism (SDRM) was voted down, the discussion moved away from orderly restructuring of sovereign debt towards analysing the moral and legal foundations of claims, and categorising types of debts, as well as discussing litigation by private creditors. This evolution only occurred because no sovereign insolvency procedure exists. Concepts such as odious debts were revived, new ones, such as criminal or illegitimate debts, or abusive credits have been explored. This evolution should not come as a surprise. Advocating the emulation of US municipal insolvency, I mentioned early on that fair insolvency mechanisms are likely to avoid such discussions: “The fact that fault is not discussed (unless criminal acts have been committed), but the procedure instead sticks to restoring economic viability, may also be ap- pealing.” (Raffer 1990, p.310) Appa-rently, it was not appealing enough to creditors. Now they are confronted with close scrutiny of why and how credits were granted. Multilateral claims of being preferred creditors were investigated and found to be without base (cf. Raffer 2004, 2005a, 2007a, 2007b).

Left without a mechanism to solve their problem, over-indebted countries had to seek practical solutions. One example is Argentina’s unilateral debt reduction, which may be seen as a return to the pre-WWII scenario where coun- tries often simply discontinued paying, finally either reaching an agreement with their creditors or their acquiescence to losses. Argentina did not turn to the Bretton Woods Institutions (BWIs) that had been unable over decades to provide appropriate solutions. In the case of Iraq strong US interest forced other creditors to grant exceptional reductions. The US even revived its odious debts doctrine, before it realised how welcome that was to debt campaigners.

Politically, Argentina, Nigeria, and Ecuador document a new assertiveness of debtors forced to find a viable solution. Less than two years after her default, Argentina presented a first of- fer to her bondholders, which was modified

somewhat in 2004. In 2005 the government an- nounced that the acceptance of its offer had reached 76.15% of the debt in default. The hair- cut was roughly 70% (Helleiner 2005, p.959). Taking the amounts exchanged into account (without holdouts) sceptics calculate a much smaller overall reduction, predicting that this haircut – once again suffered by only one class of creditors – will in the end be insufficient. $62.3 billion of old bonds were exchanged for about $35.3 billion dollars of new instruments plus the corresponding GDP growth-linked cou- pons. A substantial percentage of bondholders did not accept, organising themselves into bond- holders' associations, without recovering, how- ever, anything so far. The neoliberal privatisa- tion drive now protects Argentina. There is prac- tically nothing left to attach.

Argentina’s successful recovery and her growth rates after debt reduction, also illustrate how much better fair insolvency procedures would have been for creditors. It would have been possible to combine generous relief helping Argentina to recover quickly with contingency clauses allowing creditors to participate more fully in the recovery they would have made pos- sible, thus recovering more in the end. This solu- tion would have been better for both Argentina and her creditors. One can only second the UN Secretary General (2007, pp.26f):

“The debt restructuring exercise in Ar- gentina in 2002 demonstrated again the need for a fair, transparent and orderly process for sovereign debt restructuring. … The international financial system is incomplete and insecure without a sover- eign debt workout mechanism and a new effort needs to be launched in this re- gard.”

A resolution by Nigeria’s House of Repre- sentatives calling on the President to repudiate Nigeria’s external debt on the grounds that they were odious and illegitimate seems to be the rea- son for Nigeria’s treatment by bilateral creditors.

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Legislators also sent a team to Europe to canvass debt cancellation in the continent's leading fi- nancial centres. The mover of the resolution to repudiate debt was present in Paris when Nigeria negotiated. The decision by creditors may well have had the intention to quell any public dis- cussion initiated by a debtor nation and backed by parliament, even though the Nigerian Senate later voted in favour of ho-nouring debt servic- ing for that year. Nigeria had chosen not to have a programme with the IMF, following her own economic reforms called NEEDS (National Economic Empowerment and Development Strategy) instead. This was serious, once again challenging the IMF's rule over debtors. It led to the invention of a totally new IMF-instrument, called the Policy Support Instrument (PSI) al- lowing Nigeria ample policy space. Considering that even Iraq had to sign an IMF programme, this is path-breaking.

