Towards a Reorganisation System for Sovereign Debt

Towards a Reorganisation System for Sovereign Debt Towards a Reorganisation System for Sovereign Debt An Internationa...

Author: Holger Schier

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Towards a Reorganisation System for Sovereign Debt

Towards a Reorganisation System for Sovereign Debt An International Law Perspective

By

Holger Schier

LEIDEN • BOSTON 2007

This book is printed on acid-free paper. A Cataloging-in-Publication record for this book is available from the Library of Congress. This work was accepted as thesis for the degree of Doctor Iuris at the Justus-LiebigUniversity, Gießen in November 2006.

ISBN 978 90 04 16247 1 Copyright 2007 by Koninklijke Brill NV, Leiden, The Netherlands. All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission from the publisher. Authorization to photocopy items for internal or personal use is granted by Brill provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers, MA 01923, USA. Fees are subject to change. printed in the netherlands

Contents Preface .......................................................................................... Abbreviations ...............................................................................

ix xi

Part A Introduction Chapter I. The Early Days of Sovereign Insolvency ...................... 1. Sovereign Insolvencies as a Non-Legal Issue ........................ 2. Unsustainability of the Doctrine of Sovereign Insolvency as a Non-Legal Issue ..................................................................

5 6 9

Chapter II. Early Proposals for a Legal Framework for Sovereign Debt Reorganisation ................................................................. 1. Contract Autonomy ............................................................ 2. Choice of Law and Legal Venue Selection Clauses ...............

11 11 12

Chapter III. Scope of this Work ...................................................

15

Part B Principal Reform Proposals Chapter I. The Contractual Approach ......................................... 1. The Use of Collective Action Clauses and Exit Consents ..... 2. CACs and Exit Consents in the Sovereign Context ............. 3. Proposals to Extend the Contractual Approach ................... 4. Conclusion ......................................................................... Chapter II. The Proposal for a Statutory Sovereign Debt Restructuring Mechanism ........................................................ 1. The U.S. Bankruptcy Code – A Model for International Sovereign Debt Reorganisations? ......................................... 2. Conclusion .........................................................................

19 20 26 28 32

37 39 44

vi

Contents

Part C The International Law Perspective Chapter I. The RSSD’s Normative Basis under Public International Law ..................................................................... 1. International Conventions .................................................. 2. Customary International Law ............................................. 3. General Principles of International Law ..............................

49 49 50 89

Chapter II. An Insolvency System for Sovereigns Derived from General Principles of International Law .................................... 1. Comparability of Domestic Insolvency Regimes ................. 2. Selection of the Relevant Legal Systems ............................... 3. Domestic Insolvency Orders ............................................... 4. Comparative Analysis .......................................................... 5. Synthesis .............................................................................

109 110 112 121 155 163

Chapter III. Enforcement Measures ............................................. 1. Domestic Private Law Sanctions ......................................... 2. Public International Law Sanctions ..................................... 3. New Approaches ................................................................. 4. The Limits of Traditional Sanctions – The Case for a Compliance Control Mechanism in International Financial Relations .............................................................................

195 197 203 205

Chapter IV. Implementation ....................................................... 1. Article VIII (2) (b) IMF Agreement .................................... 2. Amendment of the IMF Agreement .................................... 3. Model Law .......................................................................... 4. Application and Codification of the General Principles of Law ..................................................................................... 5. A Multiple Track Approach .................................................

249 249 251 252

213

258 262

Contents

vii

Conclusion ...................................................................................

269

Appendix ...................................................................................... Model Convention on Sovereign Debt Reorganisation .............

273 275

Bibliography .................................................................................

279

Outline of Structure .....................................................................

303

Index ............................................................................................

311

Part D Conclusion

Preface There are numerous people to whom I owe thanks. Firstly, I must of course mention Prof. Dr. Thilo Marauhn, M.Phil., for his supervision of this study throughout. Prof. Dr. Jens Adolphsen kindly prepared the second opinion on the study. Many others have helped to improve and complete the study, and I am grateful for their input. The staff at the library of the Max-Planck Institut für ausländisches und internationales Privatrecht (Hamburg), as well as the staff at the Institut Suisse de Droit Comparé (Lausanne) were always extremely helpful when it came to finding the literature I needed. The staff of the legal department of the Banque Africaine de Développement (Tunis) gave me the opportunity to learn more about the work and endeavours of this institution in the architecture of international finance. Ian Snaith, M.A. and Dr. Rebecca Parry, LL.M. from the University of Leicester supported this study in many ways, not only during my LL.M. studies in Leicester. Furthermore, I would also like to mention all my colleagues at the doctoral candidates’ research seminar at the University in Gießen for supporting this study through their helpful comments and willingness to discuss unresolved issues. Katia and Knut, thank you for your valuable advice on completing the dissertation. Kristina MacVicar, LL.M. carefully and promptly undertook the final proofreading. All remaining mistakes are – as always – mine. Most of all, I would like to thank my wife Isabell, for ‘sharing’ me with this study for so long, as well as my parents, who have always supported my education in every possible way. This study is dedicated to my parents.

Abbreviations ACP AMS BIS CAC CC CISG ECHR ECJ EMCA EMU EU FDIC FRCP FSIA G7 G10 GATS GATT GCAB GDP HIPC ICCPR ICJ ICSID ICT IFI ILC IMF InsO LCQ LDCs LIBOR LLR

African-Caribbean-Pacific Countries Aggregate Measure of Support Bank for International Settlement Collective Action Clause Code de Commerce Vienna Convention on the International Sale of Goods European Convention of Human Rights European Court of Justice Emerging Markets Creditors Association European Monetary Union European Union Federal Deposit Insurance U.S. Federal Rules of Civil Procedure Foreign Sovereign Immunities Act Group of Seven Group of Ten General Agreement on Trade in Services General Agreement on Tariffs and Trade Global Committee of Argentina Bondholders Gross Domestic Product Heavily Indebted Poor Countries Initiative International Covenants on Civil and Political Rights International Court of Justice International Centre for the Settlement of Investment Disputes International Criminal Tribunal International Financial Institution International Law Commission International Monetary Fund Insolvenzordnung Ley de Concursos y Quiebras Least Developed Countries London Inter-Bank Offered Rate Lender of Last Resort

xii

Abbreviations

MIGA NGO NPV OECD PCIJ PIN PRSP RSSD SAP SDDRF SDR SDRM SGP TIA UNCITRAL UNDP U.S. WTO

Multilateral Investment Guarantee Agency Non-Governmental Organisation Net Present Value Organisation for Economic Cooperation and Development Permanent Court of International Justice Public Information Notices Poverty Reduction Strategy Paper Reorganisation System for Sovereign Debt Structural Adjustment Programme Sovereign Debt Dispute Resolution Forum Special Drawing Right Sovereign Debt Restructuring Mechanism Stability and Growth Pact U.S. Trust Indenture Act United Nations Commission on International Trade Law United Nations Development Programme United States (of America) World Trade Organisation

Part A Introduction

There are many explanations as to why the debt crisis developed [. . .] [y]et the fact remains that the debt crisis can be seen in retrospect as a crisis, not only of international finance, but also of the international legal system that was waiting to occur.*

Financial crises of sovereign powers are an almost timeless phenomenon.1 Nevertheless, at present, no legal system regulates the relationship between insolvent2 states and their creditors.3 Some twenty years ago, it was said that “in international law neither the legal concept of state insolvency nor its legal consequences for external debt are very clear.”4 On the other hand, commentators proclaim that “in an age of increasing hope, if not faith, in law and the rule of law, it is important that crucial areas such as international financial relations should not escape the minimum standards of law if they are to remain credible.”5 The question, therefore, is whether such minimum standards exist for sovereign insolvencies and whether and/or how these can be distilled from the variety of possible legal sources. A number of solutions to this issue have been presented. By way of an introduction, the initial idea of sovereign insolvency as a non-legal issue will be presented (Chapter I), followed by an overview of the early proposals for an insolvency procedure for nation states (Chapter II). The chapter will conclude by defining the subject of the present thesis (Chapter III).

* Silard, Stephen A., International Law and the Conditions for Order in International Finance: Lessons of the Debt Crisis, (1989) 23 Int’l Law, p. 964. 1 An extensive historical overview of sovereign debt crises is provided by Borchard, Edwin, State Insolvency and Foreign Bondholders, Vol. I/II, New Haven 1951. 2 The terms bankruptcy and insolvency are used interchangeably in this discussion. I will use the term insolvency, since it is more commonly used in most (Roman) languages, and thus appears to be more appropriate in an international context. In the United Kingdom, bankruptcy law sets forth the rules dealing with the inability of natural persons to pay due debts, while insolvency law is the term used to describe the rules relating to the inability to pay of legal entities (Fletcher, Ian F., The Law of Insolvency, 3rd ed. London 2002, at 1-019 et seq.). 3 Borchard, supra n. 1, Vol. I, p. 177. 4 Horn, Norbert, Adaptation and Renegotiation of Contracts in International Trade and Finance, Antwerp 1985, p. 305. 5 Tsikata, Dotse A., Sovereign Borrowers, Foreign Creditors and the Resolution of Sovereign Insolvency – A Legal Appraisal of Contemporary Practice, Toronto 1993, p. 9.

Chapter I The Early Days of Sovereign Insolvency In early instances of sovereign insolvencies, debtor countries’ creditors, and the countries of origin of those creditors, devised various ways to discourage default and to recover the debt. A classic example of former methods of debt recovery is that of Egypt. During the reign of Pasha Ismail, from 1863 to 1879, various bonds were issued by the Khedive in France and Britain to finance “grandiose schemes, including irrigation projects, schools, palaces, the construction of the Suez Canal and the extensions of Egyptian Rule in the Sudan. Much of the money was wasted.”1 Then came the depression of 1873, and the Khedive was not able to repay the debt on schedule. The straightforward solution in the 19th century was the creation by the British and French Governments of a committee that led the effort to help the Khedive service his debts. A few years later, following an armed uprising, Britain deployed troops and its consul general took de facto control of Egypt’s government.2 However, some 100 years ago the Argentinean Secretary of State, Luis Drago, established the doctrine that public debts do not provide any justification for military intervention. This doctrine was codified in the DragoPorter-Convention of 1907.3 Furthermore, since 1945 at least, the use of military intervention to procure debt repayment is excluded on the basis of

1

2 3

Scott, Hal S.; Wellons, Philip A., International Finance, 9th ed. New York 2002, p. 1293. Ibid. This Convention Respecting the Limitation of the Employment of Force for the Recovery of Contract Debt can be found in (1908) 3 Am. J. Int’l L., suppl., p. 81 et seq.; Article 1 (1) of this Convention reads: “The contracting powers agree not to have recourse to armed forces for the recovery of contract debts claimed from the government of one country by the government of another country as being due to its nationals.”

6

Part A – Chapter I

the prohibition of the use of force contained in Article 2 (4) of the Charter of the United Nations.4

1. Sovereign Insolvencies as a Non-Legal Issue The position, which denies that sovereign debt should give rise to any legal obligations, is also associated with Drago. The contention is that there is no law whatsoever governing the case of sovereign insolvencies. The state’s obligation to repay its debt is one of honour. It is argued that, since states are sovereign entities, their debt is an unenforceable obligation; since creditors contracted freely with the states, knowing of their sovereign status, they ought also to have recognised the risk of default when they extended money to the debtor state. This view was supported by court decisions declaring that such debts were debts of honour rather than legal obligations.5 1.1. Choice of Law Clauses in Sovereign Bond and Loan Contracts However, the contemporary practice of extending loans to states and of issuing sovereign bonds has changed in as much as these agreements are now regularly governed by a particular set of rules or legal system agreed upon by the parties.6 In the past, when sovereign loans were usually governed by the legal system of the debtor state, the case for the non-binding character of the loan obligation could still be made, as the debtor’s law lay within its sovereign discretion.7 In contrast, today, most contracts are governed by “neutral” laws.8

4

5

6

7

8

See in more detail: Meesen, Karl M., Die insolvenzrechtliche Option in der internationalen Schuldenkrise, (1990) 89 ZVglRWiss, p. 258. Cf. the decision by the English Court of Chancery Twycross v. Dreyfuss, (1877) 5 Ch. D., p. 605. Petzold, Eckart, Die internationalen Gläubiger-Schuldner-Beziehungen im Recht der Staateninsolvenz, Konstanz 1990, p. 253 et seq. In extreme cases, the sovereign therefore could completely annul its debt obligations. An example of such behaviour is provided by the Norwegian Loans Case. In this case, the Norwegian government suspended gold clauses in Norwegian bonds by law and decided that repayment should be in Norwegian Crowns; see ICJ, Case of Certain Norwegian Loans, [1957] ICJ Reports, p. 9 et seq. Mainly the law of New York and of England.

The Early Days of Sovereign Insolvency

7

1.2. Sovereign Immunity Nevertheless, the feature that could remain as an argument in favour of viewing debt contracts as mere obligations of honour is the argument of sovereign immunity. 1.2.1. Absolute Sovereign Immunity Based on the basic principle of the sovereign equality of states, it was concluded that no state should have jurisdiction over another state.9 Immunity in this sense meant that claims against a state could not be enforced before a municipal court or tribunal (jurisdictional immunity). Originally, this immunity was considered to be absolute.10 This doctrine of absolute immunity was predominant in Anglo-Saxon law until the 1950s, but has been continuously eroded since then. 1.2.2. Relative Sovereign Immunity In 1952, the United States Department of State declared in the Tate Letter that a foreign state shall not enjoy immunity from suits in cases arising out of strictly commercial activities, but only from suits involving its sovereign or public acts.11 In other words, the immunity granted to sovereigns was limited to the acta iure imperii, which are per se sovereign acts, while with regard to the acta iure gestionis, i.e. activities in the economic area in particular, states are dealt with in the same way as other natural persons or legal entities. This restrictive approach has in the meantime been adopted by most states12 and is also reflected in domestic legislation. In particular, the U.S. Foreign Sovereign Immunities Act (FSIA),13 which was passed by the U.S. Congress in 1976, provides in section 1604 that a foreign state shall be immune from jurisdiction in U.S. courts except as provided in sections 1605–1607 of the said chapter.14 Thus, there will be no immunity in cases where a sovereign

9 10 11 12 13

14

Brownlie, Ian, Public International Law, 5th ed. Oxford 1998, p. 289 et seq. Herdegen, Matthias, Internationales Wirtschaftsrecht, 4th ed. München 2003, p. 77. Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 628. Ibid. Foreign Sovereign Immunities Act of 1976, codified in relevant part at 28 U.S.C. §§ 1602 et seq. (2000). Similarly, a general rule of sovereign immunity from jurisdictions, which is subject to a range of exceptions, is provided for instance by the U.K. State Immunity Act 1978.

8

Part A – Chapter I

state implicitly or explicitly waived its immunity.15 Furthermore, the FSIA stipulates that a sovereign state is not immune against actions arising from acts that the state performed in connection with a commercial activity.16 As the majority of sovereign loan and bond contracts contain such waivers of jurisdictional immunity,17 the crucial question is whether sovereign borrowings constitute a commercial activity within the meaning of the FSIA. In Republic of Argentina v. Weltover, Inc., the United States Supreme Court held that the issuance of bonds by Argentina to its foreign creditors was a commercial activity and that only acts that may be performed exclusively by the sovereign qua sovereign fell within the immunity protection.18 This interpretation has in the meantime been accepted as common ground, so that the issuance of bonds, as well as the taking up of a loan by a sovereign is generally regarded as a commercial activity.19

15 16

17

18 19

28 U.S.C. § 1605(a)(1). These are above all the acts specifically mentioned by the act, namely (1) commercial activities carried out in the United States, (2) acts performed in the United States in connection with commercial activity carried on outside the United States and (3) acts performed outside the United States in connection with commercial activity carried on outside the United States, which have a direct effect in the United States. Cremer, Matthias, Privatrechtliche Verträge als Instrument zur Beilegung staatlicher Insolvenzkrisen: neue Ansätze in der Entwicklung eines internationalen Staateninsolvenzrechts, Köln 1991, p. 31; in contrast an arbitration agreement in the investment protection treaty between the CSSR and Germany was not considered to contain an implicit waiver of sovereign immunity (BGH, Judgment 4 October 2005 – VII ZB 8/05, (2006) MDR, p. 414). 504 U.S. 614 (1992). Power, Philip J., Sovereign Debt: The Rise of the Secondary Market and Its Implications for Future Restructurings, (1996) 64 Fordham L. Rev., p. 2730; see also: Section 3(3) of the U.K. State Immunity Act (1978); Art. 2 (1) c ILC Draft on Jurisdictional Immunities. Nevertheless, even if there is a waiver, this does not necessarily mean, that all sovereign assets are subject to enforcement actions. Notably assets like foreign embassy accounts will regularly be excluded (cf. BVerfG, Judgment 6 December 2006 – 2 BvM 9/03, [2007] WM, p. 57 et seq.); Kleinlein, Thomas, Anforderungen an den Verzicht auf dipolmatische Immunität (2007) 60 NJW, p. 2591.

The Early Days of Sovereign Insolvency

9

2. Unsustainability of the Doctrine of Sovereign Insolvency as a Non-Legal Issue State sovereignty does not automatically render loan agreements by states an unjudiciable area. Moreover, the fact that the concept of sovereignty and non-interference is in constant flux, as trials against former heads of state like Milosevic or Pinochet illustrate, must also be taken into account. These developments also include international economic relations. It was as a consequence of this that it was common practice for South American governments, to insert a “Calvo clause” into their international contracts.20 Under this clause, a foreign national cannot assert special rights but is subject to the local laws.21 The Calvo doctrine insists that foreigners be submitted to the courts of the state in which they did business and that only its national laws apply, thus obliging the foreign contractor to refrain from referring to public international law or seeking protection from the foreign party’s home courts.22 Most South American countries, however, subsequently abstained from using the Calvo clause.23 Consequently, a modern understanding of sovereignty does not exclude the establishment of a reorganisation system for sovereign debt.

20 21 22 23

Brownlie, supra n. 14, p. 548 et seq. Cf. e.g. Art. 24 of the Bolivian constitution. Wood, Philip, Law and Practice of International Finance London, 1980, p. 92 et seq. Theodoru, Heleni, Investitionsschutzverträge vor Schiedsgerichten, Berlin 2001, p. 76 et seq. The last remaining elements of the Calvo Doctrine from an international law perspective are said to have been rejected by the ICSID award in the proceeding CMS v. Argentina ((2003) 42 ILM p. 788 et seq.), Schill, Stephan, From Calvo to CMS: Burying an International Legacy – Argentina’s Currency Reform in the Face of Investment Protection: The ICSID Case CMS v. Argentina, [2005] SchiedsVZ, p. 292.

Chapter II Early Proposals for a Legal Framework for Sovereign Debt Reorganisation First proposals for a legal framework for sovereign debt reorganisation emerged at the end of the 19th century.1 The suggestions made ranged from using the debt contract as the sole source of interpretation and solution of conflict (1) to the application of a set of national legal rules in accordance with the provisions governing the conflict of laws (2).

1. Contract Autonomy One doctrine that is also the subject of intense debate in relation to the shape and existence of a lex mercatoria, is the doctrine of contract autonomy (often referred to by German commentators as rechtsordnungsloser Vertrag).2 In effect, a contract can in itself be law. According to the doctrine of contract autonomy, the terms of the agreement are decisive for all issues and no reference to any other law is necessary. However, the question arises whether the agreement can also exist without an overarching legal order that exists prior to the contract. Further to the inability of the contracting parties to foresee all eventualities, and thus the inherent incompleteness of the contract, the parties also lack the power to give the contract binding power without reference to any existing legal system from which this binding character could be derived, since there is a gap of enforceability.3 Finally, the existence of choice of law provisions and venue selection clauses hints at the parties’

1 2

3

Meili, Fr., Der Staatsbankrott und die moderne Rechtswissenschaft, Berlin 1895. Reithmann, Christoph; Martiny, Dieter, Internationales Vertragsrecht, 6th ed. Köln 1996, p. 58. Bowett, Derek William, State Contracts with Aliens: Contemporary Developments on Compensation for Termination or Breach, (1988) 59 BYIL, p. 50.

12

Part A – Chapter II

intention to be subject to a legal order outside the contract. A loan contract cannot, therefore, suffice as a legal underpinning for a system of sovereign debt reorganisation.

2. Choice of Law and Legal Venue Selection Clauses Debt contracts of sovereigns, be it in the form of loans or bonds, usually contain choice of law and legal venue selection clauses.4 In general, the parties can agree on every national legal order, although in practice, most loan and bond agreements are governed by English or New York law. It is not necessary that the whole contract be governed by the same legal system. Instead, the parties can choose different systems to govern the various parts of the agreement.5 Difficulties caused by an explicit choice of law flow from the (lack of ) balance of powers between the contracting parties. The stronger party will always attempt to declare the order that it sees as more favourable as the governing legal order. This is most often the ‘home’ legal order, since the party is more used to it, making this legal order seem to be more predictable and easier to handle.6 As illustrated above, this is particularly disadvantageous if the creditors agree to the law of the debtor state as governing law because here there is a risk that the state may change its law to the disadvantage of its creditors.7 Although, sometimes, parties try to avoid such changes by introducing stability clauses (Versteinerungsklauseln), the legislator can de facto circumvent such clauses by refusing to accept them.8

4

5

6

7

8

Baars, Alf; Böckel, Margret, Argentinische Staatsanleihen vor deutschen und argentinischen Gerichten, (2004) 16 ZBB, p. 449; a famous exception is the loan agreement in the case Allied Bank International v. Banco Credito Agricola de Cartago ((1984) 23 I.L.M., p. 742 et seq. (2d Cir. 1984). In this case Banco Credito Agricola had been prevented from making payments by respective restrictions imposed by the government of Costa Rica in response to a liquidity crisis. Nevertheless, the court made reference to legal orders. This leads to the so called dépeçage, Kegel, Gerhard; Schurig, Klaus, Internationales Privatrecht, 9th ed., München 2004, p. 141. This difficulty is one of the core reasons for the emergence of the idea of a lex mercatoria: Weise, Paul-Frank, Lex mercatoria: materielles Recht vor der internationalen Handelsschiedsgerichtsbarkeit, Frankfurt 1990, p. 1. See the example of the Norwegian Loans Case, ICJ, Case of Certain Norwegian Loans, [1957] ICJ Reports, p. 9 et seq. Petzold, Eckart, Die internationalen Gläubiger-Schuldner-Beziehungen im Recht der Staateninsolvenz, Konstanz 1990.

Legal Framework for Sovereign Debt Reorganisation

13

A compromise in this case is often the choice of a third neutral law, so that both parties have an equal position as far as their knowledge of the law is concerned. This, however, can only be guaranteed if both parties are more or less equally familiar with the law chosen, as well as with its socio-cultural background.9 With regard to international loan and bond contracts between states and private institutions such as banks, which are usually represented by international law firms with offices and lawyers all over the globe, this problem is likely to be of minor importance. Nevertheless, it should not be neglected completely, at any rate for the Least Developed Countries (LDCs), which often do not have sufficient resources to obtain legal advice from those same major international law firms.10 The absence of choice of law clauses does not usually mean that the parties want to avoid the application of a particular national legal order, but rather is a compromise between parties unable to agree.11 In such cases, the court will look for the most significant relationship of the contract e.g. a venue selection clause or reference to particular legal orders,12 which will lead to the governing law. Even then, however, problems may occur as a result of the fact that the law was made to reflect the national circumstances, while it is now to apply in an international context. In addition to lacunae in the national law, further difficulties in the application of this law in the context of state insolvencies stem from the particular legal personality of the state. Accordingly, to the disadvantage of creditors, due to the debtor’s sovereign inviolability, enforcement of potential court rulings is not possible in the territory of the debtor state; on the other hand, and to the advantage of the creditors, the sovereign, by means of its taxation power, has possibilities to raise new funds that no other creditor has in this form.13

9 10

11

12

13

Weise, supra n. 6, p. 2. According e.g. to a study by World Bank official Michael Pomerleano, the lack of human technical capacity is among the primordial reasons for the difficulties in handling sovereign financial crises in developing countries (Back to Basics: Critical Financial Sector Professions Required in the Aftermath of an Asset Bubble, available at: www1.worldbank.org/finance/ html/readings_seacen.02.html). Semkow, Brian W., Syndicating and Rescheduling International Financial Transactions: A Survey of the Legal Issues Encountered by Commercial Banks, (1984) 18 Int’l Law., p. 904. Münchener Kommentar/Martiny, Kommentar zum BGB,Vol. X, 3rd ed., München 1998, Art. 27 n. 40 et seq. Leyendecker, Ludwig, Auslandsverschuldung und Völkerrecht, Frankfurt am Main 1988, p. 7 et seq.

Chapter III Scope of this Work Thus, neither the contract itself, nor a simple reference to domestic law by means of a venue selection clause or a choice of law clause can be regarded as probate means to solve sovereign debt reorganisation issues. The discussion on a reform of the international system of sovereign debt restructuring started to attract growing attention in the 1980s1 but it was not until Anne Krueger, then first deputy managing director of the International Monetary Fund (IMF), proposed a Sovereign Debt Restructuring Mechanism (SDRM) in November 2001,2 that this idea attracted world-wide attention. “There is,” she said, “a gaping hole [in the international financial architecture]: we lack incentives to help countries with unsustainable debts resolve them promptly and in an orderly way [. . .] It is high time this hole was filled.”3 In light of the fact that the U.S. vetoed this proposal in the spring of 2003, this study will re-analyze the proposal by the IMF, as well as potential alternatives, as the discussion initiated by Anne Krueger can enable the politicians to find viable alternatives before the next Argentine-type default leads to unnecessary economic losses4 caused by the absence of a legal framework necessary for a stable international financial architecture.

1

2

3 4

For details see: Rogoff, Kenneth; Zettelmayer, Jeromin, Early Ideas on Sovereign Bankruptcy Reorganisation: A Survey, IMF Working Paper 02/57, March 2002. Krueger, Anne O., International Financial Architecture for 2002: A New Approach to Sovereign Debt Restructuring, address given at the National Economists’ Club Annual Members’ Dinner, American Enterprise Institute, Washington D.C., 26 November, 2001, available at: www.imf.org/external/np/speeches/ 2001/112601.htm. Ibid. Rating agencies estimate that foreign banks lost at least $54bn due to the Argentine default. The American Citigroup alone reported losses of $2,2bn; Die Welt, 26 April 2002, p. 18.

