In ten years, defaults that end up in courts have almost tripled

El Cronista

In ten years, defaults that end up in courts have almost tripled

Before 2000, only 13% of the defaults set off legal actions.  After that date, 36%.  In the last 10 years, 90% of the complaints have been filed by vultures.

 

Wednesday, January 09, 2013

 

By Laura García

 

They are the ones who say no.  The ones that decide to go for broke.  Those that plant themselves.  The countries in bankruptcy have been dealing with the holdouts – the investors that don’t accept the terms of debt restructuring – for decades.  But in recent years the threat has grown: today there aren’t ‘genuine’ banks or bondholders anymore like in the Latin American debt crisis of the 80s without the vulture funds, opaque and speculative, that have turned litigation into a war of attrition and a “hunt for frigates”.

 

An academic study that collected information since the 1970s to date shows that in the last ten years, the percentage of defaults that end up in court has tripled.  While the number of restructurings has significantly fallen since the 80s, the proportion of countries affected by litigation has shot up.  Before the year 2000, only 13% of restructurings set off legal actions by creditors.  After that date, 36% ended up “trapped” in a holdout battle.

 

According to the paper, “Sovereign Defaults in Court. The Rise of Creditor Litigation,” led by Julian Schumacher, of the Hertie School of Governance, Free University Berlin, of a universe of 176 restructurings in the last four decades, in 29 there were lawsuits, which represents 16%.  This means that of 69 governments that defaulted, 27 went toe to toe with holdouts.

 

But just one default episode, of Argentina, concentrates more than half of the disputes of commercial creditors, with a total of 47 cases (without counting multiple lawsuits from a single creditor).  In the second place appears the Brady swap of Peru in 1997, with 12 complaints that arrived to U.S. courts, while Iraq (2006) and Nicaragua (1995) share third place with four lawsuits each.   Congo (2007), Ecuador (2000), Liberia (2009), Nigeria (1983) and Zambia (1994) had to face three lawsuits each.  Over a review of 29 restructurings that faced some level of litigiousness, 18 dealt with only a single lawsuit.

 

But the occurrence of lawsuits not only rose in recent years.  There also appeared new “actors” that changed the rules of the game.  In the last decade, in fact, almost 90% of the holdout lawsuits were filed by the vulture funds.  Addicted to the easy prey like good scavengers, they tend to prefer the most vulnerable countries.  Of the 20 legal cases filed against poor and Highly Indebted Poor Countries (HIPCs), 13 were promoted by this kind of investors, which are always based in tax havens and which even can act as seasonal vehicles, created specifically for a particular lawsuit.

 

The three eras

 

But in reality the vultures didn’t begin flying over the landscape of sovereign bankruptcies until the middle of the 1990s.  Until then, in what could be called the first era of restructurings, linked to the Latin American debt crisis, the majority of the lawsuits were filed by banks or investors that sought to get better conditions than those negotiated through the London Club.  The emblematic case of this first stage dates to 1982, when Allied Bank refused to participate in a restructuring orchestrated by Costa Rica.  Then it was seen for the first time that the holdout strategy could work and that the classic defense based on sovereign immunity (Foreign Sovereign Immunities Act de 1976) might not be sufficient to shield a country from legal stalking.  

 

The case of Weltover v. Argentina, in 1992, ended up bringing that protection down to the ground, when the Supreme Court upheld that the emission of debt in the international markets was a “commercial activity” and that a suspension of payments directly affected the interests of the United States.  Concretely, the decision granted the U.S. courts jurisdiction over bonds emitted under the law of that country.

 

In the second era, that of the vultures, the first big victory for this new legal fauna was the case of CIBC against the Brazil Central Bank.  The fund Dart, which had refused to participate in the 1992 swap, went to court and showed how lucrative it could be to attach against countries in default.  From a strictly legal point of view, it was a turning point in eroding the defense argument of prohibiting the purchase of debt with the sole intention of filing a lawsuit, which was definitively eliminated in 2004 thanks to the vulture lobby.

 

The last era is the hunt for assets, a career of getting one’s hands on what one can to collect.  This is how the vulture funds are litigating against Argentina today as they have already tried to attach from the presidential plane to the assets of the central bank to the pension funds of the AFJP and the dinosaur fossils in an exhibition in Europe.  But the majority of attempts of this nature were rejected in the last instance in view of the laws of sovereign immunity (which protect not against a lawsuit but do against an attachment).  The last rulings from the U.S. established that only assets that are in the country and are used for commercial ends can be affected.

 

An isolated case, that of Elliott v. Peru in 2000, with a peculiar interpretation of the pari passu clause – which obliges giving equal treatment to the creditors – has set off a series of similar attempts without success (for example, against the Republic of Congo), launching the vultures again into a search for attachable assets as the best strategy.

 

But the legal battle that has enveloped Argenitna and the ruling that impedes paying the rest of the bondholders without paying the debt with the vulture funds, could again change the brief history of restrcuturings.  And inaugurate the new – much darker – era of the holdout threat.