Finally, Ecuador decided to have all claims vetted by a debt audit commission to investigate the country’s debt burden with foreign creditors on a loan-by-loan basis. The commission was asked to look into legal questions, financial terms and conditions, and any social and/or en- vironmental impacts which may have resulted from the loan, and to report its recommendations to the government. The point now is not whether Ecuador can pay but whether Ecuador should pay. Checking loans as such is not new. Over two decades ago, Costa Rica saved almost 10% of the interest in arrears by verifying past-due interest claimed by banks loan-by-loan. But then, it was checked whether calculations were correct, now the legal title is checked. This is a quantum leap, whatever the results may be.

All these evolutions would not have taken place if a viable and fair solution had been im- plemented early on. In a way, they are substi- tutes to a fair sovereign insolvency procedure. Economic facts assert themselves. What cannot be paid must go unpaid. The only question is how losses are distributed. In this respect, dis- cussing the legal base of claims is helpful, be- cause it protects bona fide creditors.

This paper will discuss the following issues on which present discussion focuses

• creditor litigation • illegitimate debts

• intra-creditor distribution of losses in the cases of insolvency and contested claims

• derivates, such as credit default swaps that attempt to attenuate risk

Creditor litigation

Official creditors have steadfastly opposed fair procedures granting all legally interested parties their full rights, especially the right to defend their interests. The Paris Club expects private and non-Paris-Club creditors to imple- ment the Club's decisions - to grant “comparable treatment” - although they had no say and were not even heard. Unsurprisingly, this has pro- duced a wave of litigation. Cases of bilateral creditors selling their claims to commercial creditors are extraordinary examples of double standards. Created by official creditors not pro- viding a proper legal mechanism, the litigation problem has increasingly caught public atten- tion: “Commercial creditors’ lawsuits against HIPCs present a growing challenge to the im- plementation of the HIPC Initiative.” (IDA & IMF 2007, p.6) Concern has also been expressed by the UK, the G8, and the Paris Club, without, however, any real action taken.

Eventually, the Paris Club (2007a) sug- gested contractual changes restricting the right to sell claims, as well as “small amendments to national legislation” banning lawsuits. This is good, could be implemented easily, but may not even be necessary. “With nary a peep from the markets” Iraq’s prime assets were put outside creditors’ reach, “the most controversial early aspiration of the IMF’s Sovereign Debt Restruc- turing Mechanism (SDRM), shelved just weeks before” (Gelpern 2005, p.396) was imple- mented. Its most hotly debated element, a stay on lawsuits, was simply implemented at the stroke of a pen, without discussion or resistance. The New York third district court refused to grant attachments against Argentina, arguing that this would disrupt negotiations with other creditors after the US government had presented an amicus curiae brief supporting Argentina's request for a stay to all enforcement. In Allied Bank International v. Banco Credito Agricola de Cartago, Costa Rica had been granted insol- vency protection, which was withdrawn after the US executive branch clarified as amicus curiae that supporting Costa Rica was not U.S. policy. Apparently, stopping lawsuits is as easy as speaking out ”in disgust at the recent actions of

so-called ‘vulture funds’” (Paris Club 2007a). Paris Club members have just chosen not to do it.

The wording of this declaration also invites questions: “Paris Club creditors confirm that they are committed to avoid selling their claims on HIPC countries to other creditors who do not intend to provide debt relief under the HIPC ini- tiative, and urge other creditors to follow suit.” (ibid.) Literally that means that selling to such “other creditors” is not definitely excluded.