16

Part A – Chapter III

This thesis will address the issue of how the legal gap in the international financial architecture may be filled. First, an overview of the principal reform proposals will be given (Part B). Against this backdrop, it shall be considered whether, and to what extent, a legal framework can be derived from an international law perspective (Part C). The next sections will then illustrate how such a reorganisation system for sovereign debt based on international law could be enforced (Part C, Chapter III) and in which ways it might be implemented (Part C, Chapter IV). Following a final summary, the study will conclude by proposing a model draft convention on sovereign debt reorganisation (Part D).

Part B Principal Reform Proposals Two principal reform proposals can be distinguished in the discussion of sovereign debt reorganisation. On the one hand, private creditors in particular, but also the U.S. Treasury have called for a contractual solution. They advocate the use of collective action clauses (CACs) in sovereign bonds to facilitate the reorganisation of sovereign debt (Chapter I). On the other hand, academics, as well as – most importantly – the IMF suggest the establishment of a statutory solution, as in the form of the SDRM (Chapter II).

Chapter I The Contractual Approach The core objective of the contractual approach – like that of the statutory proposal – is to facilitate reorganisation by making it easier for debtors and creditors to negotiate a deal. To this end, the promoters of the contractual approach suggest changes in policy emphasis and an augmented ‘toolbox’ of contractual clauses.1 Those tools are primarily CACs and exit consents. CACs are provisions in bonds intended to improve the organisation of the creditors’ community; CACs allow a qualified majority of bondholders to modify the terms of a bond contract, including the terms on principal and interest, while restraining a minority of so called “hold-out creditors” to undermine the restructuring process, in order to provide the restructuring process with a degree of order and predictability.2 Most syndicated bank loans to states include such CACs. However, over the last decade, lending to emerging markets has significantly shifted towards bonds.3 For instance, 92 percent of the debt to be restructured in the Argentine case was bonds.4

1

2 3

4

Taylor, John B., Sovereign Debt Restructuring: A U.S. Perspective, Remarks at the IIF Conference “Sovereign Debt Workouts: Hopes and Hazards”, Washington, 2 April 2002, available at: www.ustreas.gov/press/releases/ po2056.htm; see also: Buchheit, Lee C.; Gulati, G. Mitu, Sovereign Bonds and the Collective Will, (2002) 51 Emory L.J., p. 1317 et seq. (hereinafter: Buchheit/Gulati (2002)), whose article has impressed some commentators so much that they call it “the single most important analysis to date of majority voting provisions – and indeed, of sovereign debt issues generally” Skeel, David A., Can Majority Voting Provisions Do it All?, (2003) 52 Emory L.J., p. 425. Buchheit/Gulati (2002), supra n. 1, p. 1324. During the 1990s net flows of capital to developing countries from bond financing exceeded net bank lending to developing countries by a margin of 50 percent, approximately $300 bn in net bond flows compared to approximately $190bn in net bank lending; see: World Bank, [2000] Global Development Finance, p. 36. Credit Suisse/First Boston, Argentina’s Dubai Proposal : Worse than Already Lowered Expectations, Emerging Markets Sovereign Strategy Daily (23 September 2003) available at: www. emta.org/keyper/Argentina0923.pdf (figures as of 23 September 2003).

20

Part B – Chapter I

In contrast to syndicated bank loans, though, a majority of all internationally emerging market bonds are issued under laws for which CACs are not customary, most notably the law of the State of New York.5 An exception has to be made for bond contracts governed by English law, which almost invariably contain CACs.6 Exit consents (also known as exit amendments) are a kind of reduced CAC, since they only apply to a restricted area of bond clauses.7 They are of particular interest for bonds that are issued in jurisdictions in which CACs are uncommon. According to those laws, unanimity is usually required to modify payment terms. However, with the issuer’s consent, a simple majority is permitted to modify other bond provisions.8 The study is structured as follows: Part 1 describes the use of collective action clauses and exit consents in general under the legal systems which, for the purposes of this study, are most important, i.e. England and New York. Part 2 analyzes the possibility of a transfer of these instruments to sovereign bonds.

1. The Use of Collective Action Clauses and Exit Consents 1.1. Collective Action Clauses First, the challenges to be met by CACs and how these operate in practice will be discussed. The contractual approach favoured by the insertion of CACs in bonds faces two main challenges. Firstly, there are collective representation problems, such as how to start and manage a re-negotiation when much of the debt is in the form of publicly traded bonds, which are

5

6

7

8

From 1990 to August 2000, 871 of a total of 2452 emerging market bonds were issued under the law of New York (Becker, Torbjörn et al., Bond Restructuring and Moral Hazard: Are Collective Action Clauses Costly?, IMF WP/01/92, July 2001, p. 7). Similarly, bonds issued under German and Japanese law do not contain CACs (Berensmann, Kathrin, Involving Private Creditors in the Prevention and Resolution of International Debt Crises, Reports and Working Papers 8/2003, p. 24). 1031 of 2452 emerging market bonds (Becker; ibid.). Apart from bonds floated under English law as a rule CACs are included in bonds under Luxembourg law (Berensmann, ibid.). Buchheit, Lee C.; Gulati, G. Mitu, Exit Consents in Sovereign Bond Exchanges, (2000) 48 UCLA L. Rev., p. 59 (hereinafter: Buchheit/Gulati (2000)). I.e. the non-payment terms.

The Contractual Approach

21

widely distributed (1.1.1).9 Secondly, I will touch on the issue of majority action problems (1.1.2).10 1.1.1. Collective Representation The problem of collective representation occurs when bonds are issued in bearer form, since bearer bonds are transferable by delivery and there is no central register of the identities of current holders.11 An issuer seeking a coordinated restructuring of payment obligations is required to give adequate notice to the bondholders as to the date, time and place of the planned meeting, as well as regarding the details of the proposed modifications. The issuer can try to give notice by mailing to the individual bondholders, in the case of registered bondholders or, in the case of bearer bonds, by publication in specified newspapers.12 Furthermore, in the case of modern Eurobonds, which are currently primarily issued in the form of global notes held by custodians, notice is usually given through clearing systems such as Euroclear and Cedelbank. However, to further improve and facilitate the ways of efficiently giving notice13 (which is still difficult to do) various institutional devices such as a standing council or a trustee for each issue, can be used to ensure that there is a discussion between debtor and creditors. Such devices can be introduced into bonds by inserting collective representation clauses.14 These provisions allow one party, for instance the bond trustee,15 to negotiate the broad outlines of a reorganisation programme with the bond issuer and

9

10

11

12

13

14

15

Buchheit, Lee C., A Lawyer’s Perspective on the New International Financial Architecture, (1999) 14 J.I.B.L., p. 228 (hereinafter: Buchheit (1999)). Dixon, Liz; Wall, David, Collective Action Problems and Collective Action Clauses, [June 2000] Fin. Stability Rev., p. 143. In contrast, registered bonds are transferred through a register and certificates are issued to the registered holders (Yianni, Andrew, Resolution of Sovereign Financial Crises – Evolution of the Private Sector Restructuring Process, [June 1999] Fin. Stability Rev., p. 82). Liu, Yan, Collective Action Clauses in Sovereign Bonds, IMF Working Paper, Washington 30 August 2002, p. 5. For instance there are more than 700.000 bondholders in Europe, Asia and the U.S., which were affected by the Argentine default, FAZ, 21 February 2004, p. 19. For a sample collective representation clause see: Buchheit, Lee C., The Collective Representation Clause, [September 1998] Int’l Fin. L. Rev., p. 10 (hereinafter: Buchheit (1998a)). See: Dixon/Wall, supra n. 10, p. 145; a description of the various possible legal documentary bond structures under English and US law is given by Yianni, supra n. 11, p. 80.

22


representatives of other creditors without long delays after the need for such a solution becomes apparent.16 1.1.2. Collective Action Various types of clause are inserted to deal with collective action problems. Significant problems are due in particular to the fact that bondholders, in contrast to institutional creditors such as banks, are not committed to repeat lending, so they do not have any incentive not to extract the “maximum advantage from one ‘game’ of debt default.”17 Furthermore, individual bondholders are not subject to any ‘suasion’ like that to which banks are subject from the side of the respective central banks.18 Individual bondholders therefore have strong incentives not to participate in sovereign debt reorganisation, which could potentially entail costly debt reductions, but instead to hold out, hoping to “reap the benefit of any ensuing gains” in the full value of their claims.19 Consequently, such individual creditors can take advantage of the financial concessions granted to the debtor state by its fellow creditors.20 The collective action clause currently used most frequently by the official sector to overcome this deficit, is the majority action clause.21 This clause authorises a majority of bondholders to amend the terms of a bond even

16

17 18 19

20

21

Buchheit (1998a), supra n. 14, p. 9. Argentina was encountering first experiences with another method of tackling the collective representation problems, since it opened registers for creditors in Buenos Aires, Washington, Tokyo, Frankfurt, Rome and London. Registration in these registers was voluntary (FAZ, 30 December 2003, p. 19). It has, however, been criticized that the main purpose of the registers was to facilitate direct negotiations with creditors and to sideline the alliance of the Argentina Bondholders’ Committee (ABC), which represented around 70 institutional investors; Task Force Argentina (TFA), representing Italian retail investors; and the Argentine Bond Restructuring Agency (Abra), which represented mainly German and Austrian retail investors. However, only Abra had the legal power to sign an agreement with Argentina on behalf of its members (FT-Europe, 12 January 2004, p. 4). Scott Hal S., A Bankruptcy Procedure for Sovereign Debtors, (2003) 37 Int’l Law, p. 116. Ibid. See the graphic description by: Cohen, Benjamin, A Global Chapter 11, (1989) 75 Foreign Policy, p. 110. Buchheit, Lee C., Majority Action Clauses May Help Resolve Debt Crises, [August 1998] Int’l Fin. L. Rev., p. 13 (hereinafter: Buchheit (1998)). Dixon/Wall, supra n. 10, p. 143.


23

against the explicit will of a minority.22 Since this could potentially lead to an oppression of minorities by the majority creditors, it has been argued that an inter-creditor duty to act in the best interest of all bondholders could be invoked to challenge the validity of majority-approved amendments.23 However, U.S. Courts have decided against such obligations, at least with regard to instruments that involve sophisticated parties and carefully detailed arms-length agreements.24 This conclusion, though, might be inappropriate in cases where no commercial justification for the majority decision can be given.25 To strike an adequate balance between the protection of minority bondholders against abuse and prevention of the reorganisation through disruptive behaviour by individual creditors, high thresholds for majority voting are regularly included, while unanimity is not required. Although the most common threshold seems to be 75 percent of the value of the bond issue represented at the meeting, in practice, an acceptance of over 90 percent is often achieved.26 These supermajorities have the advantage of reassuring potential bondholders that the majority clauses are exclusively used to defeat true ‘vultures’. This guarantee would certainly not exist in cases where the payment terms of a bond could be altered against the will of 49 percent of the bondholders.27 One point, made inter alia by Dixon and Wall, who hint at international bonds that set the minimum quorum for an adjourned meeting at only 25 percent, remains.28 Under such bond documentation, it would, theoretically, be possible for bondholders holding a mere 18.75 percent29 to impose

22 23

24

25

26

27

28

29

Buchheit (1998), supra n. 20, p. 13. See: CIBC Bank and Trust Company (Cayman) Limited v. Banco Central do Brasil, et al., 886 F. Supp. 1105 (S.D.N.Y. 1995). Banque Arabe et Internationale d’Investissement v. Maryland National Bank, 819 F. Supp. 1282 (S.D.N.Y. 1993). Buchheit/Gulati (2002), supra n. 1, p. 1341; this might be particularly relevant, where bonds are overwhelmingly held by retail bondholders who are generally less sophisticated. For instance, in the recent restructurings of Pakistan and the Ukraine, acceptance rates of 94 percent and over 98 percent, respectively, were achieved (Eichengreen, Barry; Rühl, Christof, The Bail-In Problem: Systematic Goals, Ad Hoc Means, May 2000, pp. 23, 27). Tarullo, Daniel K., Rules, Discretion, and Authority in International Financial Reform, [2001] J. Int. Econ. L., n. 186. The minimum quorum for a first meeting is generally set at two thirds of principal outstanding, Dixon/Wall, supra n. 10, p. 144. I.e. 75 percent of the 25 percent minimum bondholder attendance.

24


changes to the payment terms binding on all bondholders.30 But, in addition to the limited practical relevance of this issue,31 this risk acts as an incentive to appear at the meeting.32 Further to majority action clauses, sharing clauses can be introduced to deal with collective action problems that can occur when a creditor commences a lawsuit without the agreement of the other bondholders. These clauses require each potential litigant to share any amounts recovered by way of the lawsuit with its fellow bondholders.33 For instance, a bondholder holding one percent of the bond issue, who recovers in a suit, would have to transfer 99 percent of this recovery to the other bondholders. This obviously discourages disruptive litigation.34 Although such clauses are routinely included in syndicated bank loans, they have not yet played an important role in the current CACs debate in relation to international bonds.35 Finally, non-acceleration or de-acceleration clauses may reverse any acceleration of a bond, which occurs if a sufficient creditor quorum36 declares due the full outstanding amount payable upon occurrence of an event of default.37 De-acceleration clauses are not included except in New York style bonds. However, the same effect can be triggered for bonds governed by English law by changing the maturity date back from the accelerated date to another one using the majority action clause.38 1.2. Exit Consents Since the U.S. Trust Indenture Act (TIA) prohibits CACs for corporate bonds,39 another means to handle the problem of dissident creditors and the

30 31 32 33

34

35 36 37 38 39

Dixon/Wall, supra n. 10, p. 144. Adjourned meetings are the rare exception, cf. Liu, supra n. 12, p. 6. Dixon/Wall, supra n. 10, p. 144. Goldman, Samuel E., Mavericks in the Market: The Emerging Problem of Hold-Outs in Sovereign Debt Restructuring, (2000) 5 UCLA J. Int’l L & Foreign Aff., p. 170. Buchheit, Lee C., Changing Bond Documentation: The Sharing Clause, [July 1998] Int’l Fin. L. Rev., p. 17. Buchheit (1999), supra n. 9, p. 228. In general 25 percent of the bond value. Liu, supra n. 12, p. 10 et seq. Ibid., p. 12. The (mainly historical) reasons for this legislation are discussed in detail by Roe, Mark J., The Voting Prohibition in Bond Workouts, (1987) 97 Yale L.J., p. 250 et seq.


25

danger of disruption of the restructuring process had to be found.40 Such an alternative is the use of amendment clauses to alter non-payment terms of the bond by the creditor majority, thereby making it less attractive to encourage potentially dissenting creditors to take part in the exchange.41 This technique is called “exit consents” since the bond issuer solicits the agreement of the bond creditors to the amendment of the old bond, just as those lenders exchange their bonds for the borrowers’ new debt instruments.42 Amendment clauses provide the issuer with the possibility to amend the bond with majority consent,43 to change any terms of the contract, except the date of payment of the principal or interest on the bond or the principal amount of the bond or the interest rate thereon. Clauses that could be changed by means of exit amendments in the corporate context are, for example, the contractual obligation upon the issuer to keep its bond listed on a stock exchange, or financial covenants such as negative pledge clauses,44 which could either be removed completely from the bond or otherwise weakened.45 Additionally, in the sovereign context the sovereign’s submission to a foreign jurisdiction or the waiver of sovereign immunity could be abrogated.46 The issuer’s consent is made a compulsory precondition in order to prevent holdout creditors from reversing the amendments with their new majority after the exit of the consenting creditors.47 Used in the U.S. as a means to facilitate corporate debt restructuring since the 1980s, exit consents were subject to criticisms right from the start. The risk of coercive mischief in particular is mentioned i.e., if the corporate bond issuer or the creditor majority does not act in the best interest of all creditors. This situation can occur especially if a creditor, who is not convinced of the advantages of the exchange offer, submits only because he does not want 40

41 42 43 44

45 46 47

Although the TIA only applies to corporate borrowers and thus is not applicable to foreign sovereign bond issuers, nor to private issues by domestic or foreign entities, and, consequently, there is no legal bar in the U.S. to using CACs in international sovereign bonds, they do not feature in most American-style bonds, which is due largely to market practice (Buchheit/Gulati (2000), supra n. 7, p. 83). Goldman, supra n. 33, p. 175. Buchheit/Gulati (2000), supra n. 7, p. 59. Usually one-half or two-thirds in aggregate principal amount. I.e. clauses which limit the sovereign’s power of subordinating debt that arises from the credit agreement containing the negative pledge clause, Goldman, supra n. 33, p. 170. Buchheit/Gulati (2000), supra n. 7, p. 82. Ibid., p. 81. Ibid., p. 82.

26


to run the risk of the necessary majority of his co-bondholders agreeing to the offer and approving the harmful amendments.48 On the other hand, no creditor can claim to be surprised by the exercise of an amendment clause, since this clause was already included in the bond documentation at the time of purchase. This reasoning is all the more true as the parties in the corporate bond market are usually highly sophisticated, often institutional, buyers that are accustomed to such provisions and whom it should not be difficult to contact in the event of a planned change of the bond terms.49 The U.S. courts appear to share this view. Thus, in Katz v. Oak Industries Inc.,50 the leading case on exit consents, the Delaware Court of Chancery held that an exchange offer based on exit consents was neither coercive, nor did it violate the issuer’s obligation to act in good faith with regard to its bondholders.51 Although New York Courts, which most probably would have to decide on the legality of an exit consent in a sovereign bond, have not yet decided on the issue in a sovereign bond contract, legal doctrine requires judges in New York to follow the Delaware approach for corporations using exit consents.52

2. CACs and Exit Consents in the Sovereign Context 2.1. CACs in Sovereign Bonds As part of the discussion on a sovereign debt restructuring mechanism (SDRM), the IMF highlighted the following features as being of particular importance:53

48

49 50 51 52

53

Coffee, John C.; Klein, William A., Bondholder Coercion: The Problem of Constrained Choice in Debt Tender Offers and Recapitalizations, (1991) 58 U. Chi. L. Rev., p. 1226 et seq. Buchheit/Gulati (2000), supra n. 7, p. 69 et seq. Katz v. Oak Industries Inc., 508 A.2d 873 (Del. Ch. 1986). Ibid. Buchheit/Gulati (2000), supra n. 7, p. 73 et seq.; more cautiously: Buchheit/Gulati (2002) in their recent publication about CACs, supra n. 1, p. 1346. Krueger, Anne O., A New Approach to Sovereign Debt Restructuring, Washington D.C. April 2002, p. 11.


27

– a majority voting provision binding all relevant creditors to an agreement (plan of reorganisation) accepted by a qualified majority of creditors; – an automatic standstill on creditor enforcement during the restructuring negotiations; – priority financing providing fresh money to the company after it enters into the reorganisation procedure by granting the new creditors seniority of their claims; and – protection of creditors’ interests during the standstill period. Therefore, the question is to what extent these features can – at least in theory – be achieved by using CACs. Buchheit/Gulati make several suggestions in this respect: While it is reasonable to see majority action clauses as a mechanism to ensure majority voting, it is more difficult to understand how an automatic standstill could be triggered by the use of CACs. Indeed, it is only possible to reach comparable results by using de-acceleration provisions and sharing clauses. As noted above, the potential use of a de-acceleration clause constitutes a risk for the litigant creditor, in that he may commence costly litigation but, ultimately, be left with a claim reduced to the proportion of payment left unpaid after the settlement.54 This mechanism has already discouraged litigation against Ecuador during its debt restructuring.55 Sharing clauses, requiring a litigant creditor to share any amounts recovered during legal proceedings with the other creditors on a pro rata basis, are a further deterrent against disruptive litigation.56 Sharing clauses as well as de-acceleration clauses are, however, not widespread in sovereign bonds.57 Furthermore, de-acceleration clauses require the consent of a majority of at least 50 percent of the bondholders, which is not always easy to obtain and makes the issuer of the bond dependent on the outcome of time-consuming and often expensive negotiations. Priority financing could be replicated by contract clause through the use of modified pari passu clauses.58 ‘Pari passu’ clauses, which are standard in the

54 55

56 57 58

Buchheit/Gulati (2002), supra n. 1, p. 1347. Buchheit, Lee C., How Ecuador Escaped the Brady Bond Trap, [December 2000] Int’l Fin. L. Rev., p. 18. Liu, supra n. 12, p. 14. See: Dixon/Wall, supra n. 10, p. 143. Literally: with equal step, or side by side.

28


vast majority of sovereign bonds,59 would have to be altered. Pari passu clauses warrant that ‘the obligations of the Guarantor here-under do rank at least pari passu in priority of payment with all other external indebtedness of the Guarantor, and its interest thereon.’60 Accordingly, a corresponding change to ‘non pari passu’ for new creditors could grant them senior claims. Creditor protection during the standstill could potentially be improved by measures such as the prohibition of preferential payments or the appointment of a trustee. 2.2. Exit Consents in Sovereign Bonds In the sovereign context, most features of a sovereign insolvency procedure that can be imitated with CACs, can also be duplicated by exit consents. An advantage of the use of exit consents in sovereign bonds compared with CACs is that the former do not require changes in existing laws or standard bond documentation.61 Consequently, implementation would not require too much effort. In addition, one of the leitmotivs of the debate on a new international financial architecture is the increased involvement of the private sector in sharing the burden of sovereign financial crises. Exit consents would provide a solution that could be implemented without public sector intervention.62

3. Proposals to Extend the Contractual Approach A recent proposal by John Taylor, Under-Secretary of the U.S. Treasury, aimed at the insertion of further provisions into international sovereign bond contracts that have not yet been used in standard bond documentation: these are ‘engagement clauses’ and ‘initiation clauses’.63

59 60 61 62 63

Gulati, G. Mitu; Klee, Kenneth N., Sovereign Piracy, (2001) 56 Bus. Lawyer, p. 636. Ibid. Buchheit/Gulati (2000), supra n. 7, p. 83. Ibid. Taylor, supra n. 1.


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3.1. Engagement Clauses Engagement clauses would be introduced to better define the procedure of negotiations between debtor countries and their bond creditors. They would specify the manner in which creditors would be represented, the kind of data the sovereign has to provide to the creditors’ representative and deadlines for the provision of such information.64 The creditors’ representative would have not only administrative functions but also the power to negotiate with the debtor state. Thus, engagement clauses are a variation on the representation clause that gives the creditors’ representative a stronger role.65 However, market participants have expressed the opinion that instead of delegating more and more competence to a representative, they would prefer to have ‘a seat at the table’ and actively participate in negotiating the restructuring terms and exchange offers.66 There is obviously a fear that, otherwise, the restructuring lacks transparency – to the disadvantage of the bondholders.67 As an alternative, the Model Covenants for Sovereign Debt Issues, which were issued by the Emerging Markets Creditors Association (EMCA),68 therefore propose the creation of creditors’ committees to represent the respective differing interests. 3.2. Initiation Clauses Initiation Clauses would deal with the first phases of a reorganisation. They would govern how the debtor can initiate the process, as well as the legal relationship between the debtor and its creditors in the period thereafter. In particular, such clauses would be inserted into new bond contracts to prescribe how a debtor country, by triggering the restructuring process, could start a ‘cooling off period’ of around two months, during which time the debtor would be protected against any legal actions by its creditors.69 The effects would be similar to the automatic standstill on creditor enforcement actions that is common in domestic corporate insolvency procedures.

64 65 66

67 68 69

Ibid. Liu, supra n. 12, p. 17. Chamberlin, Michael M., A Casual Observer’s Commentary on the Taylor Proposal and the EMCA’s Model Covenants for New Sovereign Debt Issues (8/9/02), p. 8 et seq. Cf. ibid. The Model Covenants are available at: www.emta.org. Taylor, supra n. 1.

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3.3. Aggregation Clauses Further to the clauses discussed in the Taylor proposal, the insertion of aggregation clauses has also been put forward for discussion. Aggregation clauses would help to deal with the problem that each bond issue has its own independent amendment provisions. Indeed, diversity of emerging market debt instruments has become a major obstacle to efficient restructuring negotiations. For instance, Argentina has issued more than 150 types of defaulted bonds across eight jurisdictions in seven currencies.70 Consequently, in the case of multiple bond issues, the amendment of one bond does not affect other bonds.71 Aggregation clauses would overcome this obstacle by aggregating creditor claims for voting purposes across all bonds and other debt instruments.72 Theoretically at least, such aggregation by means of contractual agreement is feasible under New York as well as English law.73 3.4. Class Actions In addition to such modifications of the bond documentation, it has been suggested that the U.S. class action could be used as a device to avoid a piecemeal asset foreclosure while the sovereign debtor is negotiating the terms of reorganisation and to facilitate a more comprehensive debt reorganisation.74 Class actions are, broadly speaking, a mechanism that can be used where a large number of claimants is affected by conduct that the plaintiffs attribute to the defendant. In this case, a small group of representative claimants can bring a suit on behalf of the whole class. This avoids the impracticality of all class members joining in the class action lawsuit.75 If the requirements for a class action are met, all class members – regardless of whether they were present or absent – are bound by the adjudication of common issues of law and fact and are barred from filing suit regarding those issues again.76

70 71 72 73 74 75

76

FT-Europe, 8 March 2004, p. 11. Liu, supra n. 12, p. 20. Ibid. Ibid., p. 22. Buchheit/Gulati (2000), supra n. 7, p. 1352 et seq. Debevoise, Whitney; Orta, David, The Class Action Threat to Sovereign Workouts, [July 2003] IFLR, p. 43. Ibid.


