#11034 - Miscellaneous - Contracts

In 2007, a country, ruled by dictator not representative, borrowed $700 million 30 yrs, 12% interest rate, from 18 of the biggest international banks. Revolution in 2012, dictator overthrown, do the new government need to paid back? At the time contract signed, there were rumors about revolutions. – similar to Iraq debt. Countries can’t go bankrupt (they can’t sell out all their parts.)

1. Precedent: Williams

2. Absence of reasonable choice: People in Iraq don’t know what they’re buying. People don’t have the choice of not entering into the contract.

3. Reasonbleness of the terms: creditors know that there might be a revolution, so they ask for higher rates, this can be reasonable.

4. Lenders are in a better position to avoid this problem; they priced it into their rates.

Sovereign Debt Article by Gulati

1. Key ideas:

   1. Finances countries, keeps the world economy going

   2. Unforgiving of mistakes, no real formal bankruptcy processes, need to instead get the creditors on board

   3. Affects everyone

2. Why repay?

   1. Establish reputation as trustworthy debtor

   2. National honor

   3. Prevent diplomatic fiction

3. Difficult to enforce?

   1. States are sovereign, their assets are not usually able to be seized, can’t really force into bankruptcy and liquidate assets

4. Key debates

   1. Vulture creditors

   2. Odious debts (from despotic government unrelated to the welfare of the state)

   3. Financing of distasteful regimes – do loans basically allow dictators to get legitimacy and stay in office? (think financing during apartheid)

5. Unique Features of Sovereign Debt

   1. Intergenerational tensions – those who borrow aren’t always those who pay it back

   2. Government officials as agents – are the governments truly agents of their people? Can you be an agent of future generations?

   3. Mixed motivations of certain lenders

      1. Some motivations: geopolitical influence, stimulating exports, locking in access to natural resources, without really expecting to be paid back on time

   4. No formal bankruptcy mechanism

      1. Creditors don’t have to worry about the debtor running to the protection of bankruptcy laws

      2. No way to force dissident creditors to go along with a settlement

      3. Completely exposed to creditor lawsuits, because cannot protect themselves

   5. Sovereign debtor as defendant

Gulati’s article: exit consents in sovereign bond exchanges

1. Exit consent: seek the consent of this supermajority of bondholders to amend provisions in the bonds in order to render those old bonds less attractive to any bondholder who may be thinking of declining the exchange and staying behind.

2. Payment terms: currency, interests, dates, methods of payment - high vote to change

3. Non payment terms: pari passu, negative pledge, waiver of sovereign immunity - low vote

4. Administrative terms: no vote

5. How to force people to agree to the modification? The alternative must be worse

   1. If I can only get 51% and modify nonpayment terms, I give 51% a new bonds that pay less, but with a lot of protections, when 51% give me the old bond, 51% vote on the old bond, remove the contract protections (nonpayment terms such as the pari passu clause) a disincentive for the old bond holders to holdout.

   2. Katz: if you don’t tender, you get 100%: duty between the investors and issuers.

   3. Assenagon: if you don’t tender, you get nothing: duties among the bond holders.

6. Criticism:

   1. coercion (prisoner’s dilemma): exit consent encouragers the prospective holdout creditor to accept an offer that the holdout may not, except for the prospect of being left with a bond stripped of important prospective covenants, have otherwise found attractive.

   2. Counterargument:

      1. exit consents in the benign way (to keep holdouts from disrupting an offer that is in the best interest of the issuer and the bondholders) is more common than a pernicious way (attempting to cheat unwary or disorganized bondholders)

      2. Bondholders are capable of communicating with each other to avoid the prisoner’s dilemma type situation.

7. Legality of exit consents:

   1. Boiler-plate doctrine: when interpreting boiler-plate terms, greater weight will be given by NY courts to relevant decisions in other jurisdictions, particularly when market participants can be presumed to have been aware of those other decisions. Because market participants have a strong interest in seeing a uniform, predictable interpretation of standard boiler-plate provisions in commercial contracts.

   2. Sovereign context: bond held by large institutions, prisoner’s dilemma unlikely to happen. No need for court intervention because both parties are sophisticated enough to negotiate.

8. Position of existing bond holders:

   1. Tortious interference:

      1. whether they breach the terms of contract (unlikely, because contracts allow amendments to nonpayment terms)

      2. If the alleged tortfeasor is a party to the contract (bondholder), only available remedy Is action to breach of contract

   2. Implied duties

      1. Good faith and fair dealing: no “corrupt and unwarranted exercise of the power of the majority,” and “openly collusive behavior”

   3. Reputation:

      1. institutions are unlikely to risk their business reputation by participating in an arrangement that could be characterized as a gratuitous swipe at fellow lenders.

      2. Unless the practice is collusive and cannot be justified by reference to the legitimate commercial interests of those accepting the exchange offer, using exit consents in corporate bond exchanges does not usually result in reputational damage.

9. Possible changes to bonds

   1. Waiver of jurisdictional immunity for lawsuits could be removed

   2. Submission to the jurisdiction of a foreign court could be revised

   3. Financial covenants binding the issuer can...