It need be recalled that not only so-called “vultures” have litigated. Original creditors have also sued for fulfillment (cf. IDA & IMF 2007, p.105). They were unjustly and unjustifiedly denied their basic right of participating in a pro- cedure affecting their claims, in other words they simply were expropriated by decisions of public servants meeting in secrecy in Paris. Even if they had in principle been prepared to grant the same reduction – both in absolute and rela- tive terms the private sector has granted more relief so far than several important official credi- tors – it seems understandable that the disrespect of official creditors for the Rule of Law may well have made some original creditors deter- mined to insist on stipulated amounts. After all,

pacta sunt servanda, but may be changed by

negotiated settlements or laws. Laws may termi- nate, modify, or permit a party to terminate or modify contracts, explicitly allowing unilateral changes of contractual rights (cf. Raffer 2007b). Although honouring contracts is a fundamental legal, economic, and ethical principle, all legal systems recognise circumstances where contrac- tual rights can no longer be enforced, or indeed cease to exist. But this is stipulated by laws, not enforced by dubious administrative fiat.

Furthermore, the weakest actor, the debtor, is told to gain comparable treatment from ex- cluded creditors, whose rights have just been violated. Should a recalcitrant creditor take debtors to court in a Paris Club member country, debtors will not be protected by this creditor country but lose the case. Putting an end to such absurdities and injustice is in the best interest of all bona fide creditors and the debtor. Unfortu- nately, official creditors are so busily preaching the Rule of Law to others that they have no time left to apply it themselves.

Ten of the 44 cases of litigation listed by IDA & IMF (2007, p. 32; p.105) were filed in

courts in the HIPCs themselves. Barring miscar- riage of justice, creditors are bound to win, al- though not necessarily the whole amount sued for. Put in a nutshell: “Given the voluntary na- ture of the HIPC Initiative, creditors do not have a legally binding obligation to participate in the Initiative.” (ibid., p.32) Claims continue to exist unchanged unless all creditors agree “voluntar- ily” to what others have decided.

Of these 44 cases eight, nearly one fifth, were “in arbitration” (including one case at ICSID that was dropped). This underlines that even litigating creditors – the pariah group at the moment – are prepared to accept fair arbitration, unlike official creditors torpedoing the very foundation of any legal system that no one must be allowed to be judge in their own case. They have done anything they could to avoid giving up their present dominating role in debt man- agement by agreeing to arbitration on sovereign debts.

The second and more prominent group of litigating creditors (so-called “vultures”) buy claims at discounts to sue for their full values. As moral issues have received ample attention, this paper wants to recall boring facts, whose clarification is nevertheless helpful:

• the purely legal characteristic of such claims, and

• the fundamental difference between pri- vate creditors subject to laws and offi- cial creditors making the laws and obliged to defend decent legal and ap- propriate economic principles.

Purely legally, vultures exercise their rights in a way no different from what happens every day in practically any country. More risk-averse creditors sell their claims at a discount, and new owners try to get full repayment. Once insol- vency proceedings start, which recognizes that full payment to all bona fide creditors is or may be impossible, an automatic stay of individual lawsuits occurs. Municipal laws provide this appropriate mechanism safeguarding fairness to anyone affected. Whenever the right of creditors to payments (pacta sunt servanda) collides with the principle recognised generally (not only in the case of debts) by all civilised legal systems that fulfilment must not be enforced at the cost of inhuman distress, of violating human rights and human dignity. Human rights enjoy uncon- ditional priority. In contrast to present attempts

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of making litigators not use their right, this is a proper and fair solution. Any creditor is party, and can influence the outcome. No one is forced to accept what has been decided without their participation. With good reason, municipal laws do not rely on codes of good conduct or moral suasion, hoping that no creditor would try to enforce claims that legally continue to exist and remain enforceable, because of moral considera- tions. If ethics, morals or expressing “disgust” sufficed, laws would not be needed.

Unfortunately, regarding Southern sover- eigns precisely this is propagated as the solution, apparently to avoid a neutral decision maker. The Chancellor of the Exchequer’s (Treasury 2007) answer to Parliament puts present official attitudes in a nutshell. Deploring vulture activi- ties, he called himself “determined to limit the damage done by such funds”. However, a “vol- untary code of conduct”, a “Charter on Respon- sible Lending that includes a commitment to protect developing countries from vulture fund activity” produced by the G8, or to “continue to strengthen debt management capacity amongst HIPCs” will not solve the problem. Those called “responsible creditors” by the Chancellor (pre- sumably those not litigating) have accepted the decisions of the Paris Club, and are likely to continue to do so. For them, such code is basi- cally unnecessary, unless they change their atti- tude. Those choosing litigation – be they origi- nal creditors or “vultures” – are not bound and will presumably not change their behaviour. Why should a method obviously inadequate in all municipal laws work internationally?

