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Gregory Makoff is the author of ‘Default: The Landmark Court Battle over Argentina’s $100 Billion Debt Restructuring’. Brad Setser is a senior fellow at the Council on Foreign Relations. Antonio Weiss is former counsellor to the Secretary of the US Treasury.
Since Covid pummelled the worlds’ economies in 2020, the substantial sovereign debts of low-income countries have been a headline concern.
The need for any debt relief has often been contested, actual debt relief has been granted too slowly, and the required amount of relief has been disputed. Frustration with the Paris Club’s successor, the Common Framework, has triggered a search for alternatives.
While international policymakers and experts have proposed reforms of the Common Framework to speed up negotiations, civil society organisations identified the possibility of using legislation in the State of New York to improve outcomes. It’s in this context that, this week, the New York Senate is poised to pass a bill designed to support the orderly restructuring of sovereign debt.
Instead of trying to change the international negotiation process — as some proposed legislation would have — the new law narrowly seeks to reduce the risk of holdout litigation in the state. New York has long been the favoured jurisdiction for holdout creditors bringing legal actions against foreign sovereigns. Such creditors are typically distressed debt hedge funds who buy debt at a steep discount only to seek repayment, in full, in a court of law. These investors typically have deep pockets to fund litigation and no real intention of negotiating an orderly restructuring.
Today, there are actions outstanding against Sri Lanka and Argentina. In the last 25 years, cases have been brought against countries including Peru, Poland, Panama, Ecuador, Ivory Coast, and Paraguay. The most famous case of all was the epic litigation against Argentina, which ran from 2001 through 2016. The new law would discourage unwarranted litigation that would disrupt a negotiated restructuring.
Sovereign borrowers face a unique challenge when they can’t pay their debts: unlike businesses, they are unable to file for protection from creditors and reorganise their debts under the bankruptcy code.
The consequence is that when a foreign sovereign defaults on a bond or loan, the restructuring of the debt takes place under the constant threat of litigation, because investors holding bonds documented under the laws of the State of New York (or any other State) have the unambiguous right to sue and seek to collect in full.
Some investors have used their right to litigate to pursue countries in court for years in an effort to win full repayment of outstanding principal (and substantial amounts of past due interest) — even after most creditors have accepted a significant loss pursuant to a consensual debt restructuring to help the country recover. Deterring such uncooperative behaviour is the target of the new law.
The bill has two working parts.
First, it restores to New York law the “champerty” defence to sovereign borrowers with respect to claims over $500,000. New York State champerty doctrine proscribes the purchase of claims “with the intent and purpose to sue.” This doctrine has long been in New York law; however, an appeals court ruling in 1999 and a 2004 bill to provide a safe harbour for large claims removed the defence.
The new bill would eliminate the $500,000 safe harbour, but only for lawsuits brought by litigious, uncooperative actors that do not make good faith efforts to help find a co-operative solution. Yet the bill protects the health of the sovereign debt ecosystem by specifying that the change in law is not intended to apply to regular buyers of new sovereign debt issuances or to co-operative distressed debt hedge funds — such as those that regularly serve on creditor committees, or that generally accept deals supported by other creditors following a negotiation.
Second, it changes the statutory interest rate applied to New York judgments to a market rate from the current rate of 9 per cent, which was set in law when market rates were much higher. The new rate would be set at the federal statutory rate, which is equal to the prevailing yield of the one-year Treasury bill, currently around 5 per cent.
This would lower the rate at which sovereign bond claims compound on unpaid interest after default. This was a material consideration in the Argentina litigation, because the longer it took to settle, the more certain hedge funds profited.
The reason is that, before money judgments are granted, bond claims grow by the amount of missed bond coupon payments plus 9 per cent interest on such missed payments. Such growth in claims, theoretically, makes it more profitable for the hedge funds to delay settlement and continue to litigate. Resetting New York’s judgement interest rate to the federal statutory rate will lower the financial incentive to drag out litigation.
While these provisions disincentivize uncooperative behaviour in sovereign debt restructuring, sceptics may ask: why enact this law when litigation has been less of a problem since the market adopted powerful Collective Action Clauses in the wake of Argentina’s messy re-default under court order in 2014?
The answer is that this contract reform does nothing to prevent litigation while deals are being negotiated — and not all debt instruments have adequate collective action clauses.
So, as long as sovereigns can’t file for bankruptcy, limits on aggressive sovereign debt litigation are warranted to protect the majority of investors from the tyranny of the legally savvy minority who seek a better deal at their expense.
We encourage the Assembly to pass the bill and the Governor to sign it. The bill is narrow, targeted, and warranted. It will be good for business in the State of New York and will reduce wasteful litigation in our courts.