Government bonds were long considered a safe investment that offered the potential for high returns. However, after Argentina announced in 2002 that it would no longer service its bond debt and after Greece restructured its sovereign debt in March and December 2012, the question arises as to what investors can do to avoid the significant losses of capital (up to 70% in case of Argentina and over 80% in case of Greece) which almost always accompany sovereign debt restructurings.
This article considers whether investors can avoid losses in a sovereign debt crisis by taking recourse to the courts.
Like corporate bonds, government bonds are agreements under private law which are subject to the selected national legal system. Traditional government bonds provide the bondholder a claim for interest to be paid in regular instalments and a claim for repayment of the face value of the bond at the end of the term. If the state issuing the bond no longer meets its obligations under the bond, e.g. by suspending interest payments, this generally constitutes a breach of contract. The creditors can then cancel the bond, demand payment of all outstanding and unpaid interest and capital and bring proceedings for payment before the court specified in the bond, or before an international court of arbitration.
In a typical bond restructuring scenario insolvent states usually ask selected creditors, typically banks or hedge funds, to form the so-called Bank Advisory Committee or London Club and negotiate the terms of the restructuring with the debtor. The results of these negotiations are then presented to all relevant creditors who are asked to restructure their claims on the proposed terms. From a technical point of view, the restructuring proposal generally provides that the creditors should swap their bonds for new bonds with inferior conditions by a certain date. Where interest is still being paid on the bonds at the time of the restructuring proposal, the state implicitly or explicitly announces that after the expiry of the deadline for tendering the existing bonds for exchange, it will cease to make payments on the bonds not tendered.
In the past, states have often inserted socalled Collective Action Clauses (CACs) in the terms and conditions of their bonds in order to prevent creditors who refuse to participate in the restructuring from bringing proceedings for default of payment. CACs provide that a certain majority of creditors of a particular bond series may agree on the restructuring with binding effect for all other creditors of that bond series. Thus, if CACs have been properly agreed in a bond and if the required majority of creditors agrees to the restructuring, a payment default in relation to the bonds which have not been tendered for restructuring does not constitute a breach of the terms and conditions of the bonds. In such a case, any legal action brought by creditors who chose not to participate in the restructuring will be unsuccessful.
Most of the Greek bonds restructured in 2012 did however not contain CACs. As a result, the Greek government took a special course of action. It chose to pay off bond creditors whose securities were subject to English law (only around 10% of Greek bonds), then used legislation to add CACs retrospectively to the bonds subject to Greek law, and finally held votes on a restructuring plan for the Greek-law bonds.
The reason for this different treatment was that creditors with bonds subject to Greek law would only have been able to bring proceedings for default of payment before the Greek courts, which would have acknowledged the law to introduce CACs and refused the claim. An overwhelming majority of creditors holding bonds subject to Greek law therefore decided to agree to the restructuring. However, creditors whose bonds were subject to English law would have been able to bring proceedings in England, where the courts would probably not have applied the Greek law introducing the CACs. If these creditors had taken legal action, Greece would have been left exposed to several years of court proceedings, most likely resulting in a positive outcome for the creditors.
A prime example for the use of the courts by creditors who have decided against participating in a restructuring of their sovereign bonds is the case of Argentina. After the Argentinian state defaulted in 2002, many of Argentina’s creditors with bonds subject to German law or other foreign laws brought proceedings for their claims before the German and other foreign courts. However, enforcing the judgements proved to be very difficult because Argentina barely had any assets outside of Argentinan territory that could be seized. The creditors were not short of creative ideas, though. All options were considered: from an Argentinian dinosaur exhibition in Germany to a ship belonging to the Argentinian navy in the Congo and even money for travel expenses carried by the Argentinian president Cristina Fernández de Kirchner in her handbag on a state visit, none of which was however successful.
In the US however, creditors seem to have had better luck with enforcing their judgments. In early 2013, a New York appeal court confirmed an injunction order banning inter alia banks in New York from forwarding or accepting Argentinian payments on the restructured bonds until the judgment holders who had successfully obtained judgments in the USA had received pro-rata payments on their non-restructured bonds. In other words, if Argentina does not pay the holders of its non-restructured government bonds it will no longer be able to use New York as a financial centre.
These examples show that creditors are not defenceless when asked to participate in a sovereign debt restructuring. However, it is also clear that there are significant obstacles involved in bringing legal action against a sovereign state and enforcing a judgment. It should also be borne in mind that pursuing their interests in the courts may cause considerable reputational damage to institutional investors. As far as the general public are concerned, sovereign debt restructurings serve the public interest and should take priority over private interests. Losses sustained by private creditors due to a sovereign debt restructuring are often shrugged off as “speculative losses” which are acceptable in view of the high interest rates payable on government bonds.
Comprehensive advice is therefore essential for creditors who are presented a restructuring proposal by an insolvent state. Depending on the terms and conditions of the bonds held by the creditor, a lawyer will need to consider the following aspects:
- which law is applicable to the bonds;
- whether a payment default by the issuing state breaches the terms and conditions of the bonds;
- whether the bonds contains effective CACs and whether the applicable majority of creditors has validly agreed to the restructuring as prescribed by the CAC and the applicable law;
- which court would have jurisdiction for any potential legal action;
- the legal risks of a suit and the costs involved;
- whether it is possible to enforce a potential judgment and what means are available for this.
Backed by their lawyer’s assessment and advice, creditors will be in a position to decide what action to take when asked to vote upon a debt restructuring proposal and whether taking recourse to the courts might be a financially viable option.