31

The prerequisites for a (federal) class action are set out in the Federal Rules of Civil Procedure (FRCP) 23(a). This provision requires that: the class is so numerous that joinder of all members is impracticable (1), there are questions of law or fact common to the class (2), the claims or defences of the representative parties are typical of the claims or defences of the class (3), and the representative parties will fairly and adequately protect the interest of the class (4). In addition to the requirements of Rule 23(a), a case seeking to be certified as a class action must meet the criteria set up in FRCP 23(b). Most importantly, an action may be maintained as a class action if individual actions would create a risk of inconsistent77 or varying adjudications;78 or adjudication would, in practical terms, substantially impair or impede the ability of the other class members not parties to the adjudication to protect their interests.79 The latter alternative specifically addresses situations where the defendant lacks sufficient funds to satisfy the claims of all potential class members (‘Limited funds class’).80 In such cases, class actions are mandatory.81 In contrast, in class actions pursuant to FRCP 23(b)(3) individual members of the class are allowed to ‘opt-out’ of the class and pursue individual remedies.82 The court may certify a class action according to FRCP 23(b)(3) if this device is superior to other available methods for the fair and efficient resolution of the dispute. The court has broad discretion to decide on that issue. In the context of sovereign debt reorganisation, however, U.S. courts have, to date, denied class certification pursuant to FRCP 23(b)(3).83 In particular, the courts reasoned that the classes were ill-defined and that it was not possible for the sovereign to ascertain which of its bondholders voted to remain involved in the debt restructuring process and which opted-out to pursue individual litigation. Moreover, it was argued that, in the sovereign context, where class members are dispersed all over the world, a class action would fail to provide the defendant with the usual benefit

77 78 79 80 81 82 83

Cf. FRCP 23(b)(1)(A). Cf. FRCP 23(b)(1)(A). Cf. FRCP 23(b)(1)(B). Debevoise/Orta, supra n. 75, p. 43. Buchheit/Gulati (2002), supra n. 1, p. 1353. Ibid. Cf. HW Urban v. Argentina, Case No 02-Civ 5699; Applestein v. Argentina, Case No 02Civ 4124.

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of this device, namely the avoidance of subsequent individual lawsuits.84 Consequently, it was not possible to convince the courts that class actions were a superior means to resolve sovereign debt crisis as required according to FRCP 23(b)(3). Therefore, one might want to consider a limited funds class action according to FRCP 23(b)(1)(B). However, it is questionable whether this approach would be more promising due to the complexities of the process of sovereign debt reorganisation.85 Furthermore, the class action device is limited to the U.S. jurisdiction.86 Most sovereign debtors issue their bonds under a variety of legal systems;87, 88 the overwhelming majority of those legal systems do not have procedural mechanisms that are even slightly comparable to the U.S. class action.89 Consequently, U.S. courts would be the exclusive resort for sovereign debtors seeking this sort of collective debt reorganisation, which could cause difficulties from a political point of view.90 While a carefully structured class action might nevertheless serve as a step towards easier sovereign debt reorganisations in the U.S.,91 this mechanism is of little use for sovereign debt issued under other legislations.

4. Conclusion A more sophisticated new bond documentation, as suggested by the advocates of the contractual approach, could possibly mimic important features as they are commonly (and beneficially) used in domestic insolvency laws. 4.1. Exit Amendments Exit amendments provide a means of altering the bond documentation that is available in bonds issued under English as well as New York State law. 84 85 86 87 88 89 90 91

This potential flaw is also conceded by Buchheit/Gulati (2002), supra n. 1, p. 1356. Debevoise/Orta, supra n. 75, p. 44. Buchheit/Gulati (2002), supra n. 1, p. 1356. See: Yianni, supra n. 11, p. 79. See: Yianni, supra n. 11, p. 79. Skeel, supra n. 1, p. 423. Ibid. Skeel, David A., Why the Class Action Strategy is Worth a Second Look, [September 2003] Int’l Fin. L. Rev., p. 3.


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However, as explained above, exit consents may only vary non-payment terms. Therefore, it will be more difficult to force hold-outs to submit, since payment terms are basically the only terms that matter for this group. Moreover, using exit amendments to mimic features of statutory insolvency procedures is rather complicated. Most importantly, the courts have not yet decided on whether the creative use of exit consents in New York-style bonds,92 beyond the traditional range of use, would be within the legal boundaries. This gives rise to significant legal uncertainties. As the respective creative use of class actions illustrates, New York courts are reluctant to accept corporate insolvency instruments in the sovereign context. 4.2. Collective Action Clauses The application of CACs, particularly in the form of majority action clauses and collective representation clauses, could be much more relevant than exit amendments. When these clauses were discussed more intensively, the market participants reacted reluctantly. The creditors’ major objection was that the insertion of CACs would make it too easy to default. In turn, debtors did not want to insert such clauses into their new debt instruments, as they were afraid that borrowing costs would rise in cases where CACs are inserted93 leading one commentator to note that “without the issuing governments as groom and investors as bride”, the CAC initiative “is not going to be much of a wedding.”94 However, supporters of CACs argue that, by allowing an organised and accelerated restructuring process, these provisions could reduce borrowing costs.95 Research in this field is still in the early stages and the results obtained so far are contradictory. While Eichengreen/Mody came to the conclusion that there is evidence of higher spreads for less credit-worthy issuers – which would include most emerging markets96 – and a reduction of borrowing costs for more credit-worthy issuers,97 other research suggested that CACs do not

92 93 94 95 96 97

Or any other bond, that does not include CACs. Eichengreen/Rühl, supra n. 26, p. 13. FT, supra n. 77, citing a senior investment banker. Becker et al., supra n. 5, p. 5. Ibid., p. 11. Eichengreen, Barry; Mody, Ashoka; Would Collective Action Clauses Raise Borrowing Costs?,

34


influence borrowing costs.98 The latter view is supported by the argument that most market participants are not even aware of the governing law when buying a bond. Furthermore, rating agencies do not take into account the governing law when rating bonds, which seems to indicate that they are not seen as a potentially risky factor.99 In fact, markets’ scepticism seems to be decreasing. Thus, in February 2003 Mexico was the first emerging market that issued bonds containing CACs under New York State law100 thereby overcoming the ‘First-moverproblem’.101 Since then, Uruguay exchanged its old bonds in a restructuring against new bonds including CACs102 and Argentina, Brazil and South Africa have also issued or announced an intention to issue ‘Yankee bonds’ containing majority voting provisions. On balance, these events signal an increasing acceptance of CACs in emerging markets.103 In contrast, creditors’ groups are still critical. They argue that a majority restructuring rule would leave minority bondholders in a very vulnerable position, assuming that they are forced by the majority into very unfavourable deals.104 Inter alia, there are concerns about ‘vote buying’, i.e. that the debtor could provide undisclosed financial incentives to induce a qualified majority. For example, the sovereign debtor could improperly influence creditor entities under its control.105 To address these minority creditor grievances, the invention of a neutral institution could be considered. By means of arbitration clauses, parties could agree to refer disputes to an arbitral tribunal.106 Such clauses are most

NBER Working Paper 7458, Cambridge November 1999; see also the updated version, which is available at: www.elsa.berkley.edu/-eichengr/governinglawnew.pdf. 98 Becker et al., supra n. 5. 99 Becker et al., supra n. 5, p. 26. 100 FT-Europe, 28 October 2003, p. 7. 101 Tarullo, supra n. 27, p. 670. 102 VENRO, Zwischenbilanz der Umsetzung des „Monterrey Konsensus“, Bonn, January 2004, p. 21. 103 Skeel, supra n. 89, p. 2. 104 Macmillan, Rory, Towards a Sovereign Debt Work-Out System, (1995) 16 Northwestern J. Int’l L., p. 100. 105 Häusler, Gerd et al., Sovereign Debt Restructuring Mechanism – Further Considerations, IMF Working Paper, 14 August 2002, p. 27. 106 Ebenroth, Carsten-Thomas; Parche, Ulrich, Schiedsgerichtsklauseln als alternative Streiterledigungsmechanismen in internationalen Konsortialverträgen und Umschuldungsabkommen, (1990) 36 RIW, p. 341 et seq.


35

useful where highly complicated factual circumstances are concerned.107 This arbitral tribunal could then make decisions regarding claim verification and integrity of the voting process. The advantage of arbitral tribunals compared with domestic courts would be that the debtor would not have to unveil its financial situation before a state court, which might be embarrassing, due to the usually public procedures, while arbitration procedures are non-public. Moreover, the arbitral tribunal might be faster, as it would not have to deal with a workload comparable to domestic courts. Lastly, the arbiters would be selected according to their competence in the field of sovereign debt, so that they would potentially be better able to deal with the technical issues in question. The practical use of CACs in sovereign debt reorganisations remains to be seen. Recent bond restructurings show that countries whose bonds included such provisions decided not to invoke them, in particular due to insufficient time that would have been necessary to negotiate under the terms of the CACs, and because there was concern that a bondholder’s meeting could be used as a forum within which opposing creditors could co-ordinate their actions.108 Furthermore, the sustainability of a debt restructuring reached by contract clauses is sometimes questionable. For instance Ecuador, which successfully restructured its debt in 2000 using exit consents109 has again been hit by its severe debt situation some years later.110 Ultimately, the use of contract clauses only represents half the battle in reaching fast and sustainable solutions to sovereign debt crises. This is because such contract clauses cannot be used except in the case of new bonds. Much sovereign debt – such as Brady-Bonds,111 which will not mature until 2025 – would be unaffected.112 While, theoretically, there is an opportunity, to change the bond covenants via exit consent swaps,113 thereby exchanging

107 108 109 110 111

112 113

Ibid., p. 346. Dixon/Wall, supra n. 10, p. 150 et seq. Buchheit/Gulati (2000), supra n. 7, p. 83 et seq. FT, 21 January 2003, p. 10. Brady bonds, which were issued between 1988–1995, are thirty year bullet bonds on which the interest is due in one payment at the end of thirty years. The principal and twelve to eighteen months of interest are secured by thirty year U.S. zero coupon bonds; see: Scott, supra n. 17, p. 106. Macmillan, supra n. 104, p. 100 et seq. Ghosal, Sayantan; Miller, Marcus, Co-ordination Failure, Moral Hazard and Sovereign Bankruptcy Procedures, University of Warwick Working Paper, 21 July 2002, p. 2.

36


the old bonds for new ones that include CACs, it is illusory to assume that creditors would accept such changes. Or, if they did so, then debtors would probably not be willing to pay the amounts creditors would claim in additional revenue.114

114

Scott, supra n. 17, p. 122.

Chapter II The Proposal for a Statutory Sovereign Debt Restructuring Mechanism A statutory approach, as suggested by the IMF, could provide a sustainable solution that would also cover existing debt.1 The intellectual origins of the IMF’s Sovereign Debt Restructuring Mechanism (SDRM) can be traced back to the U.S. Bankruptcy Code, in particular Chapters 92 and 11 thereof.3 While Chapter 9 deals with the reorganisation of insolvent municipalities, Chapter 11 addresses the reorganisation of corporations. The proposal to use the U.S. Bankruptcy Code as a model for sovereign debt reorganisation was first advocated in 1981 by Oechsli, who argued in favour of an analogy with Chapter 11.4 Several other authors followed his approach,5 but some shifted the focus from Chapter 11 to Chapter 9.6

1

2 3 4

5

6

Krueger, Anne O., A New Approach to Sovereign Debt Restructuring, Washington D.C. April 2002; see also: IMF, The Design of the Sovereign Debt Restructuring Mechanism – Further Considerations, Washington D.C. 27 November 2002; available at: www.imf.org/external/ np/sdrm/2002/ 112702.pdf. 11 U.S.C. §§ 901 et seq. (1994 & Suppl. IV 1998). 11 U.S.C. §§ 1101 et seq. (1994 & Suppl. IV 1998). Oechsli, Christopher G., Procedural Guidelines for Renegotiating LDC Debt: An Analogy to Chapter 11 of the U.S. Bankruptcy Reform Act, (1981) 21 Va. J. Int’l L., p. 309 et seq. Cohen, Benjamin, A Global Chapter 11, (1989) 75 Foreign Policy, p. 109 et seq.; Suratgar, David, The International Financial System and the Management of the International Debt Crisis, in Suratgar, David (ed.), Default and Rescheduling: Corporate and Sovereign Borrowers in Difficulty, London 1984, p. 151 et seq.; Petzold, Eckart, Die internationalen GläubigerSchuldner-Beziehungen im Recht der Staateninsolvenz, Konstanz 1986, p. 433; Reinisch, August, The Need for an International Insolvency Procedure, (1994) 42 Österreichisches Bank-Archiv, p. 115 et seq.; Schwarcz, Steven L., Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, (2000) 85 Cornell L. Rev., p. 956 et seq. Chun, John H., “Post-Modern Sovereign Debt Crisis: Did Mexico Need an International Bankruptcy Forum”, (1996) 64 Fordham L. Rev., p. 2653; Raffer, Kunibert, Applying Chapter 9 Insolvency to International Debts: An Economically Efficient Solution with a Human Face, (1990) 18 World Economy, p. 301.

38

Part B – Chapter II

Similarly, Krueger stressed in her proposal that Chapter 9 is, in many respects, of greater relevance for a reorganisation system for sovereign debt than corporate rehabilitation laws such as Chapter 11.7 Those parallels result specifically from the differences arising from the sovereign status of states and municipalities. For instance, Chapter 9 reorganisation cases for municipal debtors cannot be converted into a liquidation process. In the same way, it has been reiterated that “companies may go down, but governments must not”.8 Hence, there is no question that the liquidation and distribution of a state’s elected government is excluded. The reason most advocates of a statutory approach focus on Chapter 11 as the conceptual basis might be that Chapter 9 in essence incorporates Chapter 11 by reference9 and is said to add little to the other chapters10 that is not already obvious11 on account of the municipal status. Notwithstanding the major differences in these proposals, they all proceed from a triple premise:12 First of all, they agree that the current ‘Ad hocery’ in responding to sovereign debt reorganisations leads to significant inefficiencies in the allocation of resources. This aspect is generally correlated to the issue of the current inadequacy of incentive structures, which favour lending and borrowing that should not occur. Secondly, as the constant repetition of financial crises indicates, a change in the international financial structure appears overly due. Finally, only a set of rules, binding on the actors (i.e. emerging markets’ governments as debtors, creditor governments, international financial institutions, such as the IMF or the World Bank and private entities, in particular banks) can realign governmental and public behaviour to improve efficiency, equity and accountability. In order to provide an overview of the statutory approach, the relevant provisions of the U.S. Bankruptcy Code shall be highlighted and their applicability in the sovereign context briefly illustrated.13

7 8

9 10 11 12

13

Krueger, supra n. 1, p. 12. Macmillan, Rory, Towards a Sovereign Debt Work-Out System, (1995) 16 Northwestern J. Int’l L., p. 74. 11 U.S.C. § 901. Schwarcz, supra n. 5, p. 970. Ibid. Cf. Tarullo, Daniel K., Rules, Discretion, and Authority in International Financial Reform, [2001] J. Int. Econ. L., p. 618. For an analysis of the substance of those proposals see the discussion in Part C, Chapter II, 5.2.

Statutory Sovereign Debt Restructuring Mechanism

39

1. The U.S. Bankruptcy Code – A Model for International Sovereign Debt Reorganisations? 1.1. Initiation of Proceedings According to section 30114 a debtor may initiate proceedings by voluntarily filing for insolvency without necessarily having to be insolvent. In contrast to corporate debtors, however, section 109(c)(3), which requires insolvency, restricts this right for municipalities. According to section 101(32)(C), insolvency means “that the municipality is generally not paying its debts as they become due [or is] unable to pay its debts as they become due.”15 Moreover, section 921(c) allows the insolvency court to dismiss a debtor’s petition for commencement of insolvency procedures if it is not filed in good faith.16 Under certain circumstances, notably if the debtor is generally not paying its debts when due, creditors may file an involuntary insolvency case against the debtor pursuant to section 303.17 In the sovereign context, a debtor state with ‘unsustainable debt’ would determine whether to activate the reorganisation proceedings. While it is commonly accepted that creditors should not be allowed to activate the process, since hardly any sovereign would be willing to subject itself to involuntary reorganisation proceedings,18 the question as to what role private creditors and/or third parties, such as the IMF, should play in determining the sustainability of the debt, and thus the debtor’s right to initiate proceedings, remains unanswered. While some commentators abstain from submitting the petition to any preconditions19 others suggest that creditors should be allowed to object to the filing of the petition on similar grounds as are afforded by Chapter 920 or that a judgment on the sustainability of the debt by the IMF would be required.21

14 15

16

17 18 19 20 21

Provisions without denomination of a law refer to the U.S. Bankruptcy Code. Whether a municipality may file for insolvency is thus based on a cash flow test (cf. McConnell, Michael W.; Picker, Randal C., When Cities Go Broke: A Conceptual Introduction to Municipal Bankruptcy, (1993) 60 U. Chi. L. Rev., p. 456). Good faith petitions are also commonly required in corporate reorganization procedures; Broude, Richard F. (et al.), Collier International Business Insolvency Guide – Vol. I – Insolvency Law of the United States, New York 2003, § 7.03[3]. 11 U.S.C. § 303(h). Schwarcz, supra n. 5, p. 981. Cohen, supra n. 5, p. 125. Chun, supra n. 6, p. 2679. Krueger, supra n. 1, p. 23.

40


1.2. Stay The Code creates what is called an ‘automatic stay’ when a Chapter 11 petition is filed.22 The stay results in the suspension of the enforcement of all lawsuits and claims against the debtor that arose before the initiation of such cases as well as all other actions against the debtor’s assets. A set-off against current claims that accrued before the petition is also excluded.23 This stay prevents third parties from trying to dissemble the debtor’s property on a piecemeal basis and affords the debtor an opportunity to try to reorganize.24 In the sovereign context, some commentators argue that activation of the reorganisation procedure should similarly result in an automatic stay on individual litigation efforts to prevent an opening of the floodgates and asset-grab races.25 Others oppose this view, contending that an automatic stay would not be necessary, as similar effects could be reached by way of a unilateral moratorium.26 In particular, due to the scarcity of assets under foreign jurisdictions, the benefits of the stay, it is argued, are limited as only those assets are potentially subject to a seizure.27 Nevertheless, commentators see a risk that litigation could inhibit progress in reorganisation negotiations between debtor and creditors.28 1.3. Priority Financing Section 364 sets forth the procedure for debtors to obtain priority financing from the credit and capital market to facilitate a ‘fresh start’. Thus, it is possible for the debtor to obtain unsecured credit and incur unsecured debt in the ordinary course of business as an administrative expense.29 If this scheme of creditor preferences is insufficient to attract the requisite capital, the judge may furthermore authorize the granting of collateral.30

22 23 24

25 26 27 28 29 30

11 U.S.C. § 362; the respective provision in the municipal context is 11 U.S.C. § 922. 11 U.S.C. § 362(a)(7). The main function of the stay mechanism is thus to prevent a rush to the exits by the creditors. Chun, supra n. 6, p. 2679. Schwarcz, supra n. 5, p. 985. Ibid. Krueger, supra n. 1, p. 16. 11 U.S.C. § 364(a). 11 U.S.C. § 364(c), (d).


41

The judge may also authorize the obtaining of credit secured by a senior lien on property already pledged as collateral if the original secured party is adequately secured.31 In the process of sovereign debt reorganisation, there has been a discussion of whether new financings shall be excluded from the SDRM. Consequently, they would not be required to suffer the cuts ultimately imposed by the reorganisation upon other creditors. It is suggested that such new resources should be provided by the IMF, which already has a de facto priority of claims.32 However, an important aspect of the statutory approach is seen by some commentators in explicitly discharging the IMF of its function as provider of fresh funds for liquidity-strapped countries, thereby avoiding the need for the investment of any more taxpayers’ money.33 Moreover, it has been asserted that reliance on private capital markets would establish a “market test on each loan and on each adjustment program”.34 Of course, this market test can only go as far as private market participants can monitor appropriate investment of the new funds.35 1.4. Debtor-in-Possession The U.S. Bankruptcy Code incorporated the concept of debtor-in-possession, i.e. that during the reorganisation procedures, the management of the debtor company remains in power and continues to run the business. A trustee is only appointed in cases such as fraud.36 The governments of an indebted state shall also remain in power. A form of judicially enforced receivership or administration by a trustee would, as discussed above, be in contradiction to the principle of state sovereignty.37

31 32 33

34 35 36

37

11 U.S.C. § 364(d). Schwarcz, supra n. 5, p. 1015. Sachs, Jeffrey, Do We Need an International Lender of Last Resort, Frank D. Graham Lecture, Princeton University, 20 April 1995, p. 11 et seq. Ibid., p. 12. Schwarcz, supra n. 5, p. 989. Cf. 11 U.S.C. §§ 1101, 1107; similarly, § 904 provides that the court may not interfere with any of the political or governmental powers of the municipal debtors. But see: Oechsli, supra n. 4, p. 335 et seq.

42


1.5. Creditors’ Committee As the debtor remains largely in control of the business, some kind of monitoring is assured by the instalment of (at least one) creditors’ committee, with broad powers to participate in the reorganisation proceedings and to represent the group of creditors as a whole.38 Costs and expenses of the creditors’ committee are paid from the debtor’s estate.39 In the case of sovereign debt reorganisation, the rationale for creditors’ committees is all the more pertinent due to the significant collective representation problems described above. As in corporate reorganisations, coordination could be improved by the establishment of creditors’ committees. The questions of whether such committee should be established by means of one international committee or rather by means of several national committees and whether or not it would be a standing committee remain unanswered.40 1.6. Majority Voting Sections 1123 and 1126 govern the contents and acceptance of the reorganisation plan. For a period of 120 days after the filing of the petition, the debtor has the exclusive right to file a reorganisation plan.41 After this time, the debtor loses its exclusive right and other parties may also file a plan. The Code requires that certain mandatory provisions, for example concerning the designation of classes42 or adequate means of implementation, must be included in every reorganisation plan.43 However, the essence of the plan and the terms of reorganisation, are at the discretion of the negotiating parties. A plan is accepted if a majority outvotes a minority. According to section 1126(c), an affirmative vote by the creditors requires a majority of at least two-thirds and more than a simple majority. Such a vote binds all creditors, including those who voted negatively or abstained from voting.44

38 39 40 41 42 43 44

11 U.S.C. §§ 1102 et seq. 11. U.S.C. § 503(b)(3)(F). Macmillan, supra n. 8, p. 88 et seq. 11 U.S.C. § 1121(b). 11 U.S.C. § 1122. 11 U.S.C. § 1123. 11 U.S.C. § 1126(c).


43

In contrast, in international sovereign debt reorganisations, debt instruments that do not contain CACs require unanimity to change the essential terms of lending; unanimity can be difficult or even impossible to obtain.45 If it is to be obtained then states usually have to grant significant concessions to hold-outs to avoid them blocking the reorganisation.46 To solve this problem, voting in the sovereign context should similarly be subject to approval by a majority vote, in which case the reorganisation proposal would become binding on all creditors whose claims were restructured.47 1.7. Cramdown Finally, section 1129 sets forth the prerequisites for a ‘cramdown’. If a class of creditors rejects the plan, the court may nevertheless approve it if creditors in each class receive value under the plan equal to the amount of their claims, or if creditors whose claims are junior in priority receive nothing.48 Confirmation of a plan binds all creditors regardless of whether or not they registered their claims.49 Once again, commentators are divided in their views as to how far the U.S. Bankruptcy Code provides a valuable model. While some argue that a cramdown procedure would be necessary to prevent hold-out classes,50 others advocate that a respective clause should not be included for sovereign debt reorganisation, because of the difficulties connected with the application of such provision.51 Specifically, a cramdown requires the assessment of a debtor as a going-concern in order to ensure that a creditor class obtains at least the value under the reorganisation plan that it would otherwise have obtained as liquidation value.52 This is already a tricky issue in the domestic context. Any attempt to value a debtor country would be even more difficult

45

46 47 48 49 50 51 52

Eichengreen, Barry; Portes, Richard, Crisis? What Crisis? Orderly Workouts for Sovereign Debtors, London 1995, p. 26. Cf. Cohen, supra n. 5, p. 110. Ibid., p. 125. 11 U.S.C. § 1129(b). 11 U.S.C. § 1141. Chun, supra n. 6, p. 2683; see also the discussion by Krueger, supra n. 1, p. 23 et seq. Schwarcz, supra n. 5, p. 1005 et seq. So-called “fair and equitable treatment test”.

44


and would also be inherently speculative.53 Moreover, the contention is that, unlike Chapter 11 proceedings, the process of sovereign debt reorganisation lacks a mechanism to enforce a majority-approved plan on a dissenting debtor or the creditors’ minority.54 Another open question is what amount of debt shall be covered by the debt reorganisation and, consequently, on which creditors a cramdown would be binding. It is proposed therefore, that certain claims would be deemed automatically ineligible for the restructuring, including claims held by international organisations such as the IMF.55 Other commentators want to include all debt, but suggest different classifications according to factors such as whether the debt is private or public, or whether it is foreign or domestic.56

2. Conclusion The IMF’s proposal for a statutory SDRM ultimately failed due to political resistance in the international community.57 The specific reasons for this resistance remain rather unclear. Instead of assessing the political decision, however, one must ask whether the fundamental approach underpinning most statutory proposals, namely the analogy to one domestic insolvency law as a basis for an international reorganisation system, should be welcomed. To this extent, the brief summary of statutory proposals based on the U.S. Bankruptcy Code is insightful as it highlights two essential points. First, that domestic insolvency law may provide some valuable points of departure for the drafting of a system of reorganisation for sovereign debt. Second, that even though the advocates of a statutory approach use a common basis from which results are drawn, this does not necessarily mean that

53 54 55 56 57

Schwarcz, supra n. 5, p. 1007 et seq. Oechsli, supra n. 4, p. 338. Krueger, supra n. 1, p. 17 et seq. Schwarcz, supra n. 5, p. 1006. Cf. Richard Euliss who writes that “the biggest weakness of the SDRM [proposal by the IMF] lies not in its substantive attributes, but rather in the procedural protocol necessary to bring the concept into existence” (idem, The Feasibility of the IMF’s Sovereign Debt Restructuring Mechanism: An Alternative Statutory Approach to Mollify American Reservations, (2003) 19 Am. U. Int’l L. Rev., p. 126).


