First Tuesday Update is our monthly take on current issues in commercial disputes, international arbitration, and judgment enforcement.
Sovereign bonds are back in the news as certain countries (e.g., Argentina and Venezuela) face financial instability. Moreover, as investors search for yield in reaction to unsettled times, sovereign bonds could be an attractive opportunity. Investors should consider the advantages and drawbacks of doing business with foreign sovereigns and what options aggrieved investors have if things go wrong.
A key feature distinguishing sovereigns from private parties is sovereign immunity. In the event of a default, it is typically much more difficult to execute against sovereign assets. This is because laws in nearly all countries provide most sovereigns and their assets (including companies they own) with substantial protections and immunities. Regardless, sovereigns have been able to borrow large amounts of funds from the capital markets by entering into agreements that waive sovereign immunity and provide remedies to private investors. Investors, however, must consider their rights carefully—especially when investing in countries where the political and financial risk is high.
It was not so long ago that opt-out creditors and Argentina were engaged in fierce litigation in the Southern District of New York. With a change in government, Argentina focused on restructuring its fiscal situation and reached a settlement with Elliott Management in 2016. Yet, there is renewed attention on Argentina. As reported by CNBC two weeks ago, "Argentina is on the cusp of registering another devastating default, analysts have told CNBC, as international investors anxiously await the outcome of 'do-or-die' debt restructuring talks." Venezuela also remains an issue of concern. PDVSA remains in default on its bonds and sanctions have precluded it from raising more funds in the capital markets.
In these situations, private parties generally fall into two categories: those that hold defaulted instruments and those looking for additional opportunities to invest (subject to, of course, any applicable sanctions, which may preclude US persons from such opportunities). Both scenarios require careful consideration of what rights you have or what rights you would want should you become involved with a sovereign.
One of the most important provisions to focus on when doing business with a sovereign is the waiver of sovereign immunity. Private parties should seek the most explicit and broadest waiver they can including waving immunity before and after judgment. When it comes to post-judgment issues, certain sovereign immunity laws, like the US Foreign Sovereign Immunity Act, provide that execution against a sovereign cannot occur until a court has "determined that a reasonable period of time has elapsed following the entry of judgment . . . ." 28 U.S.C. § 1610. There is no reason why waiver provisions should not dispense with the "reasonable notice" requirement as well.
A very close second after waiver is to reach an agreement on the forum where a dispute will be heard (outside of the sovereign's country) and how service of process will be accepted. Often private parties obtain these agreements for a particular jurisdiction. Investors should consider obtaining waivers or consent for any jurisdictions where there are available assets.
Often parties will obtain guarantees from entities that are ultimately owned by a foreign state but those entities are too far removed from that ownership to enjoy immunity. This guarantee can be a hollow comfort if the entity has no meaningful assets.
When it comes to sovereign bonds, particular attention should be paid not only to all of the concepts identified above but also the rights of individual bond holders versus the requirement for collective action. It can be that even if a sovereign defaults, the indenture trustee may not have authority to sue unless a sufficient number of bondholders affirmatively act.
All of these issues need to be examined carefully and each of these points apply both to foreign governments as well as state-owned companies.
The reality is, however, that the ability to obtain each of these provisions may not be realistic depending on the particular situation and an investor's negotiating power. Given these realities, investors should mitigate political risk by investing through entities located in countries with Bilateral Investment Treaties (BITs) with the sovereign at issue. Steptoe also advises clients on the structuring of their international investments so as to ensure that any disputes with the host country will be subject to international arbitration under a BIT or other applicable treaty. Investors may have the right to bring their claims against the host state before an international arbitration tribunal under the auspices of the World Bank's International Centre for Settlement of Investment Disputes (ICSID) if the investors’ home state and the host state of the investment are parties to (a) a bilateral investment treaty (BIT), (b) a free trade agreement with investment protection provisions (e.g., the Korea-United States Free Trade Agreement), or (c) a multilateral investment treaty (e.g., the North American Free Trade Agreement (NAFTA) or the Energy Charter Treaty (ECT)).
Once a judgment or arbitral award is issued, it takes very unique skills to enforce against a foreign sovereign. Steptoe's judgment enforcement and asset protection practice is among the best in the world, and we have been involved in sovereign bonds cases. We skillfully navigate various domestic and international laws to enforce judgments, including against foreign governments.
Sovereign debt crises are likely to continue. And there is no legally and politically recognized procedure for restructuring the debt of distressed sovereigns. This means that domestic courts and arbitral tribunals—in ad hoc proceedings with creditors racing for assets (i.e., first in time is first in right)—are likely to continue to handle these disputes for the foreseeable future. Investors should take all necessary precautions to seek out the best agreements they can on the front-end; carefully consider the rights of existing agreements if they are investing in existing opportunities; invest through BIT countries to mitigate political risk; and call upon Steptoe to assist with any and all of these complex issues.