Forum shopping: another sovereign debt dilemma

In the absence of an international insolvency regime for states, forum shopping is a real possibility for bondholders that oppose sovereign restructures. This process may allow them to demand full payment before an appropriate venue, which may compromise sovereign debt restructurings. Nevertheless, national remedies may also be valuable alternatives to an international regime.

Over the years there have been several attempts to establish an international set of rules regulating sovereign defaults, but none of these have flourished. The proposals succumbed to political and practical issues, though, rather than legal. The reasons given by those opposing the new regimes revolved around moral hazard concerns, meaning whether states would have the incentive to meet obligations under a codified restructuring mechanism for sovereign debt.

However, the existing regulatory oversight allows room for the phenomena of venue selection. Forum shopping in unsustainable sovereign debt positions is a creditor-driven process. It is grounded on the fundamental principle that a sovereign does not have insolvency capacity. In other words, the principle that a state cannot be declared insolvent. The benefits of this are apparent.

By the same token, though, the sovereign is prevented from restructuring its debt in a holistic and definite manner. The words of Lord Collins, dealing in the UK Supreme Court with the recognition and enforcement of a New York Court judgment on Argentinean bonds, illustrate the point perfectly.

In the pivotal case of NML Capital Limited v Republic of Argentina Trinity Term [2011] UKSC 31, Lord Collins stated that Argentina's sovereign debt moratorium in December 2001 and the subsequent restructuring of most of its debt, had no effect in the English proceedings. This was because:

• "there is no international insolvency regime for States;" and

• "the bonds are governed by New York law and are unaffected by any Argentine moratorium."

This means that the voluntary efforts to reschedule state financial obligations are sovereign workouts. These are not binding on third parties, but only on participating bondholders. They produce legal effects only within the territory of the state restructuring its debt, where the sovereign can exercise judicial control and impose such terms through legislative acts.

Recalcitrant bondholders are therefore permitted to engage in venue selection practices, taking advantage of this gap in the law. The way this is usually effected is to first file a request seeking to enforce the bonds, either on the basis of the contractually stipulated provisions on jurisdiction or on another jurisdictional basis (for example, location of assets). The result is to neutralise the effects of the sovereign debt restructurings.

The law applied for the determination of such claims also contradicts universally accepted principles of corporate insolvency law. It is these laws that have traditionally underpinned sovereign debt restructurings, and to which such sovereign restructurings systemically belong.

"Sovereigns have both the incentive and accumulated experience to formulate uniform rules in this field"

One of the main pillars of insolvency law is the crucial distinction between the lex concursus and lex contractus, meaning the law governing the (insolvency) proceedings and the applicable law of the agreement. In most advanced jurisdictions, applicable law and jurisdictional provisions stipulated in lending instruments are vastly indifferent for the modus operandi of insolvency proceedings. This is unless specific carve outs have been provided in the insolvency law of the state, where the insolvency is declared.

Take the example of insolvency law provisions in pending proceedings that provide for a simple majority threshold for the acceptance of a reorganisation plan. In this situation, any terms in any type of lending documentation, irrespective of the law that governs the lending facility, that require a higher or lower percentage of acceptance, would be entirely irrelevant and would have no impact on the proposed restructuring.

Applying this principle to a state reorganisation mechanism could form the theoretical basis on which a state may impose its national insolvency law on the acceptance rate of a sovereign bond restructuring offer. This would take precedence over the contractual terms on acceptance rates, as contained in the bonds themselves. Under certain qualifications, this principle could have formed an alternative to the collective action clauses (CACs) approach in the Greek PSI exercise, encompassing in its scope both Greek law and foreign law bonds.

Recognition and enforcement of favourable rulings is then sought by opposing creditors before friendly venues, usually those prone to a more restrictive reading of the state immunity doctrine. Legal asymmetry on immunity laws across Europe and the world further enable forum shopping.

The distinction turns on whether the issuance of bonds is a public act of a sovereign (acta jure imperii), which should afford the state immunity defence, or simply a commercial act (acta jure gestionis), which does not justify any special protection.

Both the English and the US courts, two jurisdictions of choice in sovereign bonds, have taken a more limited view on the state immunity doctrine. Unsurprisingly, and on account of their strict provisions of domestic legislation on state immunity, the two venues are often the place for either the inception of proceedings against a sovereign, or a forum in which recognition is sought.

"This principle could have formed an alternative to the CACs approach in the Greek PSI exercise"

Holdout litigation, and its inherent forum shopping practices, have the potential to adversely affect the orderly operation and conclusion of sovereign debt restructuring plans. The acceptance rate in recent sovereign debt reorganisations, including Argentina and Greece, is usually beyond 90%. Corporate insolvency law provisions in jurisdictions internationally, set the cram down yardstick for imposing acceptance of restructuring plans at substantially lower rates.

Therefore, in practice and at the right time, a monetary judgment in favour of holdout bondholders seeking to enforce their contractual claims against sovereign debtors – coupled with protracted recession that hinders all efforts for growth and economic extroversion – may well disrupt a state's repayment plan and jeopardise the entire restructuring process.

With no agreed rules regulating the international insolvency of a state, sovereign debt restructurings are bound to be entangled in prolonged litigation. The lack of uniformity inevitably leads to different court rulings, ensuring that opportunistic forum shopping strategies will continue. More than a decade after its first exchange offer, Argentina is still straggling with judgements ordering the state to make payment to holdout bondholders at the same pace it repays bondholders who accepted a hefty haircut.

"English and US courts have taken a more limited view on the state immunity doctrine"

An international sovereign insolvency regime would redress this gap in the law. Notwithstanding the political constraints, sovereigns have both the incentive and accumulated experience to formulate uniform rules in this field. Perhaps Europe, taking advantage of its existing institutional structure and the dire financial position of some of its member states, can be a pioneer and implement legislation in this direction.

Nevertheless, an alternative to an international regime may be within the reach of national legislators. Initially a customary rule of private international law, later forming part of codified insolvency provisions, the law governing insolvency related proceedings of foreign debtors is the law where insolvency is delcared (lex loci concursus).

The same principle can be applied in the case of sovereign debtors. Therefore, states could pass legislation to provide that any restructuring-related proceedings commenced before the country's courts will be solely determined by the laws of the defaulting sovereign.

This has the potential of minimising venue selection attempts. It may not be a distant possibility, given that states seem to be taking a more active stance on the need for universally effective sovereign restructurings. This is most evident in the case of the US, with New York courts hearing Argentina's appeal against holdout bondholders.

By George B Bazinas and Yiannis Sakkas of Bazinas Law Firm in Athens