45

these results are similar. On the contrary; the broad variety of suggested solutions, which all commentators claim are based on the U.S. Bankruptcy Code, illustrates that this piece of legislation cannot be regarded as a priori best suited for adoption in the sovereign context. Rather, all commentators agree that, due to the particular circumstances of sovereign debt reorganisations, adaptation is necessary, although the measures proposed differ in many respects. However, if adaptation is unavoidable in any case, why should not the necessary legal foundation for a public international law problem, namely the lack of a proper reorganisation system, be obtained from the very sources of this law. Furthermore, the basis of the statutory proposals discussed above, i.e. Chapter 9 and Chapter 11, was developed in a national context. It is essential that this be kept in mind, since there is interdependence of legal rules, which means there are only a few rules that can be understood and applied without reference to other legal rules or concepts.58 In other words, a national set of provisions might be useful in the context of its own, complex national legal framework, but inconsistent and even harmful in an international context in the absence of such framework.59 Moreover, there is a general tendency for judges and lawyers to decide a case without consulting the full store of case law and critical literature, sticking instead to the national material.60 This tendency would be re-enforced yet more if a national law were applied internationally. However, the aim of advocates of the statutory approach is the establishment of a new treaty61 or the amendment of an existing one, such as the IMF’s Articles of Agreement.62 A treaty, though, should not be construed in the same manner as domestic legislation, but according to generally agreed basic principles.63 Finally, the latent legitimacy problems facing a statutory approach based on one domestic law become apparent in view of Article 38 ICJ Statute. This provision, which is regarded as the most authoritative statement with

58

59 60

61 62 63

Cf. Pistor, Katharina, The Standardization of Law and its Effects on Developing Countries, (2002) 50 Am. J. Comp. L., p. 98 et seq. Ibid., p. 108. Allegaert, Theodore, Recalcitrant Creditors Against Debtor Nations, or How to Play Darts, (1997) 6 Minn. J. Global Trade, p. 453 et seq. Schwarcz, supra n. 5, p. 1011 et seq. Krueger, supra n. 1, p. 33 et seq. Cf. Gold, Joseph, The Fund Agreement in the Courts, Washington 1962, p. 5.

46


respect to the sources of international law,64 does not contain any indication that gaps in the international legal architecture should be filled by reference to a single national law. Instead, Article 38 ICJ Statute requires that recourse be taken to the proper instruments of public international law.

64

Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 66.

Part C The International Law Perspective

Chapter I The RSSD’s Normative Basis under Public International Law According to Article 38(1) of the Statute of the International Court of Justice (ICJ Statute), the sources that shall be applied in an international law context are: international conventions (1), customary international law (2) and the general principles of law recognised by civilised nations (3).1

1. International Conventions Due to the lack of a formal legislature, international “statutory” law is notoriously thin on the ground. The more delicate an issue is, i.e. the more national sovereignty is potentially encroached upon, the fewer written treaties and conventions exist on which the sovereigns could agree. Therefore, there is at present no proper state debt reorganisation law in the form of an international convention.2 Nevertheless, when the ICJ was confronted, for instance, with the lack of a company law in the area of public international law, it did not stop there, but rather started to find legal principles to deal with the open issues based on a comparison of domestic legal orders.3 In other words, the finding that an insolvency law for sovereigns does not exist, constitutes not the

1

2

3

As subsidiary means for the determination of rules of law, Article 38(1)(d) ICJ Statute furthermore provides that reference shall be made to “judicial decisions and the teachings of the most highly qualified publicists of the various nations.” See: Dolzer, Rudolf, Staatliche Zahlungsunfähigkeit: Zum Begriff und zu den Rechtsfolgen im Völkerrecht, in: Jekewitz, Jürgen (ed.), Des Menschen Recht zwischen Freiheit und Verantwortung, Berlin 1989, p. 540. Cf. ICJ, Barcelona-Traction, [1970] ICJ Reports, p. 3 et seq.

50

Part C – Chapter I

end, but rather the beginning of the process to discover the content of this area of law.4

2. Customary International Law A state faced with insolvency may in principal consider the following options: stop all repayments (2.1) and/or to request the start of negotiations for debt rescheduling or debt relief (2.2). In both cases, customary international law could serve as a legal basis. 2.1. A Right to Stop Repayment of Sovereign Debt? A fundamental rule of international law, and in particular the law of treaties, is the doctrine of pacta sunt servanda. Accordingly, the non-repayment of debt, as a non-performance of a duty created by a contract, constitutes an internationally wrongful act.5 Moreover, in the case of monetary obligations there is no case of absolute objective impossibility.6 However, it is worth questioning whether there are any circumstances that would justify the non-performance of the treaty. To this extent, reference could be made to customary international law. Article 38 I lit. b ICJ Statute provides that the ICJ has to apply “international custom, as evidence of a general practice accepted as law”. There is agreement that the wording used in Article 38 I lit. b is misleading, as customary international law is not proof of the existence of a state practice; indeed, the converse is true: state practice is the conditio sine qua non for the emergence of customary international law.7 The prerequisites for state practice are disputed. Usually, it is argued that the emergence of customary international law requires a certain factual behaviour of states or other subjects of public international law combined with the conviction to behave in such a manner because of a legal obligation. In contrast, according to some commentators, customary international law can also flow from a mere settled

4 5

6 7

Cf. Mann, F.A., Reflections on a Commercial Law of Nations, (1957) 33 B.Y.I.L., p. 33. Bothe, Michael; Brink, Josef, Public Debt Restructuring, the Case for International Economic Co-operation, (1986) 29 G.Y.I.L., p. 92. Cf. Art. 61 (1) Vienna Convention on the Law of Treaties. Verdross, Alfred; Simma, Bruno, Universelles Völkerrecht: Theorie und Praxis, 3rd ed., Berlin 1984, §§ 552 et seq.

The RSSD’s Normative Basis

51

state practice,8 since a conviction as a psychological phenomenon could not be proven for a state as a legal person.9 However, this line of argumentation is somewhat over-subtle. If one were to follow this approach, one would also have to require that ‘the state’, meaning the legal person, show a certain behaviour. But a state is able to act only through its official institutions. The argument that the conviction of the state that is first to declare the existence of a certain provision of customary international law – which by doing so triggers a common settled practice (consuetudo) – is erroneous because, at the moment of the declaration, the stated practice does not (yet) exist.10 However, in many cases, a practice is based initially on considerations such as political interests or comity and the belief in being legally obliged to act in this way comes only after some time.11 Furthermore, although state practice can often suffice as a basis for customary international law, an opinio iuris has to be required to allow a differentiation between rules which, though sometimes better respected, are legally non-binding (because they form part of soft law), and legal norms.12 Thus, the two elements necessary for the emergence of customary international law are state practice combined with the opinio iuris that this practice reflects binding legal obligations.13 2.1.1. Clausula rebus sic stantibus Following these preliminary remarks, a first line of argument in favour of a right to stop debt repayment might draw on the doctrine of clausula rebus sic stantibus,14 the underlying concept of which is that obligations can, as a result of supervening developments, be subject to changes.15 This concept,

8

9 10 11 12

13 14

15

Kopelmanas, Lazare, Custom as a Means of the Creation of International Law, (1937) 18 B.Y.I.L., p. 135 stating that “[. . .] the necessity for adopting, [. . .] the psychological theory of custom comes in the end to deprive customary law of a great part of its importance and quantity.” Ibid., p. 130. Kunz, Josef L., The Nature of Customary International Law, (1953) 47 A.J.I.L., p. 667. Verdross/Simma, supra n. 7, § 563. Bernhardt, Rudolf, Customary International Law, in: Bernhardt, Rudolf (ed.), Encyclopedia of Public International Law, Vol. I, Amsterdam 1992, p. 899. ICJ, North Sea Continental Shelf Case, [1969] ICJ Reports, p. 44. Hereinafter referred to as clausula; the term originates in a Civilist maxim: Conventio omnis intellegitur clausula rebus sic stantibus and means that every contract is to be understood as being based on the assumption of things remaining as they were, that is at the time of its conclusion; see: Schwarzenberger, Georg, Clausula rebus sic stantibus, in: Bernhardt, Rudolf (ed.), Encyclopedia of Public International Law, Vol. I, Amsterdam 1992, p. 611. Ibid.

52


which is accepted as part of customary international law,16 has been incorporated in Article 62 of the Vienna Convention on the Law of Treaties.17 Credit agreements between debtor countries and their (public) creditors are usually long-term.18 Thus, many changes may occur. The exchange and interest rates as well as the general world economic context are of particular relevance in this regard.19 2.1.1.1. Change of Currency or Interest Rates Generally, sovereign debt is denominated in US Dollars or Euros. If the domestic currency floats down by a percentage x against the dollar or the euro, this has a significant impact on the debt, since government redemption costs on the debt will increase by the same x percent.20 As far as interest rates are concerned, one benefit of developing countries’ turning to the bond markets is the preference of those markets for fixed rate instruments.21 For the least developed countries, however, there is almost no private credit market. They rely mainly on lending from public financial institutions whose credits are still mostly based on floating interest rates such as the London Inter-Bank Offered Rate (LIBOR). If the LIBOR rises significantly, this will also greatly affect the debt service burden of those borrowing countries.22 These variations occurring during the life of a credit agreement between a sovereign debtor and its creditors, can undoubtedly have major impacts on the (in)solvency of a state.23 However, the parties generally agree on variable interest rates as well as on payment in foreign currency in their debt agreements. The parties thus explicitly accept that exchange rates may change over time. If such variations do indeed occur, they cannot constitute a reason for making the

16 17

18

19 20

21

22 23

ICJ, Fisheries Jurisdiction Case (United Kingdom v. Iceland), (1973) ICJ Reports, p. 18. Due to its status as part of customary international law, the clausula also applies in countries that are not party to the Vienna Convention on the Law of Treaties; see: Brandl, Ulrike, Die Beendigung als Sanktion völkerrechtlicher Verträge, (2003) 41 AVR, p. 109. For instance, Argentina planned to issue bonds with a repayment period of 42 years; FAZ, 23 October 2003, p. 21. Kappel, Rolf, Wege aus der Entwicklungskrise, Frankfurt 1990, p. 145 et seq. For example in the 1994 Mexican foreign exchange crisis the Mexican peso floated down by 50 percent against the dollar in only four weeks (cf. Scott, Hal S., A Bankruptcy Procedure for Sovereign Debtors, (2003) 37 Int’l Law, p. 106 et seq.) Buchheit, Lee C., Cross Border Lending: What’s Different this Time?, (1995) 16 Nw. J. Int’l L. & Bus., p. 50. Ibid., p. 51. Cf. ibid.


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contract unenforceable.24 The clausula doctrine cannot be invoked under these circumstances. In contrast, changes upon which the parties did not agree are those concerning the world economic context. Many developing countries in the past suffered, and often even today suffer from the fall in commodity prices. In general, the terms of trade have been to the detriment of developing countries.25 This deterioration is often connected with the trade policies in industrialised countries. For instance, those countries often block imports from developing countries through their prohibitively high import taxes and customs or make imports useless, as they cannot compete with heavilysubsidised domestic products.26 2.1.1.2. Change of Policy A possible line of argument might now be that developing countries concluded their debt agreements against the backdrop of certain pro-debtor country policies supported by industrialized countries and the subsequent non-convergence with these policies. There are various examples for such change of policy being referred to as a basis for invoking the clausula doctrine. A historical example for such use of the clausula is the case of the Netherlands, which suspended their development co-operation with Surinam after a military coup in that country, since the human rights situation was considered to be unsustainable thereafter.27 In support thereof, commentators argue that in order to be a viable tool in times of major political change, such as in Eastern Europe currently, the clausula must also cover changes in policy.28 Recent decisions by the European

24

25

26

27

28

Hahn, Hugo J., Öffentliche Auslandsschulden und Völkerrecht, in: Börner, Bodo (ed.), Einigkeit und Recht und Freiheit – Festschrift für Karl Carstens am 70. Geburtstag am 14. Dezember 1984, Köln 1984, p. 366 (hereinafter: Hahn (1984)). Ajayi, Ibi S., An Analysis of External Debt and Capital Flight in the Heavily Indebted Poor Countries of Sub-Saharan Africa in: Iqbal, Zubair; Kanbur, Ravi (ed.), External Finance for Low Income Countries, Washington D.C. 1997, p. 79. As a result of the ongoing negative economic and financial effects of policy changes by other countries on developing countries, the IMF has launched a new funding programme. While the so-called Trade Integration Mechanism (TIM) is not, according to the IMF, to be regarded as a new lending facility, it is designated to provide additional funding under existing IMF programmes to countries that have been hit by the trade policy changes in other countries (FT-Europe, 14 April 2004, p. 3). Rohls, Wilhelm, Die Voraussetzungen der Clausula Rebus Sic Stantibus im Völkerrecht, Münster 1989, p. 60. Simmler, Christiane, “Change of Policy” Die Änderung der politischen Linie eines Staates

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Court of Justice (ECJ) and the ICJ also tend to accept political changes as a possible basis for the clausula. Thus, in its Racke decision,29 the ECJ came to the conclusion that the EU was allowed to suspend the co-operation agreement between the Union and the former Republic of Yugoslavia on the grounds that the broad goals of this agreement, as defined in its preamble and its Article 1 (in particular an improvement of the mutual trade relations as well as an increase of wealth of the population)30 could not be attained in a war-torn country such as Yugoslavia at the time of suspension. A change of policy as a basis for the invocation of the clausula is also accepted in principle in the ICJ’s decision on the Gabčíkovo-Nagymaros Project between Hungary and Slovakia, agreeing that a fundamental change in circumstances may, under certain circumstances, allow a party to invoke the termination or suspension of the treaty.31 With regard to the financial and economic policy statements of industrialized countries vis-à-vis developing countries, reference can be made to numerous UN declarations. For example, the UN and its sub-divisions have repeatedly underlined the importance of combating the debt problem of developing nations. In 1978 the UNCTAD Trade and Development Board agreed on a resolution stating that: Developed donor countries will seek to adopt measures for such an adjustment of terms of past and bilateral official development assistance, or other equivalent measures [. . .] in order to enhance the development efforts of those developing countries in the light of internationally agreed objectives and conclusions on aid.32

Furthermore, in 1986 the General Assembly of the United Nations pronounced a right to development of each individual, including the right to participate in economical, social, cultural and political development.33 Art. 3 (1) of the aforementioned declaration continues:

29 30

31

32 33

als Voraussetzung für eine einseitige Vertragsänderung nach Art. 62 WVRK, (1999) 37 AVR, p. 234. ECJ, Racke/Hauptzollamt Mainz, Slg. 1998/I-3655. See: EC, Kooperationsabkommen zwischen der Europäischen Wirtschaftsgemeinschaft und der Sozialistischen Föderativen Republik Jugoslawien (EC 2471/94). ICJ, Case Concerning the Gabčíkovo-Nagymaros Project, (1997) ICJ Reports, p. 35 et seq. UN, Resolutions and Decisions, Suppl. 1 (1978) Res. 165 (S-IX) A 4. UN, Resolutions and Decisions, Suppl. 1 (1986) Res. 41/128, p. 365 et seq, Art. 1 (1).


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States have the primary responsibility for the creation of national and international conditions favourable to the realisation of the right to development.34

In a later resolution, the General Assembly then stressed that debt relief is a precondition for this right to development.35 Finally, the March 2002 Monterrey Consensus obliges both creditors and debtors to “share the responsibility for preventing and resolving unsustainable debt situations”.36 Similarly, the General Agreement on Tariffs and Trade (GATT) stipulates in section two that: [. . .]in the field of trade and economic endeavour [the contracting parties’ relations] should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income [. . .]

The GATT further stipulates that, to contribute to the attainment of these objectives, the contracting parties were eager to enter “into reciprocal and mutually advantageous arrangements.”37 These goals, however, are not always reflected in the terms as negotiated between the parties. For example, one of the original objectives of the 1996 Uruguay trade round negotiations was to liberalise trade in agriculture and to bring all measures affecting import access and export competition under strengthened, and more operationally effective, GATT rules and disciplinary measures.38 Indeed, as a result of the negotiations, market access was liberalised by converting non-tariff barriers to tariffs and by prohibiting further non-tariff barriers.39 However, the benefits for developing countries of tariff obligations and tariff reduction were undermined by many industrialised countries setting tariff equivalents for non-tariff barriers at excessively high levels.40 In particular for the commodities that are most important for developing countries, such as sugar, tobacco or meat, the tariffs were fixed

34 35 36

37 38

39

40

Ibid. UN, Resolutions and Decisions, Suppl. 1 (1986) Res. 41/133, p. 378. UN, Doc. A Q/CONF. 198/11, Report of the International Conference on Financing for Development, p. 11. GATT (1947), Preamble section 3. Cf. Sutherland, Peter D., Concluding the Uruguay Round – Creating the New Architecture of Trade For the Global Ecomomy, (2000) 24 Fordham Int’l L.J., p. 16. Martin, Will; Winters, Alan I. (ed.), The Uruguay Round and Developing Economies, World Bank Discussion Paper No. 307, Washington D.C. 1995, p. 8. Ibid., p. 11 et seq.

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at the highest levels.41 Furthermore, the Agreement on Agriculture, which was also a result of the Uruguay round, led to some sort of ‘grandfather subsidies’ since past receivers of subsidies were allowed to maintain them, while the introduction of new subsidies was prohibited.42 In this way, the existing unfair competitive advantages of industrialised countries were institutionalised. Finally, the Agreement on Agriculture set forth provisions to reduce domestic subsidies. The required reduction was calculated on the basis of an Aggregate Measure of Support (AMS), which is a baseline figure taking into account all domestic subsidies during the 1986–88 base period.43 The system of measuring compliance consisted of three “boxes”: “amber box” subsidies, which were deemed to be the most distortive to trade and were therefore forbidden; “blue-box” subsidies, which included certain direct payments to farmers under production limiting programs; and “green box” subsidies, which were deemed to have minimal or no trade-distorting effects.44 The latter two types of subsidy are excluded from the calculation of the current total AMS, which limits the efficiency of the agreement to an substantial degree, since this excludes precisely those subsidies most commonly used by developed countries, namely U.S. deficiency payments and EU compensation payments.45 The fact that the U.S. and the EU dominated the negotiations on agricultural aspects of the Uruguay Round agreements46 becomes all the more apparent from the definition of amber box subsidies. The reductions required by the Agreement under this heading produced only minimal effects on domestic support, since they were calculated according to the 1986–88 base period of extremely high domestic subsidies. When the Agreement eventually entered into effect, subsidies were considerably lower, so that only a reduction of a few percentage points was necessary for

41

42 43

44 45

46

Gonzalez, Carmen G., Institutionalizing Inequality: The WTO Agreement on Agriculture, Food Security and Developing Countries, (2002) 27 Column. J. Envt’l L., p. 461. Ibid., p. 464. McNiel, Dale E., Furthering the Reforms of Agricultural Policies in the Millennium Round, (2000) 9 Minn. J. Global Trade, p. 57. Ibid. Cf. McMahon, Joseph, The Uruguay Round and Agriculture: Charting a New Direction?, (1995) 29 Int’l Law, p. 427. Cf. Ritchie, Mark; Dawkins, Kirstin, WTO Food and Agriculture Rules: Sustainable Agriculture and the Human Right to Food, (2000) 9 Minn. J. Global Trade, p. 16.


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compliance with the Agreement.47 Thus, a move away from the noble goals of the GATT’s preamble is clearly apparent.48 The same is true of the UN declarations. In contrast to the statements therein, many creditor countries reduce their development finance, grant less favourable loans to developing countries or actively avoid a more structured procedure to improve the reorganisation of sovereign debt. However, even if one is inclined to accept certain policy changes introduced by industrialized countries with regard to developing nations, there are various differences between these and the Gabčíkovo case or the Racke decision. First of all, in Racke as well as in the Gabčíkovo case, the conditions and objectives that subsequently changed were included in the agreement to be suspended, while debt contracts do not usually refer to any goals of good trade co-operation or even of future debt relief. Furthermore, in both cases, the policy changes occurred in relation to legally binding obligations. In contrast, neither the preamble of the GATT, nor UN decisions are of a comparable binding nature. Although UN declarations can indicate the existence of international customary law,49 they are not sufficient for the emergence of customary international law, since they have only the character of recommendations.50 Even in the case of unanimous declarations by the General Assembly, these declarations cannot be seen as an expression of legally binding statements if at least some of the voting countries understood the resolution to be a (mere) political declaration.51 If these merely political declarations have some effect on contracts through mechanisms such as the clausula, this would, through the backdoor, make them binding again. An additional obstacle is that the prevalent political conditions would have to be so closely linked to the object and purpose of the treaty as to constitute

47 48

49

50

51

Gonzalez, supra n. 41, p. 467 et seq. A recent report by UNCTAD on trade preferences for LDCs revealed that the world’s poorest countries are still receiving only limited benefits from preferential trade schemes designed to help them due to gaps in coverage and restrictive rules of origins. Thus, less than half of all LDC exports to Canada, the EU, Japan and the US come in duty-free. All other products remain dutiable (FT-Europe, 7 April 2004, p. 6). ICJ, Case Concerning Military and Paramilitary Activities in and against Nicaragua, [1986] ICJ Reports, p. 99 et seq. Herdegen, Matthias, Völkerrecht, 2nd ed. München 2002, p. 144 (hereinafter: Herdegen (2002)). Ibid., p. 145.

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an essential basis for the consent of the parties and, in changing radically, would alter the extent of the obligations still to be performed.52 This will rarely be the case with loan agreements. 2.1.1.3. Violation of WTO Rules One could possibly argue that violations of binding WTO provisions have lead to a significant drop in income for developing countries and that it is this money they are now lacking to service their debt. A famous case one could mention in this context is the ‘bananas conflict’.53 Based upon Council Regulation 404/9354 the European Commission established three categories of banana-exporting countries. The first group, i.e. traditional banana exporting Africa-Caribbean-Pacific (ACP) countries, was allowed to import into the EU duty-free, up to an upper limit fixed for each country. The second group of non-traditional banana exporting ACP states received a maximum duty free quota of 90,000 tonnes, while the remaining countries were not granted duty-free access to the Union. In addition, ‘hurricane licence’ were designed to support producers affected by these tropical storms.55 At the request of the U.S.56 a WTO panel held that the Community’s licence allocation system, as well as the allotment of hurricane licences, was in breach of Articles I (1), III (4), X (3) and XIII(1) GATT, and also of Articles II and XVII of the General Agreement on Trade in Services (GATS).57 Measures such as the EC’s bananas regime undoubtedly harm

52 53

54 55 56

57

ICJ, supra n. 31, p. 61 et seq. From the vast literature on this case see for instance: Smith, Fiona, Renegotiating Lomé: The Impact of the World Trade Organisation on the European Community’s Development Policy after the Bananas Conflict, (2000) 25 E.L. Rev., p. 247 et seq. [1993] O.J. L47/1. Smith, supra n. 53, p. 250. Originally, the dispute was initiated by Latin American banana producers. The reason why the U.S., that does not export bananas at all, were asked to initiate the proceedings is due to the fact that a major disadvantage of the WTO’s dispute resolution system is a lack of final enforceability of panel decisions, in the sense that it would be meaningless or even harmful for (at least smaller) developing countries to retaliate against industrialised countries, the case they do not follow the panel’s orders; cf. Rom, Michael, Some Early Reflections on the Uruguay Round Agreement as Seen from the Viewpoint of a Developing Country, (1994) 28–6 J.W.T., p. 21. WTO, European Communities – Regime for the Interpretation, Sale and Distribution of Bananas – Complaint by the United States, WT/DS27/R/USA, 22 May, 1997, para. VII.97.


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developing countries’ economies.58 Nevertheless, it would be necessary to assume some kind of cross-default between the GATT/GATS provisions and the debt agreement in order to establish a link between these agreements. Furthermore, the debtor state would have to prove that a certain violation of GATT provisions resulted in its failure to service a certain debt obligation. In other words, there would have to be a causal relationship between the violation of a GATT duty and the violation of a debt contract.59 However, the likelihood that, in many instances, the rule-breaking country will not be similar to the creditor country, so that there will be no causality, is high. In addition, the negative and conditional wording of Article 62 of the Vienna Convention requires that the plea of fundamental change of circumstances only apply in exceptional cases.60 Thus, the clausula doctrine cannot be used as a means to generally avoid debt repayment, even in the case of violation of international rules. 2.1.2. Odious Debts Another approach used to find an exception from the principle of pacta sunt servanda in the area of state debt, which is particularly popular among non-governmental organisations (NGOs), is a reference to the odious debts doctrine.61 2.1.2.1. Definition The basic idea is founded upon the state practice and legal doctrine that those obligations contracted by a predecessor, contrary to the interests of its population, which are later taken over by a successor state, are odious. Those obligations are non-transferable to the successor state.62 However, further to this generally accepted principle, it is highly disputed whether so-called ‘regime debts’ are also excluded under international law. The first

58

59

60 61

62

Another example are subsidies by the EU on sugar; see: Oxfam, The Great EU Sugar Scam, Oxfam Briefing Paper 27, August 2002. Leyendecker, Ludwig, Auslandsverschuldung und Völkerrecht, Frankfurt am Main 1988, p. 164. Rohls, supra n. 27, p. 54. A list of groups supporting a cancellation of ‘odious debts’ can be found at: www.jubilee2000.org.au/ educational/odious_debts.pdf. Fiedler, Wilfried, State Succession, in: Bernhardt, Rudolf (ed.), Encyclopedia of Public International Law, Vol. IV, Amsterdam 2000, p. 646.