More money for IDA’s Debt Reduction Fa- cility, to “help countries to eliminate their com- mercial debts at the earliest possible opportu- nity” may indeed “reduce the likelihood of debts being sold on to aggressive creditors”, but may well raise expectations, thus inducing creditors to demand higher percentages or full repayment. For HIPCs, official creditors participating in the initiative could no doubt cover these claims even if buy-back prices went up. Legal assistance to HIPCs is definitely helpful, but does not elimi- nate the problem. Legally, these claims remain valid and enforceable – with or without legal assistance.

Not all countries rely on words, though. In June 2006, for example, a bill was tabled in the French Assemblée Nationale, aiming at making lawsuits by vultures more difficult in France. It

would give French judges discretional powers to take the efforts of other creditors to provide any debt relief and the debtor’s capacities into con- sideration. “The text is certainly not as strong as it could be and has not yet become law in France but such measures are welcome and are defi- nitely a step in the right direction.” (Paris Club 2007a).

The question remains unanswered why offi- cial creditors deny an appropriate and efficient mechanism that would abolish this problem, as well as the Rule of Law, to the South, clinging so fervently to being judge and jury in their own cause. It need be mentioned that this is exclu- sively done in the case of Southern sovereign debtors. Germany’s London Accord stipulated arbitration between Germany and its creditors. In fact, my proposal in 1987 to use arbitration rather than national courts was inspired by the German case (Raffer 1989). Again, what’s good for the goose is apparently not considered good for the gander by geese themselves.

No government would even dream of behav- ing in this way when it comes to firms or indi- viduals delinquent in debt service due to them. Most naturally, courts would have the power to decide and to protect debtors. Creditor govern- ments would simply sue and accept court ver- dicts. Internationally, there is one law for the rich and another one for the poor. There is no logical nor economic justification for this dis- crimination of debtors. Sadly, it is still highly preferable to live “on right (and mostly white) side of the North-South divide.” (Raffer 1990, p.303)

Odious, illegitimate, illegal or legal debts and insolvency

Founded in 1996, the platform Jubilee 2000 UK demanded the cancellation of unpay- able debts. Determining these debts, or the ca- pacity of debtors to pay, was to be done by in- dependent arbitration. As the IBRD (2007, p.17) subsumes unpayable debts under “other catego- ries of odious debts” - completely at odds with logic, truth, and the English language – it must be clarified that “unpayable” states a mere fact without any judgement. It has nothing to do with legal questions, simply stating that penniless debtors cannot cough up a penny, irrespective of legal bases or titles of claims. Absolutely legiti- mate and legal claims may also be irrecoverable. “Unpayable” has nothing to do with “odious”.

The same goes for “unsustainable”, also sub- sumed under “odious” by the IBRD, although it equally describes an economic impossibility, not any judgement on the legal base of claims.

Jubilee 2000 UK described my insolvency proposal emulating Chapter 9 US municipal bankruptcy without using the word insolvency still considered too revolutionary by quite a few participating nongovernmental organizations (NGOs). Worldwide, many NGOs have cam- paigned for this fair and transparent arbitration process, also known by its acronym FTAP. The intransigence of official creditors blocking the emulation of insolvency induced people to look into the legal and moral bases of debts.

Doubtlessly, the revival of the concept of odious debts by the US administration to argue in favour of post-invasion Iraq encouraged NGOs not only to look into odiousness, but also to check whether other criteria applied, when scrutinising debts. Once the US realised what boost it given to debt campaigners, the admini- stration started to back-pedal vigorously. The damage was done, though. It could only be lim- ited by shunning the very word odious. Mean- while, NGOs have brought forward an array of arguments why certain types of debts should not be honoured – not always arguing as stringently as appropriate, though - as well as an equally impressive array of expressions and concepts. In