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commentator to popularize this view was the legal scholar Alexandre Nahum Sack, who wrote: If a despotic power incurs a debt, not for the needs or in the interests of the state, but to strengthen its despotic regime, to repress the population that fights against it [. . .] this debt is odious for the population of all the state.63

Consequently, it shall not be binding on the nation.64 According to this view, three conditions have to be fulfilled in order for a debt to be considered to be odious. First, the debt must have been contracted without the general consent of the nation. Otherwise, international law would prohibit states from concluding agreements that may turn out to be detrimental to them, or even those that are on their face detrimental to them, although the population appropriately legitimised the decision.65 Second, the funds borrowed

63

64

65

Sack, Alexandre Nahum, Les effets des transformations des États sur leur dettes publiques et autres obligations financière, Paris 1927, p. 157 et seq. (translation at: www.odiousdebts. org). See also in this context: Feilchenfeld, Ernst, Public Debts and State Succession, New York 1931, p. 450 et seq.; 860 et seq.; Foorman, James; Jehle, Michael, Effects of State and Government Succession on Commercial Bank Loans to Sovereign Borrowers, (1982) Ill. L.R., p. 21 et seq.; Fischer-Lescano, Andreas, Odious Debts und das Weltrecht, (2003) 36 KJ, p. 231 et seq.; Frankenberg, Günter; Knieper, Rolf, Rechtsprobleme der Überschuldung von Ländern der Dritten Welt, (1983) 29 RIW, p. 569 et seq.; O’Connell, D.P., State Succession in Municipal and International Law, Vol. I, Cambridge 1967, p. 458 et seq. Khalfan, Ashfaq et al., Advancing the Odious Debt Doctrine, CISDL Working Paper, Montreal March 2003, p. 14. More recently, the argument was made to give countries a right to repudiate their debt, even if those funds were borrowed by a democratically elected government (Cf. Nülle, Grant M., in a letter to the editor in FT-Europe, 20 February 2004, p. 12). Such repudiation of debts would be based on the principle that “in regard to public debt [opposed to private debt e.g. by a corporation, which shall have to continue to honour its debts], governments do not pledge their own assets, but taxpayers’ instead, with creditors cogniscant that the principle and interest will be paid through the involuntary confiscation of private property taxation” (ibid.) It is further argued that, if one were to ask taxpayers whether they pay their taxes willingly, or whether they are pleased to do so, the answer will certainly be negative. However, the logic that, since this is so, taxes were similar to an expropriation of private property, and that, consequently, all resulting contracts would scarcely deserve acknowledgement, is questionable (Blumencwejg, Ariel in a subsequent letter to the editor in FT-Europe, 25 February 2004, p. 12). Indeed, the unpleasantness of paying taxes does not reflect disagreement with the principle in general. Instead, this principle has been part of the social contract for quite a long time, as it was accepted as a means of striking a balance between individual freedom and social responsibility. Furthermore, if a government is democratically elected, it is, on the whole, comparable to a corporation, where the shareholders also have to ‘pay’ for the


61

must have been spent contrary to the interests of the nation. This means that, even in the case of a debt agreement with a government that is considered to be odious, the creditor would be entitled to restitution if the funds were used for the benefit of the population.66 Lastly, in addition to these objective criteria, it is also necessary that the creditors were subjectively aware of the odious purpose, and concluded the deal under that awareness.67 2.1.2.2. Types of Odious Debts Similar to the three classifications of successor state debts as odious,68 there are also three types of odious debts referred to in the case of regime debts, the purpose of which is to indicate the different contexts in which the doctrine has been invoked. The first of these categories is ‘hostile debt’. These are debts contracted in an aggressive (hostile) gesture, contrary to the interests of the population. For example at the Paris Conference of 1898, which followed the Spanish-American War and after Spain had ceded Cuba to the U.S., the U.S. refused to repay Cuban debt obligations. The U.S. argued that the loans had not been contracted for the benefit of Cuba, but rather contrary to its interests, as the funds were used to suppress, by military means, a popular uprising in Cuba and to reincorporate San Domingo into Spanish Dominions.69 The American commissioners at the peace conference furthermore argued that the burdens connected with these loans had been imposed on Cuba without the consent of its population.70 In addition to those hostile debts, there is a category of ‘war debts’, i.e. debts that are contracted by the losing state during war, or in expectancy of war. The winning side cannot be compelled to repay such debts.71 The case

66 67 68

69

70

71

decisions made by their chairmen (see ibid.) It would appear almost to be some sort of ‘cherry picking’ if a country’s voting population were able, on the one hand, to benefit from the ‘good’ decisions of its government, while on the other hand it could opt to be exonerated from bearing the consequences of the ‘bad’ ones. Ibid. Feilchenfeld, supra n. 64, p. 714. Cf. Grasshoff, Dietrich, Staatensukzessionsbedingter Schuldnerwechsel – Die Teilung öffentlicher Schulden unter Nachfolgestaaten im Dismembrationsfall, Münster 1993, p. 72 et seq. For an extensive description of the negotiations in Paris see: Feilchenfeld, supra n. 64, p. 329 et seq. The wording of the respective statement can be found at: Hoeflich, Michael, Through a Glass Darkly: Reflections upon the History of the International Law of Public Debt in Connection with State Succession, (1982) 1 Ill. L.R., p. 52 et seq. As Grasshoff notes, the dogmatic reasoning for this type of odious debt cannot be found in categories of financial law (idem, supra n. 68, p. 72).

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usually cited as an example is the British annexation of the Boer Republic in 1900. The British government refused to repay those debts incurred by the Boer Republics in order to try to repel the British military conquest calling them odious.72 A third category covers ‘political debts’, which are also often referred to as ‘dictator debts’.73 Examples cited for this category are proceeds spent on personal items, used to fight unjust wars, or distributed in a discriminatory manner.74 Cases that are therefore mentioned within this category include dictatorships, such as that found under the former Indonesian President Suharto and Nigeria’s late General Abacha, which borrowed billions of dollars from abroad, expropriated these funds for personal use and left it up to the population to repay the debts.75 Similarly, a large percentage of the funds borrowed by South Africa’s apartheid regime went toward financing the military and police and otherwise repressing the non-white majority in this country.76 Proponents of the odious debt doctrine in its broadest interpretation, which thus also includes debts contracted by dictatorial leaders in a way that provides no benefit to the population, argue that in these cases the creditors have committed a hostile act with regard to the people; they can’t therefore expect that a nation freed from a despotic power assume the ‘odious debts’, which are personal debts of that power.77

72 73

74 75

76

77

Hoeflich, supra n. 70, p. 58 et seq. Okeke, Chris N., The Debt Burden – An African Perspective, (2001) 35 Int’l Law, p. 1501 et seq. Khalfan et al., supra n. 65, p. 19. For the problems those countries are faced with, when trying to get some of the looted money back see: FT-Europe, 20 August 2003, p. 6. Rudin, Jeff, Challenging Apartheid’s Foreign Debts, available at: www.aidc.org.za/adc/ adc_booklet_ menu.html. Okeke, supra n. 73, p. 1503. See also Fischer-Lescano, supra n. 64, p. 235, who argues that due to violations of public international law, notably human rights, under the junta regime in Argentina from 1976–1983 Argentina’s debt obligations were odious. However, this approach ignores that the overwhelming part of Argentina’s debt was taken out by democratically elected governments. During the junta regime only an estimated $20bn were borrowed, most of which has been repaid in the meantime. Furthermore, all Argentine state debt was unconditionally accepted in 1984 by the democratic government under Raúl Alfonsín (Rivero, Alicia, Die Verschuldung Argentiniens während der Militärdiktatur, in: erlassjahr.de et al., Handbuch Illegitime Schulden, Düsseldorf 2003, p. 24).


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2.1.2.3. Odious Debts in International Law Consequently, it is interesting to know whether there is any evidence in international law in terms of customary acceptance of the doctrine of odious debts. The single applicable judicial decision in which “odious debts” after a change in government were considered not to be binding is the Tinoco Arbitration.78 In this case, Chief Justice Taft held that Costa Rica’s Secretary of War, Federico Tinoco, had used funds that he had gained from the issuance of several bills of credit by the Banco Internacional de Costa Rica to the Bank of Canada for his personal expenses.79 When Tinoco’s government fell and he fled the country, Costa Rica enacted a law invalidating all transactions between the state and the holders of these bills. Chief Justice Taft found that this legislation “did not constitute an international wrong.”80 While this single decision can hardly establish international custom within the meaning of Article 38 of the ICJ Statute, proponents of the odious debts doctrine often also cite a number of cases in which public debts were regarded to be unenforceable after state succession.81 This raises the question of whether one has to make a distinction between government and state succession, or whether the reference is legitimate. The basic reason for the odious debts doctrine in the field of state succession is the incongruence between the preceding and the succeeding state, and the aim is to allow the new state to integrate into the community of states in order to preserve stability and orderly relations between the states.82 However, the same goals could be claimed for government change. One might even argue that, in the case of a former dictatorship that has only recently started to establish a new democratic regime, integration into the international community is even more important. Accordingly, O’Connell writes, that

78 79 80 81

82

Great Britain v. Costa Rica, (1923) 2 Ann. Dig., p. 34 et seq. Ibid., p. 176. Ibid. In addition to the cases already mentioned concerning public debt of the Boer Republics and Cuba, these are above all the US repudiation of Texan debts (1844), the domestic practice in North and South Carolina and Mississippi in the 19th century, the Mexican repudiation of Austrian debts (1867), the Chilean conquest of Tarapaca (1880), the Soviet repudiation of tsarist debts (1918), the repudiation of Polish debts at the Treaty of Versailles (1919) and the German repudiation of Austrian debts (1938) (see: Khalfan et al., supra n. 65, p. 21). Fiedler, supra n. 62, p. 647.

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the line between these two types of change [i.e. state and government succession] in some instances wears thin to the point of disappearance, and the placing of a particular instance of change with the one or the other category is often quite arbitrary.83

Nevertheless, even if one were to assume that there were no significant differences between state and government succession, the emergence of an international custom allowing the cancellation of odious debts is doubtful. First of all, it should be acknowledged that the overwhelming majority of states, be it after liberation from former regimes or following a state succession, validated their debts.84 Moreover, the idea of creating an exception from the rule pacta sunt servanda for successor states has to be seen against the backdrop of decolonialisation and the desire to allow former colonies to become independent without a burden of debt.85 In contrast, nowadays, this perspective is vehemently rejected. Newly independent states established in the last decade did not even try to invoke the odious debts doctrine.86 The same is true for successor regimes. Typically, states do not repudiate debt, even when it was incurred under arguably ‘odious debts’ circumstances.87 This usually results from a weighing-up the advantages of a debt free budget and the fact that a ‘fresh start’ is not usually possible, as potential creditors will be reluctant to provide new funds to a debtor that recently refused to pay its debts.88 Moreover, international conventions or legal doctrine lend no support to the acceptance of an international custom. The only international convention that deals with the subject of repayment of state debt is the 1983 Vienna Convention on the Succession of States in Respect of State Property, Archives and Debts. It stipulates in Article 38 that no debt shall pass to newly emerging successor states, unless there is an agreement to that effect. The value of this convention in the discussion on odious debts is,

83 84 85

86 87

88

O’Connell, supra n. 64, p. VI. Sack, supra n. 63, p. 50 et seq. Acquaviva, Guido, The Dissolution of Yugoslavia and the Fate of its Financial Obligations, (2002) 30 Denv. J. Int’l L. & Pol’y, p. 215. Ibid. Kremer, Michael; Jayachandran, Seema, Odious Debts, IMF Working Paper, April 2002, available at: www.imf.org/external/np/res/seminars/2002/poverty/mksj.pdf, p. 7 et seq., citing the cases of Mobutu (former Zaire); Marcos (Philippines), Somoza (Nicaragua), Tudjman (Croatia) and the South African apartheid regime. Even supporters of the odious debts doctrine agree that an amicable agreement is preferable to a unilateral debt default (Fischer-Lescano, supra n. 64, p. 237).


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however, limited. First of all, the Convention has not yet entered into force and will probably never do so. Instead it is seen as an example of a failed attempt at international codification, which was not able to attract sufficient international support.89 Secondly, while the International Law Commission (ILC)90 draft for the Convention contained a provision dealing with odious debts, this provision was ultimately excluded.91 This demonstrates that, although the issue was considered during the negotiations, both the states and the commission were reluctant to include the doctrine of odious debts in a treaty. Recent developments further underline that resistance. For instance, according to the draft proposal for a modification of the 1983 Vienna Convention on Succession of States by the Institute of International Law,92 an exception from the pacta sunt servanda principle for odious debts is explicitly to be excluded.93 Finally, there are numerous difficult aspects concerning the practical application of the theory. Pursuant to the odious debts doctrine, debts shall only be considered to be odious if the population did not consent to the debt. This constitutes a difficult and onerous burden of proof. When Sack first made his proposal, he envisaged that the doctrine would be applied exclusively to dictatorial regimes.94 Then, however, the burden of proof is simply shifted, since the question remains which regimes can be stipulated to be ‘dictatorial’. Does the term include all states that are not governed by democratically elected leaders? And which standard applies? According to European ideals of democracy, many developing countries could probably be labelled at least undemocratic. The same questions arise in considering whether there is an absence of benefit. Who should decide – the population 89

90

91

92

93 94

Ruffert, Matthias, Probleme der Staatensukzession im Hinblick auf Vermögen und Schulden – Tagung der VII. Kommission des Institut de Droit International vom 21.–24.9.2001 in Trier, (2001) 54 NJW, p. 2235. The ILC is an institution created by the UN in 1947, which is made up of thirty-four experts selected by the General Assembly, and whose responsibility it is to initiate studies and make recommendations for the purpose of encouraging the development of international law and its codification; (see also: www.un.org./law/ilc). Wood, Philip, The Law and Practice of International Finance, London 1980, p. 120 et seq. The Institute of International Law is an institution that regularly assembles renowned international lawyers to contribute in an independent manner to the development of international law by adopting resolutions which are then brought to the attention of international organisations and governments; see also: www.idi-ill.org. Cf. Ruffert, supra n. 89, p. 2235. Sack, supra n. 63.

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itself?; the creditors?; or a neutral party? In the latter case, one might also ask whether the determination by external parties of a borrower country’s needs is compatible with the principle of state sovereignty and the developing world’s desire for self-determination.95 The most difficult (and in practice barely resolvable) problems follow from the requirement to prove the creditors’ subjective awareness. While a bank loan can be issued for a specific purpose specified in the contract, and while a bank might also be able to issue disbursements in instalments conditional upon the application of the funds to the specified purposes,96 this is virtually impossible for bond creditors. As bond lending in the meantime counts among the prevailing means of financing for developing countries,97 the odious debt doctrine would ultimately be harmful to developing countries as capital flows to them would significantly decline. Thus, in conclusion, the odious debt doctrine seems rather to aggravate the debt crisis instead of improving the situation of the countries concerned. In addition, there is a temptation to use the argument of odious debts to disguise political aims. Critics could cite as a recent example of this the American position in view of Iraqi debts. America seemed to be inclined to favour the cancellation of these debts.98 Indeed, large parts of the debts were due to the purchase by the Iraqi regime of weapons, particularly in the wake of the outbreak of the last Gulf war.99 In addition, according to a report published by Fitch Ratings, interest payments alone would require 37 percent of Iraq’s GDP were it to service all $120bn external debt. Default would thus appear to be unavoidable in any case.100 Nevertheless, one should also be aware that the largest creditors also include the main objectors the UN Security Council concerning the war against Iraq – above all France, Germany and Russia101 and that, at the same time,

95

96 97 98

99 100 101

Park, William W., Legal Policy Conflicts in International Banking Law, (1989) 50 Ohio St. L.J., n. 6. Khalfan et al., supra n. 65, p. 48. Scott, supra n. 20, p. 104. It is worth noting that the Bush administration seized $1.62bn in Iraqi assets frozen in the US, which are supposed to have come from illegal oil-smuggling schemes. This money was not returned to Iraq or used to compensate outstanding debt, but was transferred to an account at the Federal Reserve Bank of New York; news.com.au 1 July 2003, Bush seizes Iraqi assets, available at: www.news.com.au/common/story_page/ 0,4057,6201459%5E25778,00.html. FT-Europe, 1 May 2003, p. 19. Cf. FT-Europe, 26 May 2004, p. 29. Those three countries were owed about $3bn, $2.5bn and $4bn respectively in principal


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Iraqi debt owed to the U.S. (totalling $2.2bn) was relatively small.102 Indeed, the fact that the US did not suddenly become a proponent of general debt relief in support of the odious debts doctrine is underlined by U.S. officials’ comments that Iraq should be handled as a one-off case.103 Feilchenfeld, whose work still represents the most comprehensive treatment of the subject of odious debts to date, thus makes the point that the (non)repayment of debt contracted against the interests of the population of a state is not a question of law, but of justice.104 Due to these factors, the odious debts doctrine does not provide a valid, legally well-founded, argument for the cancellation of sovereign debt obligations. 2.1.3. State of Necessity A defence available to sovereign states under international law is the state of necessity. The early doctrine of necessity as represented by Grotius, the ‘father of international law’, coupled the state of necessity with the notion of self-preservation, i.e. when a state was threatened with ruin it was considered justifiable for the state to preserve its existence by taking any steps necessary.105 In contrast, the modern state of necessity doctrine modified

102 103 104

105

and roughly the same in unpaid interest. The second important group of creditors are the Gulf States which granted to Iraq loans running to some $50bn during the 1980–1988 Iran-Iraq war, mainly to finance the Iraqi army to protect themselves against the fundamentalist regime in Teheran; see: FT-Europe, 16 December 2003, p. 12. In fact the US won the support of the European creditors to cancel at least part of the Iraqi debt they hold. In return the Pentagon’s decision to exclude companies from countries that opposed the war from bidding for rebuilding contracts in Iraq was apparently beginning to crumble (FT-Europe, 23 December 2003, p. 1). After a visit of James Baker, US special envoy on the issue, Japan also agreed to forgive a big part of Iraq’s debt (FT-Europe, 29 December 2003, p. 4). In contrast the Gulf nations refused to discuss the issue of debt forgiveness with the US-appointed interim Governing Council, saying that it was an issue to be discussed between sovereign governments (FT-Europe, 24 December 2003, p. 3). FT-Europe, 9 June 2004, p. 4. Cf. FT-Europe, 16 December 2003, p. 12. Cf. Feilchenfeld, supra n. 64, pp. 701, 714; thus Russia has agreed to forgive a substantial part of the debt owed to it by Mongolia. This move, however, has to be seen against the backdrop, that Mongolia’s ratio of government debt to GDP, even excluding the Russian loans, is yet 93 percent. Thus it might be argued, that Russia only forgave what it could not reasonably expect to recover anyway; cf. FT-Europe, 2 January 2004, p. 11. Grotius, Hugo, De Jure Belli Ac Pacis, Libri Tres bk. II, ch. XIV, para. XIII, cl. 4 (trans. F.W. Kelsey, 1925).

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this early understanding towards a broader defence for a state’s otherwise unlawful violation of international law in the name of an essential interest.106 A codification of the modern approach can be found in Article 25 of the ILC’s Draft Articles on the International Responsibility of States (Draft Articles), which is worded as follows:107 Article 25 – Necessity 1. Necessity may not be invoked by a State as a ground for precluding the wrongfulness of an act not in conformity with an international obligation of that State unless the act: (a) Is the only way for the State to safeguard an essential interest against a grave and imminent peril; and (b) Does not seriously impair an essential interest of the State or States towards which the obligation exists, or of the international community as a whole. 2. In any case, necessity may not be invoked by a State as a ground for precluding wrongfulness, if: (a) The international obligation in question excludes the possibility of invoking necessity; or (b) “The State has contributed to the situation of necessity.”

Although the ILC’s drafts do not have the quality of a treaty, its work is accepted as an authoritative statement108 and the ICJ concluded in its Gabčíkovo decision that Article 33 – the virtually identical predecessor of Article 25 – reflects customary international law.109 Indeed, the existence of an international state of necessity is accepted by treaties such as the European Convention of Human Rights (ECHR) and the International Covenants on Civil and Political Rights (ICCPR). The state of necessity is also seen as part of international law by the overwhelming body of legal doctrine.110 In contrast, one issue that is still being discussed seriously is whether, or in how far, the state of necessity doctrine applies in the case of sovereign

106 107

108

109 110

Herdegen (2002), supra n. 50, § 59 n. 4. UN, Report of the International Law Commission – Fifty-third session (23 April–1 June and 2 July–10 August 2001), Supplement No. 10 (A/56/10), p. 194 et seq.; available at: www.un.org/ilc/reports/2001/2001/report.htm (hereinafter: UN (2001)). Boed, Roman, State of Necessity as a Justification for Internationally Wrongful Conduct, (2000) 3 Yale Hum. Rts. & Dev. L.J., p. 13. ICJ, supra n. 31, p. 40. See e.g. Herdegen (2002), supra n. 50, § 59 n. 4 et seq.; Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 710.


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insolvency.111 To this end, the following discussion will assess the conditions of necessity in relation to sovereign default. 2.1.3.1. Essential Interest Art. 25 (1) lit. a Draft Articles requires that the wrongful act must be the only possibility for the state to safeguard an essential interest. In this respect, it is striking that the term ‘essential interest’ does not necessarily include the very existence of the state itself.112 Instead, the determination of whether or not an interest is essential depends on the circumstances of the individual case and cannot generally be prejudged.113 By way of an example, Roberto Ago, who at the request of the ILC prepared a study on the concept of necessity, which later became the model for Art. 33 Draft Articles, cites the following as belonging to a state’s essential interests: “political or economic survival, the continued functioning of its essential services, the maintenance of internal peace [and] the survival of a sector of its population.”114 In addition, it is recognized that an essential interest does not have to affect the country as a whole. Rather a part of it is sufficient. This can be illustrated by the Torrey Canyon incident.115 In this incident, a Liberian oil tanker ran aground off the British coast. To avert the spillage of the entire cargo of 117,000 tons of crude oil into the sea, and the subsequent pollution of the English coastline, Britain decided to bomb the vessel.116 Although the danger of the oil spill threatened only parts of the British coast, and did not threaten Britain’s existence as such, the lawfulness of this action was not disputed.117 Similarly, in the Gabčíkovo case, the ICJ proceeded on the assumption that the threat of an ecological catastrophe in the region of Budapest as a consequence of the planned 111

112

113 114

115 116 117

In favour: Ohler, Christoph, Der Staatsbankrott, (2005) 60 JZ, p. 595; critically: Baars, Alf; Böckel, Margret, Argentinische Staatsanleihen vor deutschen und argentinischen Gerichten, (2004) 16 ZBB, p. 458 et seq.; see also: OLG Frankfurt a. M., Decision 26 June 2003 – 8 U 52/03, (2003) 56 NJW, p. 2688 et seq. UN, Report of the International Law Commission – Thirty-second session (5 May–25 July 1980), (Document A/35/10), (1980) 2 Y.I.L.C., p. 34 et seq. (hereinafter: UN (2001)). Ibid., p. 202. Ago, Roberto, Addendum to the Eighth Report on State Responsibility (Document A/ CN.4/318/ADD.5–7), (1980) II–2 Y.I.L.C., p. 156. See: UN (2001), supra n. 112, p. 202. Ibid. Ibid.

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system of dams and locks on the Danube, could establish a state of necessity and that Hungary could therefore, in principal, be allowed to violate its international obligations.118 There are numerous reasons why states that cannot service their debts may be in a situation where an essential interest is threatened. The essential interest that has to be safeguarded, namely the lives of its people, is most obvious for LDCs where even minor changes of the economic situation can cause devastating famines.119 However, for countries such as Argentina also, regional famines were reported after the default and about half of its population was living below the poverty line.120 Furthermore, at least to the extent that the defaulting country is dependent on IMF loans, it will have to implement austerity measures, such as a reduction of social welfare, which will almost unavoidably result in violent street protests, thus undermining internal peace.121 A general threat facing all defaulting states is their inability to further take part in transactions on the international financial markets.122 At present, creditors of defaulting states attempt to attach a significant range of assets located abroad, which are not protected by sovereign immunity. In particular, lawsuits have been brought to attach foreign payments, not only on restructured debt, but also on other preferred multilateral debt, or even for the importation of goods and services.123 Thus, the economic survival, and to an even greater degree the economic rehabilitation of the defaulting state, are made extremely difficult and, in the worst cases, may even be rendered impossible. Another question concerning this issue is whether creditors’ claims should be regarded in isolation or cumulatively. It is true that the size of most claims is relatively minor, so that, regarded separately, they do not constitute a

118 119 120

121

122 123

ICJ, supra n. 31, p. 39 et seq. Leyendecker, supra n. 59, p. 218. FT-Europe, 20 April 2004, p. 4; a reduction of the standard of living below this line, which was fixed at subsistence level, cannot be regarded as a mere social duress anymore, which otherwise is not sufficient to invoke a state of necessity (cf. Pfeiffer, Thomas, Zahlungskrisen ausländischer Staaten im deutschen und internationalen Rechtsverkehr, (2003) 102 ZVglRWiss, p. 141 et seq.). An example is the Dominican Republic, where street protests followed a government decision not to subsidize the electricity supply, which in turn was necessary to obtain the lifting of a suspension of an IMF loan; FT-Europe, 14 November 2003, p. 4. Pfeiffer, supra n. 120, p. 165. Scott, supra n. 20, p. 117.


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threat to a state’s financial or economic situation.124 However, due to the cross-default clauses that are inserted in most sovereign debt agreements, default with regard to one debt obligation means a default on all other obligations.125 According to the principle of equality between creditors, the debtor state is therefore obliged to repay all creditors: i.e. the decisive factor is not the effect of the obligation to repay a single debt, but rather the effect of a cumulative obligation to repay all debt.126 Furthermore, the cases of the Dart family and of NML Capital, which were both attempting to seize Argentine assets worth $700m127 and $172m128 respectively, demonstrate that even an isolated assessment could well result in the sovereign’s economic and financial stability being tangibly burdened.129 2.1.3.2. Grave and Imminent Peril Furthermore, the essential interests would have to be safeguarded against a grave and imminent peril arising from the debt repayment obligation. Otherwise, the steps taken would not be justified on grounds of necessity. The ICJ referred to the precondition of peril as a “risk [since this] is precisely what distinguishes ‘peril’ from material damage”.130 A risk of this kind for the essential interests of a defaulting state will often exist. The main threshold is, accordingly, the imminence of this risk. As to imminence, the ICJ

124

125

126 127 128

129

130

Cf. e.g. OLG Frankfurt, supra n. 111, p. 2689, underlining the fact that it should not be a problem for a country like Argentina to repay debts of around € 220,000. Goldman, Samuel E., Mavericks in the Market: The Emerging Problem of Hold-Outs in Sovereign Debt Restructuring, (2000) 5 UCLA J. Int’l L & Foreign Aff., p. 170. Dolzer, supra n. 2, p. 552. See: FT-Europe, 3 November 2003, p. 5; FAZ, 3 November 2003, p. 13. Cf. Investments Magazine, 21 November 2003; available at: www.investmentsmagazine. com/ ManageArticle.asp?c=60&a=5342. This is already the second time that the Darts – a family that accumulated an enormous wealth through the styro-foam cup industry – refused to convert under a restructuring plan, but claimed for the full amount after a sovereign debtor’s default. Their tactics are as simple as they are effective. The family buys debt papers of a country for prices substantially less than face value. When this debt is being restructured, they refuse to accede to the negotiated restructuring agreement and proceed to secure a deal for themselves, which is substantially better than the arrangement agreed to by the other creditors; for a detailed discussion of the first Dart litigation in the 1990s, concerning Brazilian debt, cf. Allegaert, Theodore, Recalcitrant Creditors Against Debtor Nations, or How to Play Darts, (1997) 6 Minn. J. Global Trade, p. 447 et seq.; Goldman, supra n. 125, p. 185 et seq. ICJ, Gabčíkovo-Nagymaros Project, supra n. 31, p. 42.

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observed that this term “is synonymous with ‘immediacy’ or ‘proximity’ and goes far beyond the concept of ‘possibility’”.131 In the context of sovereign insolvency, it was argued that the grave and imminent peril precondition, i.e. the sufficient proximity of the risk, could be seen in the immediate threat of measures of compulsory execution. Only in view of those measures could the excuse of necessity then be raised.132 This interpretation may initially appear to differ from the ICJ’s understanding of this criterion. In the Gabčíkovo case, the ICJ held that the requirement of proximity does not exclude [. . .] that a peril ‘appearing’ in the long term might be held to be ‘imminent’ as soon as it is established, at the relevant point in time, that the realization of that peril, however far off it might be, is not thereby any less certain and inevitable.133

However, provided there are no measures of compulsory execution ‘in the pipeline’, the potential dangers of a judgment in favour of debtor state creditors remain uncertain.134 The situation might be different in countries that do not distinguish between the contentious proceedings and the enforcement process. However, from a comparative point of view, most countries make a distinction between these two kinds of procedures and this is also the approach of the international law doctrine.135 Furthermore, even the ICJ concludes under its (rather broad) definition of imminence that the required proximity is not given until the final decisions upon which a behaviour resulting in a grave peril are made.136 Thus, the Regional Court Frankfurt am Main, Germany, concluded in a case concerning outstanding Argentine debt that should be secured by arrest: [E]ine unmittelbare Gefährdung der Zahlungsfähigkeit und Funktionsfähigkeit der Arrestbeklagten würde erstmals dann eintreten, wenn in dem sich anschließenden Zwangsvollstreckungsverfahren mit einer konkreten Zwangsvollstreckungsmaßnahme unmittelbar auf die Arrestbeklagte eingewirkt würde [. . .]137

131 132 133 134 135

136 137

Ibid. BVerfGE, Judgment 6 March 2003 – 2 BvR 397/02, [2003] DVBl., p. 662. ICJ, Gabčíkovo-Nagymaros Project, supra n. 31, p. 42. Cf. Ibid. Cf. LG Frankfurt, Judgment 14 March 2003 – 2–21 O 294/02, p. 6; available at: www. landgericht.frankfurt-main.de/ZS_Urteil_lang(Argentinien_I).htm. ICJ, Gabčíkovo-Nagymaros Project, supra n. 31, p. 43. LG Frankfurt/M., Judgment 14 March 2003 – 2–21 O 509/02, (2003) 58 JZ, p. 1012.


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With regard to this position, it is argued that a debtor state’s external economic and fiscal activities abroad would be virtually exhausted, since the country would be reluctant to expose any of its assets to a potential seizure.138 It seems however that the starting point for determining imminence should not be whether an enforcement action by a single creditor will fulfil the preconditions of a state of necessity. Instead, it should be asked whether or not the insolvency of a country itself is sufficient to grant the sovereign protection under the necessity doctrine.139 The individual enforcement actions should then be seen as an aggravation of the (already pre-existing) state of necessity. As to the gravity of the peril, Leyendecker discusses as possible indicators the currency reserves, GDP, export gains and balance of payments of the defaulting debtor country.140 He concludes that none of these factors can be regarded as useful to the general assessment of whether or not there is a grave peril.141 Other comments on this criterion are sparse. Neither the ILC commentaries on Art. 25, respectively Art. 33 Draft Articles, nor the ICJ judgments specify criteria for the measurement of this condition. Boed suggests that “any threat to destroy the possibility of realizing an essential interest constitutes ‘grave peril’.”142 In this sense one can also argue that in most cases where an imminent risk to an ‘essential interest’ exists, this risk will also be ‘grave’, since otherwise there will usually be no danger to an essential interest of a state. The main focus of the requirement of gravity can thus be seen as underlining the notion that “nothing short of extreme exigency” will be sufficient to invoke a state of necessity.143 2.1.3.3. “Only Means” Not only must an essential interest be in grave and imminent peril, the action taken must be the ‘only means’ available to safeguard the essential interest. In other words, if there is another means available to avoid a violation of international law, the plea of necessity is excluded.144 If such

138 139

140 141 142 143 144

Pfeiffer, supra n. 120, p. 165. Reinisch, August, Anmerkung zu LG Frankfurt/M., Urteil v. 14 March 2003 – 2–21 O 509/02, (2003) 58 JZ, p. 1015. Leyendecker, supra n. 59, p. 222. Ibid., p. 226. Boed, supra n. 108, p. 28. Ibid., p. 16. Hahn, Hugo J., Das Völkerrecht der Auslandsschuldenregelungen, (1989) 42 Kreditwesen, p. 318.

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other means, which can be adopted in compliance with international obligations, are available, this is the path that must be taken, even if it is a less convenient or a more costly one.145 In the same way, in the Gabčíkovo case it was considered that there would have been means available to Hungary other than the unilateral suspension and abandonment of the project146 although these other means would, according to the dissenting opinion of Judge Herczegh, have been “enormously expensive.”147 Thus, it could not be argued, for instance, that there will be higher costs for legal advice for a debtor country if the state of necessity can only be raised in the procedure of execution, supposing that, as a consequence, creditors with a legal title might attempt to trigger world-wide measures of execution.148 Similarly, it is not sufficient to argue that default helps to bring a national economy ‘back on the right track’ more quickly. Noteworthy possible alternative means to avoid the plea of necessity in the case of sovereign insolvency are the following: further repayment until conclusion of a restructuring agreement; new borrowing, new austerity measures and stricter budgetary discipline; tax increase; stricter control of capital flight and realisation of public assets.149 There is no generally agreed definition limiting reference to the additional cost or effort that may be borne by the debtor country when adopting alternative means. It is, however, emphasised that a limit should at least be reached if the additional cost of the alternative is of such magnitude as to render resort to it “a threat to an essential interest of the State in itself.”150 In conclusion, only if there are no means that do not in themselves jeopardize a country’s essential interests, can the plea of necessity be justified. 2.1.3.4. The Balancing Requirement As set forth in Article 25 (1) lit. b Draft Articles, the conduct in question must not “seriously impair an essential interest of the other state or states towards which the obligation exists, or of the international community as a whole.” Accordingly, it is necessary to balance the competing interests of

145 146 147 148 149 150

UN (2001), supra n. 112, p. 203. ICJ, supra n. 31, p. 43. See: Dissenting Opinion by Judge Herczegh, [1997] ICJ Reports, p. 185. Cf. Pfeiffer, supra n. 120, p. 165. Leyendecker, supra n. 59, p. 227 et seq. Boed, supra n. 108, p. 18.


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the parties concerned,151 i.e. on the one hand the interest of the debtor state who invokes the doctrine of necessity and on the other hand the harm done to the party claiming violation of obligations under international law. The balancing requirement is only met if “the interest sacrificed on the altar of ‘necessity’ [is] obviously less important than the interest it is thereby sought to save.”152 In other words, an essential interest may not be sacrificed for the sake of respecting a right that is, in objective terms, minor.153 To make the “scales tip in favour of the essential interest of the state that has acted unlawfully”,154 consideration must be given to all competing interests, whether these are interests of a state or of individuals.155 Thus, if, due to a stoppage of repayment by a debtor state, its creditors – whether private or public – themselves enter a state of necessity, the debtor state will be hindered if it wishes to invoke this defence.156 However, the balancing requirement is not fulfilled if there is a disparity between the interests concerned, but also taking into account the exceptional character of the necessity doctrine, this disparity is not too great. 2.1.3.5. Exceptions to the Application of Necessity All the preconditions discussed above must be satisfied cumulatively. However, even in this case, reference to this defence is barred if a contractually agreed provision explicitly or implicitly excludes the invocation of the state of necessity with respect to the violated obligation, or if the state invoking the defence has contributed to the state of necessity. Contract Provision The first exception to the application of necessity arises if the violated obligation is based upon a contract that contains an implicit or explicit non-derogation clause. Usually, debt agreements do not contain provisions explicitly dealing with a potential state of necessity.157 An implicit, silent waiver of the right to invoke the necessity defence, however, could be seen in the fact that the debtor state agrees to contract on 151 152 153 154 155 156 157

Herdegen (2002), supra n. 50, § 59 n. 4. UN (2001), supra n. 112, p. 50. Boed, supra n. 108, p. 19. Ibid., p. 18. UN (2001), supra n. 112, p. 204. Pfeiffer, supra n. 120, p. 166. Leyendecker, supra n. 59, p. 235.

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a private law level by issuing bonds etc. under private law. In consequence, one could try to argue that, since the state acts under private law, it has to be treated as a private entity and, thus, may not be allowed to refer to defences under public international law.158 However, this argument is flawed as it confronts the debtor state with a double disadvantage, which cannot be justified. Indeed, one could discuss the possibility of treating a sovereign acting under private law like any other private entity. In this case, the state of necessity doctrine would not be applicable. On the other hand, a private entity usually possesses certain rights and defences when it defaults, such as the automatic stay. Accordingly, these private law rights should also be granted to the sovereign. There is no reason why a state should, on the one hand be treated as a private entity, namely when it is to decide whether or not international public law defences are applicable, but on the other hand be treated as a sovereign when considering the application of private law defences. To avoid this double disadvantage states are thus granted the right to refer to the state of necessity, even if they are acting under private law. Nevertheless, the remaining question is whether an exception should be made when a sovereign is contracting with an individual, as this could be regarded as the state’s waiver of its rights under public international law, i.e. that an international law defence, such as the state of necessity, could not be invoked against an individual. This leads to the basic question of whether there is any rule to the effect that individuals cannot be subject to public international law. Firstly, as mentioned previously, there is widespread agreement as to the general distinction between governmental acts that are iure gestionis and those that are iure imperii.159 Only the latter are seen as sovereign acts that enjoy sovereign immunity. However, as discussed, there is no distinction pursuant to which governmental acts governed by private law generally deprive the sovereign of its rights under public international law.160 Traditionally, rules concerning public international law were considered to be binding only on the entities that created these norms.161 Consequently, only states were viewed as being subject to international law and capable

158

159 160 161

Cf. v. Hoffmann, Bernd, Art. 28 EGBGB, n. 193 in: Soergel, Hans Th., Kommentar zum Bürgerlichen Gesetzbuch, vol. X, Stuttgart 1996. See supra Part A, Chapter I, 1.2.2. Cf. Pfeiffer, supra n. 120, p. 166 et seq. Mowery, Lauren, A., Earth Rights, Human Rights: Can International Environmental Human Rights Affect Corporate Accountability?, (2002) 13 Fordham Envtl. L.J., p. 367.


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of bearing legal rights and duties thereunder.162 Nevertheless, this did not mean that public international law was of no relevance for individuals. A regularly quoted example for the former practices is the Société Commerciale de Belgique case of 1939.163 This case dealt with the claim of the said company against the Greek Government to repay a sum of money that the company had extended to Greece in a loan contract. However, Société Commerciale de Belgique could not itself apply to the Permanent Court of International Justice. Instead, it had to apply through the Belgium state as an intermediary.164 This practice has changed significantly over the last decades.165 The starting point of the process can be seen to be the desire of many developing nations to attract foreign investors.166 This, in turn, has led to a growing tendency to grant rights directly to individuals under international instruments, in particular those protecting investment and promoting trade, including mechanisms for corresponding dispute resolution. Thus, investors have been guaranteed fair and equitable treatment, the right of free repatriation of profits and liquidated proceeds or, most importantly, the right to receive full economic value in the event of an expropriation. The leading example of this tendency is the International Centre for the Settlement of Investment Disputes (ICSID), which was established in 1965 to provide facilities for the arbitration of international investment disputes.167 Article 25 ICSID Convention explicitly requires rationae personae that one party be a state, while the other must be a non-state actor. In so doing, full admissibility as a party in court for private entities before an international and supra-regional court of arbitration was accepted for the first time by international law.168

162

163 164 165

166

167 168

See Serreni, stating that applying public international law to private persons was “tantamount to seeking to apply the matrimonial law of France or England to relations between cats or dogs” (idem, International Economic Institutions and the Municipal Law of States, (1959–I) 96 RdC, p. 210). PCIJ, Series A/B, No. 78 (1939), p. 160 et seq. Ibid. Cf. Seidel, Gerd, Die Völkerrechtsordnung an der Schwelle zum 21. Jahrhundert, (2000) 38 AVR, p. 32 et seq. Ratner, Steven, R., Corporations and Humans Rights: A Theory of Legal Responsibility, (2001) 111 Yale L.J., p. 458. Another example is the Iran-US Claims Tribunal, established in 1981. Theodoru, Heleni, Investitionsschutzverträge vor Schiedsgerichten, Berlin 2001, p. 70; Tietje, Christian, Die Argentinien-Krise aus rechtlicher Sicht: Staatsanleihen und Staateninsolvenz, Beiträge zum Transnationalen Wirtschaftsrecht, Paper No. 37, February 2005.

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It should be noted that, except in one single case, claims have always been brought before ICSID by the non-state party.169 In contrast, a state of necessity, as discussed here, would exclusively be invoked by states. The consequences of invoking a state of necessity, entail a limitation of private parties’ rights; it is they who have to accept the stoppage of repayment without having the opportunity to take legal action. Thus, it might be questioned whether individuals, in addition to having rights under international law, can also be subject to effects that are disadvantageous to them. In fact, in contrast to the rich accretion of rights to private parties under international law, there was initially much more reluctance to impose obligations upon individuals by means of international law.170 Since the Nuremberg Trials, though, international law has increasingly recognized duties incumbent upon individuals under international law. For instance, states have accepted duties of non-state actors through the corpus of international criminal law on human rights atrocities such as war crimes, genocide or crimes against humanity.171 While, in some cases, individual responsibility is still linked with the individual acting as an agent of the state,172 treaties such as those in the area of slavery, demonstrate that wholly private actors can also incur responsibility under international law.173 One might, however, argue that duties of individuals, recognized under international criminal law and humanitarian law conventions, were intended to internationalize the offences, and to thereby distinguish them from ‘ordinary crimes’.174 In other words, one might argue that these ‘manifestations of

169

170

171 172

173

174

Lörcher, Torsten, Neue Verfahren der internationalen Streitbeilegung in Wirtschaftssachen: Verfahren vor dem Internationalen Seegerichtshof, WTO-Panelverfahren, ICSID- und WIPO Schiedsverfahren, Frankfurt/M. 2001, p. 167. Redmond, Paul, Transnational Enterprises and Human Rights: Options for Standard Setting and Compliance, (2003) 37 Int’l. Law., p. 71 et seq. Ratner, supra n. 166, p. 466 et seq. Cf. for a corresponding borderline case, the payments of compensation by German enterprises to forced labourers during the Nazi regime (Bank, Roland, Die Leistungen an NS-Zwangsarbeiter durch die Stiftung „Erinnerung, Verantwortung und Zukunft“ – Ein Modell für die Entschädigung von Menschenrechtsverletzungen?, in: Marauhn, Thilo (ed.), Die Rechtsstellung des Menschen im Völkerrecht – Entwicklungen und Perspektiven, Tübingen 2003, p. 83 et seq.) See e.g. the Supplementary Convention on the Abolition of Slavery, the Slave Trade, and Institutions and Practices Similar to Slavery of 7 September 1956. See e.g. Articles 6 et seq. of the Rome Statute of the International Criminal Court of 17 July 1998.


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evil’ are not on the same level as an individual wishing to claim repayment against a sovereign debtor. However, practice by international courts, such as the European Court of Human Rights, the European Court of Justice, or of certain UN human rights bodies, goes much further. Thus, the ECJ has held that provisions in the Treaty of Rome, which prohibit states from discriminating on the basis of nationality or gender, are equally and, above all, directly applicable to private entities.175 Moreover, there is a growing body of international legislation in favour of individual obligations, including the areas of international labour law,176 international environmental law and anti-corruption law.177 Other examples of the – at least indirect – recognition of duties of individuals under international law are the sanctions imposed by the UN Security Council, e.g., due to the Security Council’s security regime in Iraq, oil companies, which intended to trade with Iraq, had to apply for permission from the Council’s sanctions committee and comply with its directives.178 The cumulative impact of this lawmaking, case law, and application of the legal rules underlines that individuals are recognized as subjects of international law. It is beyond the scope of this work to discuss the political pros and cons of individual liability under international law.179 Nevertheless, if states and international organisations accept rights and duties of individuals in some areas, and against the backdrop that there is no general rule providing that individuals are excluded from being subject to international law,180 then there are no legal grounds why rights and duties for individuals should not be recognised in the area of international finance. Consequently, individuals can be seen as being (at least partial) subjects of international public law.181 This finding is also supported by the fact that, otherwise, private creditors would receive more favourable treatment compared with public creditors,

175 176 177 178

179

180 181

ECJ, Walrave v. Association Union Cycliste Internationale, [1974] E.C.R., p. 1405. Ratner, supra n. 166, p. 478 et seq. In detail: ibid., p. 477 et seq. UN, Annual Report of the Security Council Committee Established by Resolution 661 (1990), para. 7 et seq. Cf. Brownlie, Ian, Principles of Public International Law, 5th ed., Oxford 1998, p. 605, stressing that the extent and permanence of the progress made in terms of legal obligations on the individual under international law is determined by political conditions. Ibid., p. 66. Hobe, Stefan, Die Zukunft des Völkerrechts im Zeitalter der Globalisierung: Perspektiven der Völkerrechtsentwicklung im 21. Jahrhundert, (1999) 37 AVR, p. 264.

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who would have to bear the consequences of a stoppage of repayment resulting from a state of necessity.182 In addition, a partial ‘standstill’ on enforcement actions due to a state of necessity,183 which only affects public creditors, would provide strong incentives for rogue private creditors. Those creditors could – after the sovereign debtor has been granted a breathing space from actions by its public creditors – try even more vigorously to access the last remaining assets of the debtor state. Summing up, the fact that many creditors of defaulting countries are individuals or private entities does not hinder the invocation of a state of necessity.184 Contribution to the State of Necessity The final exception to the right to invoke a state of necessity arises “if the State in question has contributed to the occurrence of the state of necessity.”185 The cases referred to in terms of this exception are those in which the sovereign state invoking the state of necessity contributed, by act or omission, to the situation of necessity.186 Commentators argue that, usually, sovereign insolvencies will be self-inflicted187 and, in fact, all sovereign insolvencies, similar to any other case of insolvency, could be regarded as a consequence of spending more money than is taken in.188 Moreover, sovereign liquidity crises can be linked to various other erroneous acts or omissions, such as insufficient or inappropriate banking supervision or a pegged exchange rate

182

183

184

185 186

187

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Dolzer, supra n. 2, p. 549 et seq., stating that a different treatment of public and private creditors in this respect would be “surprising”. Like a standstill, a state of necessity shall provide breathing space for the debtor, in order to allow it to find a solution in collaboration with the creditors. Furthermore, both mechanisms are of a temporary nature. While a standstill is limited by the decision of the judge, the state of necessity comes to an end when one of its preconditions ceases to exist. See also OLG Frankfurt, supra n. 111, p. 2688 et seq. raising no doubts as to the general admissibility of this international law defence vis-à-vis individual creditors, but see BVerfG, Judgement 8 May 2007, available at: http://www.bundesverfassungsgericht. de/entscheidungen/ms20070508_2bvm000103.html. Article 25(2)(b) ILC Draft Convention. Cf. UN, Report of the International Law Commission – Thirty-second session (5 May – 25 July 1980), (Document A/35/10), (1980) 2 Y.I.L.C., p. 52 (hereinafter: UN (1980)). Renner, Michael, Die Rechtsstellung des Gläubigers, insbesondere bei notleidenden Anleihen, available at: www.uni-leipzig.de/bankinstitut/dokumente/2000–02–03–02.pdf, p. 26. Hahn (1984), supra n. 24, p. 371.


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that is not adapted to realistic currency rates.189 If mere causality were sufficient to establish a ‘contribution’, the state of necessity would never apply to cases of sovereign insolvency.190 Since, conversely, there is a consensus that sovereign insolvency can generally be a trigger for the state of necessity, it is also common ground that the contribution must be “sufficiently substantial and not merely incidental.”191 Nevertheless, the precise meaning of ‘contribution’ remains disputed. Some commentators favour an ‘evidence test’, according to which the debtor only contributed to the state of necessity if it intentionally neglected generally accepted ideas, in particular if the state continues to borrow, in full knowledge that it soon will become insolvent.192 In contrast, according to the first ILC commentary on Art. 33 Draft Articles, the contribution can also be by negligence.193 The third approach seems the most convincing: according to this approach, only gross negligence excludes necessity.194 The development of a country’s economy depends on myriad factors and there is no way of predicting with any certainty whether or not an economic decision is reasonable.195 For these reasons, a state must be granted a certain margin of discretion.196 Furthermore, in a case where the elementary interests of (a part of ) the population are in danger, even a contribution to the state of necessity should not exclude the necessity defence, since these interests outweigh the misconduct of the governing élite.197 2.1.4. Conclusion Neither the clausula rebus sic stantibus nor the odious debts doctrine can be referred to as a basis for the suspension or stoppage of debt repayment by sovereign states. In contrast, the state of necessity doctrine is a viable means in this respect. A country invoking necessity should, however, be aware that, while generally accepted, the defence is only allowed in exceptional cases.

189 190 191 192 193 194 195 196 197

The Argentine crisis is but one example. Pfeiffer, supra n. 120, p. 168. UN (2001), supra n. 112, p. 205. Hahn, supra n. 144, p. 318. Cf. UN (1980), supra n. 186, p. 52. Leyendecker, supra n. 59, p. 235. Dolzer, supra n. 2, p. 551. Pfeiffer, supra n. 120, p. 169. Cf. ibid.

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As underlined in the Gabčíkovo case, a state must try to avoid the default by (almost) all means. Despite this, what the foregoing discussion shows is that, while the details may be disputed, the general features of a ‘standstill’ under international law are broadly recognized. This standstill, though, is limited to the time during which the preconditions for its existence are fulfilled. Suspension is to be stopped when the state of necessity ends.198 Reaching this point as soon as possible is in the interest of all parties concerned. This necessitates a debt restructuring procedure. The next section analyses whether, or to what extent, such a procedure is already established under customary international law. 2.2. A Right to Debt Restructuring under Customary International Law? A settled state practice of debt restructuring could have emerged as a consequence of repeated debt rescheduling for sovereign debtors. Debt rescheduling traditionally took, and indeed still takes place in the London Club and the Paris Club. Neither club is a neutral agency, but they serve as agencies of the creditors, although they are designed to benefit both parties of the rescheduling process, creditors and debtors alike.199 More recently, creditor countries also established the (Enhanced) Heavily Indebted Poor Country Initiative (HIPC). While the procedures in the London Club for private bank creditors, as well as debt restructuring negotiations with bondholders, still follow an ad hoc approach,200 the rescheduling of public

198

199

200

See e.g. the ICSID decision in LG & E v. Argentina, where the Tribunal contrary to earlier awards, accepted the plea of necessity (ICSID Case No. ARB /02/1, Decision on Liability of 3 October 2006) and Schill, Stephan, Auf zu Kalypso? Staatsnotstand und Internationales Insolvenzrecht – Anmerkung zur ICSID Entscheidung LG & E Engergy Corp v. Argentina, [2007] SchiedsVZ, p. 178 et seq. critically commenting the decision; see also: OLG Frankfurt a.M., Judgment 13 June 2006–8 U 107/03, (2006) 59 NJW, p. 2931; critically Sester, Peter, Argentinische Staatsanleihen: Schicksal der “Hold Outs” nach Wegfall des Staatsnotstands, (2006) 59 NJW, p. 2892. Rahnama-Moghadam, Mashaalah et al., The Clubs of London & Paris: International Dispute Resolution in Financial Markets, (1998) 53 Disp. Resol. J., p. 72, noting that concepts such as due process, impartiality and the burden of proof are alien to those clubs. Whether or not commercial bank rescheduling takes place in the London Club depends on what the different groups of banks regard to be the best way to protect their diverse interests (Semkow, Brian W., Syndicating and Rescheduling International Financial Transactions: A Survey of the Legal Issues Encountered by Commercial Banks, (1984) 18 Int’l Law., p. 920).


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debt in the Paris Club (2.2.1) and under the HIPC Initiative (2.2.2) take a more structured form. 2.2.1. Paris Club Proceedings The Paris Club201 is a forum where public creditors and debtor states meet in order to negotiate a solution to the problems of debt stricken countries. The first such meeting took place in 1956 to restructure the debt of Argentina. Since then, the Club has reached more than 330 agreements with over 75 debtor countries, which collectively total in excess of $375bn. As the Paris Club is a forum for public creditors, its agreements do not apply to private sector debt.202 Moreover, short-term debts, i.e. debts with a maturity of one year or less, as well as debts granted after a ‘cut-off date’, are excluded. Additionally, rescheduled debt is normally not dealt with again. In addition to meetings due to negotiations of debt rescheduling, the Club convenes at least once a month for its so-called tour d’horizon.203 Participants in the rescheduling meetings are the creditor states, which are usually members of the OECD (Organisation for Economic Corporation and Development), the debtor country and the International Financial Institutions (IFIs).204 The Club has a small secretariat provided for by the French Treasury. Nevertheless, the Club has no formal legal basis or status. Instead it is based on the following fundamental principles: a case by case approach, imminent default, conditionality and equitable burden sharing.205 Imminent default requires the assessment that the debtor state will default on its external debts in the absence of relief. This assessment is made by the creditors after the debtor country that is experiencing financial difficulties has applied for Paris Club procedures.206 The creditors’ decision on imminent

201 202 203

204 205

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The name indicates the usual place of the meetings. An exception from this rule is private debt that is covered by a public sector guarantee. These meetings are used as a forum to oversee pending issues concerning debtor countries. I.e. the IMF, the World Bank and the affected regional development bank. These principles are also applied by the London Club, although in a more flexible way, Rieffel, Alexis, The Role of the Paris Club in Managing Debt Problems, Princeton Essays in International Finance No. 161, December 1985, 22. This is done by contacting the French Ministry of Finance, which will then convene the meeting, Ebenroth, Carsten Thomas, Rescheduling of the Sovereign Debt: A New Role for the Paris Club, (1995) 19 J.I.B.L., p. 281.

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default is based on an IMF report.207 In turn, the IMF itself will forecast imminent default if the debtor’s expenditures exceed its income.208 Conditionality is the second precondition to the Paris Club process.209 The debtor country must have concluded an economic adjustment programme with the IMF.210 In terms of insolvency law this can be regarded as a means to guarantee that a reorganisation plan exists.211 The principle of equitable burden sharing, which is seen as the raison d’être of the Paris Club,212 is the third condition of debt restructuring. It means that all official creditors must provide debt relief that is commensurate with their exposure to the debtor country.213 In addition, the debtor is expected to seek comparable debt relief from its private creditors.214 In this way, the rule of equal treatment of all creditors, as is common in national insolvency systems, can be found in international sovereign insolvencies.215 The comparability of treatment is facilitated by the requirement that no decision can be taken within the Paris Club without unanimous consensus among the participating creditors and their agreement to implement the terms agreed in the context of the Paris Club.

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210 211 212 213

214 215

Andrew K. Rose calls this the “litmus test for imminent default” (idem, One Reason Countries Pay Their Debts: Renegotiation and International Trade, NBER Working Paper No. 8853, Cambridge March 2002, p. 10; available at: www.nber.org/papers/w8853. Vitale, Giovanni, Multilateral Sovereign Debt Restructuring: The Paris Club and the London Club, in: Eichengreen, Barry; Portes, Richard, Crisis? What Crisis? Orderly Workouts for Sovereign Debtors, London 1995, p. 121. An exception to this precondition (as well as to the precondition of imminent default) was made in the case of Pakistan. The reason for this was an increased (geopolitical) interest of the US in that country after the Soviet Union had invaded Afghanistan. As a consequence, President Carter waived the usual preconditions for Paris Club restructuring to enable the US to participate in a rescheduling of Pakistan’s debt, cf. Hudes, Karen, Co-ordination of Paris and London Club Reschedulings, (1985) 17 N.Y.U.J. Int’l. L. & Pol., p. 559. Rieffel, supra n. 205, p. 8. Eichengreen/Portes, supra n. 208, p. 24. Rieffel, supra n. 205, p. 12. An exception from the principle of equal treatment, though, is made in favour of IFIs such as the IMF and Worldbank, who are, quasi in return for their preferential treatment in this respect, expected to provide new money to liquidity-strapped countries (Rose, supra n. 207, p. 10). Vitale, supra n. 208, p. 123. BMZ, Internationale Insolvenzregelungen für Entwicklungsländer, BMZ spezial No. 14, May 2000, p. 12.


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These principles are backed by certain rules and conventions of Paris Club agreement.216 Firstly, in order to adjust to the constantly changing circumstances of each individual debtor country, the Paris Club makes its decisions on a case-by-case basis, to allow it to adjust accordingly.217 In addition to these principles and rules, the negotiations themselves are conducted according to a fixed pattern.218 Thus, negotiations start with a presentation of the debtor country’s situation by the debtor, which is followed by questioning by the creditors. Then, the creditors make a first proposal and, if the debtor country does not accept this, further proposals follow until an agreement is reached. As a result of the negotiations, ‘agreed minutes’ are concluded between the parties.219 These agreed minutes are based on standardised forms.220 However, despite these factors, which lead to a relatively settled rescheduling procedure in the Paris Club, this institution is still an ‘ad-hoc institution’ without legal status.221 As mentioned earlier, rescheduling negotiations take place on a case-by-case basis and the results of these talks, i.e. the agreed minutes, do not constitute legally binding instruments. Instead, they generally contain a provision stating that: The representatives of the participating creditor countries agreed to recommend to their governments or appropriate institutions that they provide, through rescheduling or refinancing, debt relief on the following terms.222

In other words, they only provide the framework within which the binding bilateral rescheduling agreements are drafted.223 Consequently, even though one might be willing to accept a settled state practice in Paris Club procedures,224 due to the explicit declarations by creditors, an opinio iuris as to

216 217 218 219

220 221

222 223 224

See: Hahn (1984), supra n. 24, p. 378 et seq. Cf. www.parisclub.org Ebenroth, supra n. 206, p. 283. See: Bothe, Michael, et al. (ed.), Rechtsfragen der internationalen Verschuldenskrise – Voraussetzungen, Formen und Verfahren internationaler Umschuldungsmaßnahmen und Umschuldungsvereinbarungen, Frankfurt a.M., 1988, p. 126. Ibid. BMZ, Internationale Insolvenzregelungen für Entwicklungsländer, BMZ spezial No. 14 (May 2000), p. 11 et seq. See: Bothe, supra n. 219, p. 134. Ebenroth, supra n. 206, p. 284. In view of the more than 370 debt restructuring agreements that have by now been reached in the Paris Club, all in a similar manner, this does not seem far-fetched.

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the start of debt restructuring negotiations or their concrete features does not exist.225 On the contrary, the lack of legally binding results appears to be intended by the parties.226 The fact that the parties want a politically binding agreement does not alter this conclusion. Politically driven expectations of certain behaviour do not produce legal obligations.227 2.2.2. Proceedings under the Enhanced HIPC Initiative A more formal procedure than the Paris Club rescheduling can be found in the negotiations concerning the debts of HIPCs. The World Bank and the IMF endorsed the HIPC-Initiative in its original form in 1996, as a first comprehensive approach to reduce the external debt of those countries.228 The initiative was generally seen as a breakthrough.229 Three issues are particularly noteworthy. For the first time HIPC provides debt relief from the World Bank and the IMF together with other multilateral institutions. Furthermore, the initiative coordinates bilateral, multilateral and commercial creditors; and it uses fixed criteria, such as debt sustainability, that make the process more transparent and predictable.230 The original HIPC-Initiative was substantially altered in 1999 on the basis of a proposal of the G7 meeting in Cologne. The enhanced HIPC Initiative (HIPC II) aims to provide greater and more rapid debt relief to a larger number of countries.231 Eligibility under the HIPC-Initiative is limited to countries eligible for International Development Association (IDA) loans and for the IMF’s Poverty Reduction and Growth Facility (previously the Enhanced Structural Adjustment Facility). These countries must face an

225

226 227 228

229

230

231

But see: Reinisch, August, State Responsibility for Debts: International Law Aspects of External Debt and Debt Restructuring, Köln 1995, p. 30, who in view of the increased frequency of sovereign debt restructurings argues that a “duty to re-negotiate has evolved, or is at least in statu nascendi.” Hahn (1984), supra n. 24, p. 378. Bothe, supra n. 219, p. 133 et seq. Worldbank, The HIPC Debt Initiative, available at: www.worldbank.org/hipc/about/ hipcbr/hipcbr.htm; see also for all documents of the HIPC-Initiative: www.imf.org/external /np/hipc/doc.htm. Some commentators consider it even revolutionary. For a recent critical analysis of the HIPC initiative see: Michaelowa, Katharina, The Political Economy of the Enhanced HIPC Initiative, HWWA Discussion Papers, Hamburg 2002. Kampffmeyer, Thomas, Lösungsansätze für die ärmsten Entwicklungsländer, Aus Politik und Zeitgeschichte B 9/2000 Internetedition, p. 5, available at: www.bpb.de. Andrews, David et al., Debt Relief for Low-Income Countries – The Enhanced HIPC Initiative, IMF Pamphlet Series No. 51, Washington D.C. 1999, p. 2.


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unsustainable debt burden even after the full use of traditional debt-relief mechanisms. Basically, a country’s debt is considered to be unsustainable if it cannot be expected to meet its current and future external debt-service obligations in full without recourse to debt relief, rescheduling, or the accumulation of arrears.232 The key indicator for debt sustainability under the initiative is the net present value (NPV) of debt233 to exports. According to this indicator, country debt is considered to be unsustainable if the NPV of public and publicly guaranteed external debt of exports exceeds 150 percent or, for very open economies234 with a heavy fiscal debt burden, where the NPV of the debt-to-fiscal revenue ratio is higher than 250 percent.235 In order to ‘quality’ for assistance under the HIPC-Initiative, an eligible country enters into a two stage process. In the first stage, the country is required to establish a track record of good performance, usually by agreeing on a programme of macroeconomic reform and structural adjustment supported by the IMF and the World Bank. These agreements, which are contained in Poverty Reduction Strategy Papers (PRSPs) are, in contrast to the former Policy Framework Papers, expanded under the auspices of the debtor country.236 In support of this adjustment program, the debtor country receives concessional financing from the IMF and the World Bank, as well as flow-rescheduling by the Paris Club on Naples terms (67 percent NPV reduction). The debtor country may also seek at least comparable treatment from other bilateral and commercial creditors. If, after a period of three years, the debtor country’s debt is still unsustainable at the ‘decision point’, it enters the second stage. Paris Club creditors will now go beyond Naples terms and provide more debt reduction in NPV terms and other creditors provide comparable treatment. The country seeking to qualify for assistance has to establish a second track record of good performance under Worldbank/IMF-supported programs, including, to the extent possible, implementation of an agreed comprehensive framework of poverty reduction. The country also takes steps to strengthen debt management. 232

233

234 235 236

Trotsenburg, Axel van; MacArthur, Alan, The HIPC Initiative: Delivering Debt Relief to Poor Countries, Washington D.C., February 1999, p. 2. The NPV of debt is defined as the sum of all future debt-service obligations (i.e. principal and interest thereon) on existing debt, discounted at the market interest rate; Andrews, supra n. 231, n. 4. Defined as having an export-to-GDP ratio of at least 40 percent, ibid., p. 4. Worldbank, supra n. 228, p. 2. Kampffmeyer, supra n. 230, p. 11. See also: Andrews, supra n. 231, p. 14 et seq.

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The length of this second stage depends on the speed at which the debtor country implements a comprehensive poverty reduction strategy involving agreed upon key structural and social reforms and a macroeconomic framework designed to promote growth. At this floating completion point, all creditors provide equal reduction (in NPV terms) on their claims after the application of Naples Terms in accordance with interim relief, to reach a sustainable debt of the debtor country. The HIPC Initiative, which, to date, has approved debt relief for more than 25 countries,237 can be seen as a basis for a developing debt restructuring and relief procedure for states under international law.238 This raises the question of whether the continued practice under this initiative already provides sufficient evidence of customary international law. As underlined in the ICJ’s North Sea Continental Shelf case, the view that a rule must have long historical roots is no longer valid.239 Thus, even the relatively short time of rescheduling and relief negotiations under the HIPC initiative framework might generally be sufficient for the emergence of custom in this sense. However, the shorter the practice, the more important is the acceptance of the HIPC restructuring framework by the international community as binding law.240 The parties did not conclude a traditional treaty, but states agreed on an initiative. This initiative was not planned to be a long-lasting procedure. In contrast, in the original initiative, it was explicitly specified that this should be a unique offer, terminating by October 1998 and later by the end of 2000.241 The initiative is to be gradually phased out once this objective has been achieved. This is reaffirmed by statements such as that by Horst Köhler, then Managing Director of the IMF, (i.e. one of the initiating parties of the scheme), who is cited as follows: Clearly, debt relief is an important part of a comprehensive concept to reduce poverty. But I would caution against viewing debt relief as a panacea. Credit is an indispensable element for economic development. That is why, in the longer

237

238

239 240 241

IMF, Debt Relief under the Heavily Indebted Poor Countries (HIPC) Initiative – A Factsheet, September 2003, available at: www.imf.org/external/np/exr/facts/hipc.htm. Marauhn, Thilo, Nachhaltiges Schuldenmanagement: Völkerrechtliche Rahmenbedingungen für ein zwischenstaatliches Insolvenzverfahren, in: Dabrowski, Martin et al.(eds.); Die Diskussion um ein Insolvenzrecht für Staaten – Bewertungen eines Lösungsvorschlags zur Überwindung der Schuldenkrise, Berlin 2003, p. 284. [1969] ICJ Reports, p. 43. Bernhardt, supra n. 12, p. 901. Kampffmeyer, supra n. 230, p. 7.


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run, it will be crucial for poor countries to win the trust of private investors in their ability and willingness to repay what they borrow.242

Once again, there is thus no opinio iuris underlying HIPC procedures that is sufficient for the assumption of a debt relief procedure on the basis of international law.

3. General Principles of International Law Treaties and customs are generally referred to as the major sources of international law. As discussed above, their validity depends essentially on the consent of the subjects of law, which also possess the institutional authority to make law. The area of state insolvency, though, demonstrates that there are broad areas in international law in which such consent sufficient to constitute a common opinio iuris, does not exist. Certainly, it would not be unthinkable to subject those areas of international law to the national law of one of the parties. In fact, this is the approach undertaken by the supporters of an international Chapter 11 procedure. The drawback of this solution, however, as already discussed above, is that it leads to political and legal inappropriateness, since transactions between sovereign states, as subjects of public international law, should be governed by public international law.243 An option provided by international law might be the use of general principles of law. 3.1. General Principles as a Source of International Law General principles of international law primarily serve as a source to fill the gaps in conventional and customary international law. The rationale for the inclusion of those principles is the provision of solutions to the actors in international relations – whether in litigation, or in an extra-judicial context – even in those cases where treaties or customs fail to give adequate guidance.244 When reference is made to general principles of international law, Article 38

242 243

244

UN, Regional Training Conference Paper, Spring 2002, p. 5. Friedmann, Wolfgang, The Changing Structure of International Law, London 1964, p. 171. Elias, Olufemi; Lim, Chin, General Principles of Law, Soft Law and the Identification of International Law, (1997) 28 N.Y.I.L., p. 4.

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(1) lit. c ICJ Statute is that most frequently cited.245 According to this rule the general principles of law recognised by civilised nations can be used to “clothe the dry bones [of public international law] with flesh”,246 i.e. to fill legal lacunae as they appear in international law.247 This central function of general principles was already underlined when the statute for the PCIJ (Permanent Court of International Justice), the ICJ’s predecessor, was drafted. As pointed out by Hangerup, the Norwegian member of the drafting committee, in a case where the Court would, due to a lacuna in international law, otherwise have to declare non liquet, “[a] rule must be established to meet this eventuality to avoid the possibility of the court declaring itself incompetent through lack of an applicable rule.”248 In this context, general principles of law already play an important role in other areas of international economic law, such as the protection of foreign investments.249 Apart from their jurisdictional significance, general principles furthermore serve as a source for the interpretation of treaties and, most importantly in the present context, they can be used as a way to further develop ‘statutory’ international law by the codification of former general principles, like in the Vienna Convention on the International Sale of Goods (CISG).250 It is thanks to the general principles that international law does not have to remain static in its application, but can be adapted dynamically to the fast-growing and changing technological advances currently being experienced in international relations.251 This distinct importance of general principles, in addition to international customary law, has been disputed by commentators – mainly those from socialist and communist countries. Basically, they argue that, due to the deep contradictions between socialist (communist) and capitalist countries, there 245

246 247

248 249

250 251

The traditional reference to this provision is justified by the wording of Article 38 (1) ICJ Statute which begins with the statement that the Court’s “function is to decide in accordance with international law”. This implies that the sources listed in the remainder of the paragraph give an overview of the sources of international law; Weiß, Wolfgang, Allgemeine Rechtsgrundsätze des Völkerrechts, (2001) 39 AVR, p. 395. Friedmann, supra n. 243, p. 175. Bassiouni, M. Cherif, A Functional Approach to “General Principles of International Law”, (1990) 11 Michigan J. Int’l. L., p. 776. Quoted ibid., p. 778. Cf. Ebenroth, Carsten Thomas; Karl, Joachim, Die Multilaterale Investitions-GarantieAgentur: Kommentar zum MIGA Übereinkommen, Heidelberg 1989, at 838. Weiß, supra n. 245, p. 413 et seq. Bassiouni, supra n. 247, p. 777 et seq.


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were hardly any principles common to the legal orders of all countries.252 This argument, though, is questionable. Even before the fall of the Berlin wall, numerous tribunals, not just the ICJ, have applied general principles as a source of international law. Furthermore, general principles are regularly mentioned in international legal instruments.253 This practice proves that differences in the socio-political settings do not affect the possibility of reliance on general principles. 3.2. The Definition of “General Principles” Nevertheless, there remains widespread concern over ‘General Principles of law’. First of all, an alleged lack of an adequate definition is claimed, as expressed for instance by Schlesinger: In countless cases, international courts have referred to this source of international law [. . .] But if we read the opinions, we look in vain for an answer to the question: How did the Court know that the particular rule or principle it relied on was in fact a general principle of law recognized by civilized nations? In case after case, the judge writing the opinion simply expressed a hunch, a hunch probably based upon the legal system with which he happened to be familiar.254

While many notable arbitral decisions might indeed lead to the opinion that the judges applied the general principles according to the saying “I know it, when I see it” this does not exclude the possibility that a proper definition can be found. In fact, the scholarly debate is concerned not so much with dogmatic or doctrinal conceptions, but instead centres on the question of how evidence for a general principle can be found.255 Thirlway concluded that for a general principle it is insufficient to point to unanimity of municipal legal systems on a particular point unless the rule which it is sought to derive from them possesses such a degree of reasonableness and appropriateness for application on the international plane

252

253

254

255

Cf. Hailbronner, Kay, Ziele und Methoden völkerrechtlich relevanter Rechtsvergleichung, (1976) 36 ZaöRV, p. 198 et seq. Beyond the ICJ statute, general principles are referred to inter alia in Article 288 ECTreaty, Article 188 Euratom, Article 7 ECHR; Article 15 ICCPR. Schlesinger, Rudolf B., Research on the General Principles of Law Recognized by Civilized Nations, (1957) 51 Am. J. Int’l. L., p. 734 et seq. Bassiouni, supra n. 247, p. 770.

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for a State which acts in a contrary manner at least to have been conscious of a possibility that a rule of law might point in the opposite direction.256

In a broader sense, commentators such as Goldmann hold that general principles shall in addition include rules specific to certain areas of international law, such as international trade or international finance, even if they are not embodied in the majority of the national legal systems. This view places more emphasis on the principled character of a rule.257 In this sense McNair, a former ICJ judge said: The way in which international law borrows from [domestic law] is not by means of importing private law institutions ‘lock, stock and barrel’, ready made and fully equipped with a set of rules . . . [but that] the true view of the duty of international tribunals in this matter is to regard any features or terminology which are reminiscent of the rules and institutions of private258 law as an indication of policies and principles rather than as directly importing these rules and institutions.259

A definition of general principles in this sense would be that such principles exist where an analysis of legal orders demonstrates that a corresponding legal idea can be found in these orders. This definition, though, requires, as a next step, the clarification of how such congruency can be found and which orders shall be compared. 3.2.1. General Principles and Judicial Discretion The method used to derive general principles has to take into consideration that, on the one hand, the first line of argument, as represented by Thirlway looking for the least common denominator accepted throughout, tends to restrict the meaning of general principles to principles such as bona fide or pacta sunt servanda. These principles are so broad that they are often of little

256

257

258

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Thirlway, Hugh, The Law and Procedures of the International Court of Justice (1960–1989), (1991) 61 B.Y.I.L., p. 112 et seq. See also: Dasser, Felix, Internationale Schiedsgerichte und lex mercatoria – Rechtsvergleichender Beitrag zur Diskussion über ein nicht-staatliches Handelsrecht, Zürich 1989, p. 107. The point put forward was that a meaningful distinction of the categories of public and private law could no longer be made in contemporary domestic law or in international law. Both categories are increasingly intermixing. Consequently, there are no longer reasonable grounds for limiting the use of general principles to the private law sphere; Friedmann, supra n. 243, p. 190. ICJ, Case Concerning the International Status of South-West Africa, [1950] ICJ Report, p. 132.


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use. On the other hand, proponents of a more ‘inspired’ view have to deal with the problem of judicial discretion. General principles are not to be used as a “licence for the application of general and vague principles of objective justice.”260 While it is true that general principles require a certain degree of creative activity on the part of the judge, this sort of judicial application should not be confused with a form of judicial legislation. Rather than creating new rules, the judge’s task is to discover the existing but latent rules of law.261 Corresponding provisions, granting the judge the power to develop the law by filling legal gaps, are explicitly contained in numerous domestic laws. For instance, Italian law authorizes the judge to bridge such gaps by turning to the general principles of the Italian legal order.262 Similar powers are given to the judge inter alia under Austrian,263 Swiss264 or Mexican265 law, which provide that the judge shall take recourse to the general principles of the domestic legal order if there are any gaps in the law.266 Since such provisions, granting judicial discretion, are not uncommon on the domestic level, it might be questioned whether a judge ruling on the international level ought to be given the same discretion. One major difference here is the lack of enforcement powers of international tribunals in contrast to their domestic counterparts: “There are no sergeants-at-arms in international law.”267 Instead, one of the characterizing features of public international law is a lack of enforced sovereign command. The sovereigns themselves employ coercive measures as a means of enforcement rather than any central authority doing so.268 This same task constitutes a considerable challenge for international courts and tribunals. Unable to rely upon compelling institutional means of enforcing their decisions, they depend on voluntary obedience to their decisions. The more the

260 261

262 263 264 265 266 267

268

Ibid., p. 20. Cf. the respective commentary by the Advisory Committee for the ICJ’s statute quoted by Bassiouni, supra n. 247, p. 784. Article 12 Codice Civile. Article 7 Allgemeines Bürgerliches Gesetzbuch. Cf. Article 1 (2) Schweizerisches Zivilgesetzbuch. § 19 Codigo Civil para el distrito federal. Even more important is that role of the judge in common law jurisdictions. Ford, Christopher A., Judicial Discretion in International Jurisprudence: Article 38(1) (C) and ‘General Principles of Law’, (1994) 5 Duke J. Comp. & Int’l. L., p. 55. Ibid.

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international judges can make their cases logically and morally appealing, the more probable it will be that their judgments will be obeyed.269 3.2.2. The Method of Identifying General Principles This, in turn, requires a method of identification of general principles that guarantees the greatest possible degree of objectivity. It is generally agreed that the techniques of comparative law shall be used as the means to discover general principles in international law.270 Nevertheless, what often becomes obscured in the shadows of various suggestions, is how, in precise terms, this method shall be adopted in the context of general principles.271 Therefore, some remarks with regard to the applicable method of deducing general principles shall follow. 3.2.2.1. A Quantitative or Qualitative Standard First, the question of how ubiquitous the general principles must be arises. It could be argued that general principles not derived from unanimous state consent could threaten the stability and structure of the international legal order.272 Only in the case of general acceptance of a certain rule in all domestic legal orders could the conclusion be drawn that this rule is generally accepted as being just and fair.273 The existence of general principles 269 270

271

272 273

Ibid., p. 56. Lorenz, Werner, Rechtsvergleichung als Methode zurKonkretisierung der allgemeinen Grundsätze des Rechts, (1962) 17 JZ, p. 269 et seq.; see also: Bassiouni, supra n. 247, p. 773; Weiß, supra n. 245, p. 407; Mann, supra n. 4, p. 36 concludes that “since the elimination of the direct influence of Roman law there does not exist any system or branch of law, other than comparative law, which could develop general principles.” Cf. Mann, supra n. 4, p. 35, who notes that “international tribunals have on many occasions failed to elucidate the route which led them to their assertions [of the existence of a certain general principle]” and that “on this problem of method, the vast literature on the general principles within the meaning of Article 38 proves to be largely unhelpful.” This is all the more remarkable due to the fact that, since this statement was made in 1957, the situation has not significantly changed. Elias/Lim, supra n. 244, p. 5. According to the principle of venire contra factum proprium, a state shall not be allowed to behave in the sphere of international law in a manner different from what it accepted as a fair solution in domestic law. However, this reasoning for the validity of general principles does not provide a dogmatically exact explanation to the extent that, otherwise, principles accepted by one state domestically would also have to be applied on the international level against it, even if there is no general recognition of the principle (Weiß, supra n. 245, p. 398).


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would, accordingly, require an analysis of “the legal orders of the world” by massive comparative law projects leading to the adoption of those principles, which were found to establish the “common sub-stratum of institutions and concepts.”274 In this context, Portugal tried to bolster its position in the Right of Passage Case before the ICJ by undertaking a survey of 64 domestic legal systems to demonstrate the existence of a general principle according to which a right of passage was accepted for an enclaved territory. Portugal concluded that, since 61 of the 64 legal systems recognized such a right, a general principle existed in this regard.275 As this example suggests, a quantitative approach is quite ponderous. The scholarly effort involved is enormously time-consuming and its results are questionable.276 For instance, what if only 58 or 46 countries were to accept a right of passage? Would a (perhaps qualified) majority be sufficient and would the legal system of, say, England carry as much weight as that one of Mongolia or would that depend on the law system’s factual relevance?277 Furthermore, the wording of Article 38 ICJ Statute does not support this view. This provision talks about the general principles recognised by civilized nations. In the current discussion, it is undisputed that, due to the sovereign equality of states, as inter alia expressed by Article 2 (1) of the UN Charter, a distinction between states cannot be made in the way that some states are civilized while others are barbaric. Consequently, rather than being a relic of European colonial chauvinism, or implying any racial or cultural prejudice, the term is to be regarded as a term of art, meaning that the legal orders that build the foundations for the general principles have to be well-developed.278 This is self-evident, since if a domestic legal system is not sufficiently sophisticated, it cannot provide any input for the wording of internationally applicable general principles.279 Furthermore, Article 38 ICJ Statute requires the recognition of the principles “by civilised nations” and not “by all civilised nations.”280 Thus,

274

275 276 277 278 279 280

Sarfatti, Mario, Roman Law and Common Law: Forerunners of a General Unification of Law, (1954) 3 Int’l. & Comp. L.Q., p. 110. ICJ, Right of Passage over Indian Territory, [1960] ICJ Reports, p. 11 et seq. Ford, supra n. 267, p. 68. Dasser, supra n. 257, p. 115. Cf. Thirlway, supra n. 256, p. 124. Weiß, supra n. 245, p. 406. Ford, supra n. 267, p. 76; see also Article 21 (1) lit. c) of the Rome Statute for the International Criminal Court, which reads as follows: “The Court shall apply [. . .] general

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general principles do not have to be incorporated into all legal orders of the world.281 This is also underlined by the fact that, if this were the case, the slowest moving legal system could, in principle, block the development of international law.282 A unanimous, universal acceptance of a general principle by all states is therefore not necessary. Instead, firstly, if research in comparative law is not to be carried out as merely l’art pour l’art, countries whose legal systems do not meet the standard of development required by the particular question for which the general principle is sought should be excluded from the analysis.283 Second, representative legal systems have to be selected. In spite of the selective character of this process, this does not mean that its results are subject to nothing more than discretion. In contrast, the relevant legal orders themselves are selected according to an analytical process, which is based upon the categorisation of the legal orders of the world in five classes of law families. The major jurisdictions named are the Anglo-Saxon, the Asiatic, the Germanic, the Islamic and the Roman.284 This approach is supported by the rationale of Article 9 ICJ Statute, according to which the judges have to be elected so as to ensure “the representation of the main forms of civilisation and the principal legal systems of the world.”285 The number of national legal systems

281

282

283 284

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principles of law derived by the court from national laws of legal systems of the world including as appropriate, the national laws of States that would normally exercise jurisdiction over the crime, provided that those principles are not inconsistent with international law and internationally recognized norms and standards.” Cf. Seidl-Hohenveldern, Ignaz, General Principles of Law as Applied by the Conciliation Commissions Established Under the Peace Treaty with Italy of 1947, (1959) 53 Am. J. Int’l. L., p. 872, who concludes that “[i]f researches were to be extended so as to test each alleged general principle as to whether it is really recognized as such by all the legal systems of the world, comparatively few ‘principles’ will emerge as being indeed generally recognized.” In turn, it should be evident that a single domestic system cannot provide proof for the existence of a general principle of international law (Mann, supra n. 4, p. 38). Hailbronner, supra n. 252, p. 209. Older comparative works often cite the socialist legal system as a separate group. This group, however, vanished with the political changes in the former socialist countries (cf. Grote, Rainer, Rechtskreise im Öffentlichen Recht, (2001) 126 AöR, p. 13). Cf. also the General Assembly Resolution 2205 (XXI) of 17 December 1966 establishing the United Nations Commission on International Trade (UNCITRAL) which stipulates in its section II (1) “. . . [the composition of ] the General Assembly shall have due regard to the adequate representation of the principal economic and legal systems of the world, and of developed and developing countries”, (1968–1970) 1 Yearbook of the United Nations, p. 66.


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selected under the ‘major-legal-systems’ approach will then depend on the degree of similarity of findings that may emerge from the research. The more similar the compared legal systems are, the more probable it is that adding more countries from the same major legal system of the world will not add significantly to the result.286 3.2.2.2. Selection of the Relevant Legal Systems The classification of domestic legal orders in families, however, is not undisputed. Thus ‘legal particularists’ emphasize that legal norms and institutions emerge from, and are a reflection of, individual national circumstances.287 In particular, they are the product of a nation’s history and culture.288 These differences do indeed make comparative law more difficult,289 since “the transferability of law [. . .] (is to a certain degree) a function of political and economic similarities between cultures.”290 Nevertheless, the importance of these differences may have been overestimated.291 What remains true is that the socio-cultural, economic, political and historical background must undoubtedly be incorporated in a proper selection process.292 Dividing legal orders into families is quite useful as a means of taking these factors into consideration. Domestic legal systems are often tied together by their genealogy and history, and it is those relationships themselves in particular that

286 287

288

289

290

291

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Bassiouni, supra n. 247, p. 813. Treillard, Jacques, Généralités, in: Rodière, René (ed.), Les procédures collectives de liquidation ou de renflouement des entreprises en droit comparé, Paris 1976, p. 16: «L’éclosion d’une législation n’est jamais un phénomène spontané. Seule la mise en lumière des conditions qui ont entouré son élaboration permet de comprendre et d’apprécier les caractères d’une loi et d’expliquer les différences qui la séparent des législations étrangères relatives à la même institution.» Choudhry, Sujit, Globalization in Search of Justification: Toward a Theory of Comparative Constitutional Interpretation, (1999) 74 Ind. L.J., p. 830. One might also say that they are the main reason that makes comparative law necessary at all. Eberle, Edward J., Comparative Public Law: A Time has Arrived, in: Hübner, Ulrich; Ebke, Werner F., Festschrift für Bernhard Grossfeld, Heidelberg 1999, p. 178. Shaw, supra n. 110, p. 94. It is also noted that “different legal systems give the same or very similar solutions, even as to detail to the same problem of life, despite the great differences in their historical development, conceptual structure, and style of operation”; Zweigert, Konrad; Kötz, Hein, Introduction to Comparative Law, 2nd ed. Oxford 1987, p. 36; see also Eberle, supra n. 290, p. 178. Starck, Christian, Rechtsvergleichung im öffentlichen Recht, (1997) 52 JZ, p. 1028.

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offer sufficient justification for reaching a particular classification.293 Critics might still object that even taking into account genealogical and historical aspects, the classification into law families would not respect the specificity of many autochthonous legal orders, since these remained typical for many legal systems in Africa and Asia.294 However, as the late René David, one of the most eminent scholars of comparative law, stated: La notion de « famille de droits » ne correspond pas à une réalité biologique; on y recourt seulement à une fin didactique, pour mettre en valeur les ressemblances et les différences qui existent entre les différents droits. Cela étant, toutes les classifications ont leur mérite. Tout dépend du cadre dans lequel on se place et de la préoccupation qui, pour les uns et les autres est dominante.295

In other words, the selection of the criteria according to which the final classification is carried out, is largely dependent on the purpose of the comparative analysis.296 Consequently, the resultant group of countries that is selected can vary as necessary.297 For instance, in a case where the issue arises from an inter-state treaty, a principle should be recognized as general if it is common to the law of the states in question, even if all, or most, other nations of the world that are not party to the treaty in question do not accept the said principle.298 Accordingly, the Iran-US Claims Tribunal, which was established to adjudicate claims arising out of or following the 1979 hostage crisis in the US embassy in Teheran,299 derived general principles of law in its case law mainly from a comparison and synthesis of US-American law and Iranian law as the national legal orders of the par-

293

294 295

296

297

298 299

The genealogical relationships between different domestic orders may either be “like parent and child, or like siblings who have emerged from the same parent legal system” (Choudhry, supra n. 288, p. 838). Cf. Grote, supra n. 284, p. 14. David, René; Jauffret-Spinosi, Camille, Les grands systèmes de droit contemporain, 9th ed. Paris 1988, p. 22. This method is now also accepted by most scholars; see e.g.: Berger, Klaus Peter, The Creeping Codification of the Lex Mercatoria, The Hague 1999, p. 45 for the area of civil law; Starck, supra n. 292, p. 1026 for the area of public law; or Hailbronner, supra n. 252, p. 207, for the area of international law. A truly universal comparison of law will mainly be of interest for the area of jurisprudence (cf. Starck, supra n. 292, p. 1026). Mann, supra n. 4, p. 39. A survey of the developments leading to the establishment of this tribunal is provided by Mapp, Wayne, The Iran-United States Claims Tribunal, Manchester 1993.


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ticipating parties. Moreover, French law, as the legal system on which the Iranian Civil Code is based, played a major role. In the event, the Tribunal also referred to ‘third’ country legal orders, particularly when the litigation had a link to this country.300 3.2.2.3. Determination of the Problem After selecting the relevant legal orders, the second step in the analytical process to reveal general principles of international law is the determination of the problem. This phase does not start by searching for specific provisions or legal institutions in a domestic system, but rather by referring to a specific problem and the way in which that problem is solved in the national context (a ‘functional approach’).301 To achieve this goal, the substantive technicalities that are inherent in any domestic rule, and that are an expression of domestic doctrine, must be disregarded: das zu untersuchende Problem [muss] erbarmungslos von den Systembegriffen der eigenen Rechtsordnung gereinigt und zunächst in einer Sprache beschrieben werden, die in gemeinverständlichen Ausdrücken den als problematisch empfundenen Sachverhalt so kennzeichnet, dass die Interessenkollision, um die es geht, jedem Zuhörer – Jurist oder Laie, Deutscher oder nicht – verständlich und einsichtig macht.302

This ‘layman’s test’ thus serves to answer the question: how do the legal systems under comparison solve a certain problem, described using general and comprehensible terms.303 Instead of an in concreto inquiry, which would focus on the specificity and sameness of the provisions, the approach applied questions in abstracto, whether or not the facts in the relevant states are generally comparable to the facts in the requesting state.304 The selection of the relevant legal orders, as well as the concrete determination of the problem, is only possible with the help of evaluations. The judge or legislator

300

301

302 303 304

Schmitz, Stephan, Allgemeine Rechtsgrundsätze in der Rechtsprechung des Iran-United States Tribunals: eine Untersuchung über das anwendbare Recht, nachträgliche Leistungshindernisse und Entlastungsgründe sowie ungerechtfertigte Bereicherung, Frankfurt a.M. 1992, p. 92 et seq. For an analysis of the functional approach, with particular emphasis on comparative constitutional law, see: Tushnet, Mark, The Possibilities of Comparative Constitutional Law, (1999) 108 Yale L.J., p. 1238 et seq.; see also: Berger, supra n. 296, p. 44 et seq. Kötz, Hein, Rechtsvergleich und Rechtsdogmatik, (1990) 54 RabelsZ, p. 209. Constantinesco, Léontin-Jean, Die rechtsvergleichende Methode, Köln 1972, p. 90. Cf. Bassiouni, supra n. 247, p. 815.

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searching for general principles is well-prepared to make such evaluations, as the analysis of the variety of different domestic solutions provides him with the information necessary to do so.305 Consequently, the potential difficulties of evaluations do not arise if the objective analytical process described above is followed. Furthermore, at least in the international context, it is regularly a legal body with three or more judges or arbiters that has to decide upon such issues. Furthermore, they are supported in the process of finding the most apt solution by the disputing parties, which will often provide extensive expert opinions306 to prove the existence of general principles.307 3.2.2.4. Extension and Limitation: Reception of General Principles of Law and Determination of Specific Realities in International Financial Markets Following this process, it will be possible to distil the general principles to tackle the questions in the case at hand. What then remains to be done is to fashion workable solutions. Critics have argued that the wording ‘general principle’ would imply the need for a philosophical content, and that, therefore, those ‘principles’ could not be considered to be positive rules of law, which, in contrast, are said to embody concrete and definite elements.308 However, the distinction between ‘concrete’ rules and ‘general’ principles seems to be largely a verbal one, which has never been satisfactorily defined and adds little, if anything at all.309 The existence of a general principle does not require the generality of the legal idea underlying a legal rule, but rather the generality of its application.310 Any other distinction ignores the necessities of public international law. The essence of this branch of the law

305 306

307

308 309

310

Starck, supra n. 292, p. 1029. Which are usually produced by scholars, to give them additional authority; see for instance the article by Professor Pfeiffer from the University of Heidelberg, supra n. 120, which is based on an expert opinion he gave to Argentina. Cf. Weiß, supra n. 245, p. 418 et seq., mentioning the respective practices before the WTO Dispute Settlement Body. Leyendecker, supra n. 59, p. 303. Cf. Dasser, mentioning the differentiation between general principles and trade customs (as the term for technical norms used in the framework of the lex mercatoria), which is however merely of a terminological nature, as both are applicable under the rule of the lex mercatoria (idem, supra n. 257, p. 108). Mann, supra n. 4, p. 36.


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is that it frequently has to tackle technical issues. General principles would poorly serve the field of public international law and indeed could not develop at all if they were only understood as maxims, which are necessarily “too elementary, too obvious and even too platitudinous to permit detached evaluation of conflicting interests.”311 This conclusion is also reflected by the practice of international judicial bodies. For instance, the International Criminal Tribunal (ICT) for the Former Yugoslavia and the ICT for Rwanda decided upon the measure of sentence in several cases by reference to general principles of international law.312 Another example is provided by decisions of WTO Panels, which, for example, referred to general principles to solve questions concerning the burden of proof.313 The ‘technicality’ of a rule thus does not exclude the use of general principles. What remains to be discussed is how the selection process described above is to be supplemented by an evaluation of the different solutions to free the general principles from their analytical abstraction and ‘implement’314 them in the international context. Only the combined use of comparison and evaluation can lead to the intended goal of providing a satisfactory answer to the open questions under international law.315 Its purpose is not to grant the broadest possible efficacy of the legal orders involved in the process, as one might assume. This broadest possible efficacy (größtmögliche Wirksamkeit) is, for instance, a common means to balance contradictory fundamental basic rights in German constitutional law. In contrast to the clash of constitutional rights, there is no need to protect the existence of a single legal order or legislative decision as a value in itself. Rather, where a variety of different solutions to a particular legal problem is found, the judge takes these as an inspiration. It is not a specific domestic legal order that is applied internationally. Instead, the domestic legal systems provide the resources from which the most advanced or most appropriate solution to the particular case is taken. It is also allowed, and even inevitable in the nature of things, that compromise solutions, such as

311 312

313

314 315

Ibid., p. 38. ICTFY, Erdemovic (IT-96–22–T), 29 November 1996, at 22, 26, 60; ICTR, Kambanda (ICTR 97–23–S), 4 September 1998, at 26 et seq.; ICTR, Serushago (ICTR 98–39–S), 5 February 1999, at 22. WTO Panel Report, Brazil – Export Financing Programme for Aircraft, WT/DS46/R, 14 April 1999, at 7.47. Cf. Berger, supra n. 296, p. 53. Ibid., p. 49.

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the mutual adoption of solutions found in different legal systems, have to be found.316 In fact, it is inherent in the concept of general principles of international law that a rule, which is applied at the domestic level, cannot be transferred directly to the international level of interactions of and with other sovereign states. This is due in the first instance to the differently structured legal relationships (sovereigns inter se or sovereign-private relationships versus inter-private relations). An evaluation and adaptation of the results as gained from the legal comparison is consequently inevitable.317 The differentiation resulting from the differing levels at which the law is applied also plays a significant role for the transfer of national provisions that are substantively based and motivated by the respective ideological and political systems, such as in the area of human rights. While, for the domestic context, a comparability of national rules becomes all the more difficult because the legal substrate being compared is politically and ideologically influenced, the same is not true on the international level. Because public international law is not founded upon a proper political basis itself, it is possible to discover general principles even in areas that are domestically rooted in ideologies.318 Again, the procedure of implementing the general principles in the respective context comes to an end where the possible result is not reflected in the legal orders that build the substratum of the previous comparative analysis.319 How domestic law can be transformed into international (supranational) law via the use of general principles is illustrated in exemplary fashion by the ECJ. 3.2.2.5. The Model of the ECJ The general principles enjoy a distinct position among the sources of European Community law.320 General principles, meaning the unwritten principles of law that underpin the Community law structure, are referred to by the ECJ as well as the European Court of First Instance when filling the gaps in the written law, as well as to serve the interpretation of primary and

316 317 318 319 320

Ibid., p. 53 et seq. Hailbronner, supra n. 252, p. 196. Ibid., p. 199. Cf. Berger, supra n. 296, p. 54. Tridimas, Takis, The General Principles of EC Law, Oxford 1999, p. 4.


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secondary legislation.321 In addition to principles that cover a broad scope of application, the ECJ has also referred to general principles to deal with matters of detail, such as the validity of expressions of will or the continuation of payments during a strike.322 The key norm in respect of general principles is Article 220 EC, which charges the ECJ with the responsibility to establish a system of legal principles to ensure that, in the interpretation and application of Community law, “the law is observed”. Accordingly, the court stated in its Alegra decision that, due to a lack of written provisions in the Treaty: Unless the Court is to deny justice it is therefore obliged to solve the problem by reference to the rules acknowledged by the legislation, the learned writing and the case law of the member countries.323

In other words, the Court applies general principles in order to avoid a non liquet. The need to apply those principles is exacerbated in the European Union, due to the fact that in many respects, Community law is still in the early stages of development so that there are many lacunae; in addition to being a new political order, it is also a new political order and, as such, has no historical roots.324 The method by which general principles are derived can be called an ‘evaluative approach.’325 In the same way as the functional approach described above, the Court selects legal systems from among the EU Member States and compares them. Which legal systems are compared in the end is variable and depends on the case.326 Although it can be assumed that the Court undertakes more comparative work than explicitly reflected in its judgments,327 there is no evidence that the Court attempts to find a common denominator of all these systems or attempts to compare all Member States’ legal orders.

321

322 323

324 325 326 327

Weiß, Wolfgang, Die Verteidigungsrechte im EG-Kartellrecht – Zugleich ein Beitrag zu den allgemeinen Rechtsgrundsätzen des Gemeinschaftsrechts, Köln 1996, p. 14 et seq. (hereinafter: Weiß (1996)). Cf. the examples listed (ibid., p. 12). ECJ, Joined Cases 7/56 and 3–7/57, Alegra v. Common Assembly [1957–8] ECR 39 at 55. Tridimas, supra n. 320, p. 9. See: Lecheler, Helmut, Einführung in das Europarecht, 2nd ed. München 2003, p. 115. Weiß (1996), supra n. 321, p. 47. Daig, Hans Wolfram, Zur Rechtsvergleichung und Methodenlehre im Europäischen Gemeinschaftsrecht, in: Bernstein, Herbert et al. (eds.), FS Konrad Zweigert, Tübingen 1981, p. 405.

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Due to the possibility of chamber decisions it is furthermore not possible to trust that all legal orders would flow into the decision via the participating judges.328 Thus, there is no decision in which the Court merely cites all domestic provisions from which the general principle in question could potentially flow. Instead, it often simply states the existence of a general principle. This even happened in cases where Member States did not (yet) ratify, for instance, a treaty in which the principle was incorporated.329 So, in its Defrenne III case the ECJ referred inter alia to the accord 111 of the International Labour Organisation (ILO), despite the fact that France and Luxembourg had not yet ratified that agreement.330 Due to this eclectic approach of the ECJ, it is questioned whether the laws of any Member States have proved more influential than others. Tridimas summarizes, after a short survey, that, “if any conclusion may be drawn [. . .] it is that no national law can claim overriding influence to the development of Community public law.”331 If a certain legal order is quantitatively more often quoted or used in judgments of the ECJ, then this is due first of all to the date of accession of the specific Member State. While Britain for instance is a (relatively) late member of the EU, Germany and France have been among the founding members. In addition, reference to domestic legal orders can also be seen as linked to the number of claims brought to the Court by the nationals of the respective Member State. Thus, as the Court’s approach is not primarily quantitative, it remains to be seen whether those principles generally found in the evaluated Member States’ legal orders are seen as strictly binding rules. In this regard, a statement by Advocate-General Lagrange is illuminating: [. . .] the case law of the Court, in so far as it invokes national laws (as it does to a large extent) to define the rules of law relating to the application of the Treaty, is not content to draw on more or less arithmetical ‘common denominators’ between the different national solutions, but chooses from each of the Member States those solutions which, having regard to the objects of the Treaty, appear to be the best or, if one may use the expressions, the most progressive.332

328

329 330 331 332

Lindemann, Hans-Heinrich, Allgemeine Rechtsgrundsätze und europäischer öffentlicher Dienst, Berlin 1986, p. 38. Cf. ECJ, Defrenne III, [1978] ECR, 1379. Further examples are provided by Weiß (1996), supra n. 321, p. 24. Tridimas, supra n. 320, p. 16. Case 14/61, Hoogovens v. High Authority, [1962] ECR, 283 et seq.


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The Court’s practice demonstrates this approach. Instead of trying to identify a common denominator, it strives to identify a synthesis to provide the most appropriate solution for the case at hand, taking into consideration the goals and structure of the Community.333 The national legal orders are used not in a mechanical way, but as “sources of inspiration.”334 3.2.2.6. The Telos-Oriented Approach of the ECJ and the International Context To what extent, then, is this telos-oriented335 approach of the ECJ transferable to the public international law context? First of all, it is evident that both international tribunals and the ECJ as a regional and supranational tribunal, are given a similar mandate in terms of methodology. Both are required to synthesize principles found in domestic legal orders rather than to mechanically seek statistically predominant rules to develop new elements of law where gaps existed before.336 However, differences arise from the status of the ECJ as a regional supranational court, as opposed to an international judicial body. Indeed, the ECJ’s jurisdiction is limited to the Member States, and the process by which the Court discovers general principles is more eclectic when compared to the approach of international tribunals, in so far as the ECJ’s main purpose is to find solutions that adequately reflect the structure and the goals of the European Community.337 General principles in the ECJ’s jurisprudence do not necessarily have to be ubiquitous in the domestic systems of the Member States. Furthermore, there is a tendency of the Court to use general principles, not to derive a certain solution, but to safeguard an autonomously developed legal principle.338 This is, however, justified by the common values that are shared by all Member States.339 What is otherwise still to be derived from national legal orders can be seen as already implicitly incorporated in

333

334

335 336 337 338

339

Weiß (1996) calls this ‘gemeinschaftsrechtlicher Modifizierungsvorbehalt’, supra n. 321, p. 68. Pernice, Ingolf, Gemeinschaftsverfassung und Grundrechtsrechtsschutz – Grundlagen, Bestand und Perspektiven, (1990) 43 NJW, p. 2413. Cf. Weiß, supra n. 321, p. 61. Tridimas, supra n. 320, p. 38. Ibid., p. 38 et seq. Pernice, Ingolf, Grundrechtsgehalte im Europäischen Gemeinschaftsrecht, Baden-Baden 1979, p. 31. Weiß (1996), supra n. 321, p. 17 et seq.

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the Community order. The ECJ, thus, is less restricted in finding general principles of Community law. One will only accept a violation of judicial discretion on the European level if the principle is in blatant contradiction of a domestic legal order.340 The creative freedom afforded to the judges of the ECJ gives them the opportunity to integrate the Member States and to develop the European legal order. This is particularly important in view of the continuing process of accession of new countries to the European Union.341 A further advantage of this application of general principles by the ECJ is that it makes it possible to differentiate on a regional level.342 A comparable jurisdiction in other regions of the world could improve regional integration. The extent to which the case law of the ECJ is transferable to the international context is, however, strongly dependent on the approach chosen. The less countries are inflexible regarding their sovereign law, and the more they tend to put their own national interests last in favour of the goals of a regional community, the more the ECJ’s application of general principles can become a model for other regional tribunals.343 3.3. Conclusion The core objection raised to general principles of international law is the alleged unpredictability of the outcome of a judgment based upon these.344 This critique, though, is unconvincing. First of all, decisions in international law, be it private or public, usually have to tackle tricky issues. Thus, it is even more impossible to predict the final outcome than would usually be the case in a domestic context.345 Even if a domestic order is chosen to govern an international legal relation, there is often a lack of sufficient legal provisions to adequately regulate these relations.346 Legal gaps in cases concerning international relations are therefore unavoidable. The way in which such

340 341 342

343

344 345 346

Hailbronner, supra n. 252, p. 221. Weiß, supra n. 245, p. 410. As to the growing importance of regional international law in general, cf. Schindler, Dietrich, Regional International Law, in: Bernhardt, Rudolf (ed.), Encyclopedia of Public International Law, Vol. IV, Amsterdam 2000, p. 161 et seq. A survey of the growing tendency for regional economic unions – which historically can be seen as harbingers of further integration – is provided by Herdegen, Matthias, Internationales Wirtschaftsrecht, 4th ed. München 2003, § 9. Dasser, supra n. 257, p. 115. Schmitz, supra n. 300, p. 88. Ibid., p. 89.


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gaps are bridged is to a certain extent unpredictable for the parties to the litigation. Nevertheless, without reference to general principles, the judge would have to declare a non liquet. Even if this result were more foreseeable, it certainly is not fairer. Furthermore, the preceding discussion concerning the techniques by which general principles can be revealed has demonstrated that those principles do not lead to a decision ex aequo et bono. Instead, legal comparison can be used as an appropriate analytical method to derive a solution from the latent rules of law where written law does not yet exist. The method of comparative analysis outlined above furthermore illustrates that domestic legal systems can be used as an extensive reservoir for discovering the content of domestic legal systems. General principles are, to this extent, a fertile ground, since the international legal order benefits from the usually higher developed standards of domestic law.347 In the meantime, the international judiciary has acknowledged these benefits of general principles and more and more decisions make explicit reference to them or are based entirely upon them. Furthermore, the number of international treaties based on the comparative study of domestic legal systems and their common principles is steadily growing.348 The same drafting technique has been used more and more often for major codifications, such as those of the Swiss Law of Obligations;349 the new Dutch Civil Code; the reforms to the German Law of Obligations350 and the German Insolvency Code.351 International works such as the UNCITRAL Model Law on Cross Border Insolvency are also based on a functional comparison of the world’s “modern, efficient insolvency systems.”352 The question thus arises why an insolvency procedure for sovereigns should not also be based on these principles.

347 348

349

350 351

352

Weiß, supra n. 245, p. 416. Cf. Schadbach, Kai, The Benefits of Comparative Law: A Continental European View, (1998) 16 B.U. Int’l. L.J., p. 385. Cf. Merz, Hans, Quellen des schweizerischen Obligationenrechts: Ein Beispiel interner Rechtsvereinheitlichung, in: Bernstein, Herbert (ed.), Festschrift für Konrad Zweigert zum 70. Geburtstag, Tübingen 1981, p. 670 et seq. Rolland, Walter, Schuldrechtsreform – Allgemeiner Teil, (1992) 45 NJW, p. 2380. Grossfeld, Bernard, Comparative Law as a Comprehensive Approach: A European Tribute to Professor Jack A. Hiller, (2000) 1 Rich. J. Global L. & Bus., p. 4. UN, UNCITRAL Model Law on Cross Border Insolvency with Guide to Enactment, New York 1999, p. 19.

Chapter II An Insolvency System for Sovereigns Derived from General Principles of International Law The idea that general principles of international law can play an important role in constructing the legal framework for sovereigns acting in the area of international finance is hardly a new one. As early as 1964 – when the international financial architecture as we know it today was still in statu nascendi – Friedmann noted that states were increasingly acting like private parties in their international financial relations. This development has gained significant momentum since those days, so that there are no general objections against a transfer of principles derived from domestic insolvency laws to sovereign debt reorganisation.1 Instead, the importance of general principles in international finances is highlighted inter alia by former IMF General Counsel Fawcett, who claimed to use them as a means of revealing the meaning of technical terms in the IMF Agreement such as ‘loan’, ‘net income’ or ‘capital’.2 However, the development of a debt reorganisation system for sovereigns derived from general principles of international law would have to be possible in technical terms (1). Assuming that this obstacle can be overcome, the next step in finding general principles for such an insolvency system for sovereigns will then be to select the relevant legal systems (2). In order to establish the common structure of these systems, it is necessary as a next step to provide an overview of these systems (3). Following a functional comparison of the results obtained in this summary (4) an amalgamation of the findings will ultimately provide those rules on which an insolvency mechanism for states should be based (5). 1

2

Friedmann, Wolfgang, The Changing Structure of International Law, London 1964, p. 190 et seq. Fawcett, J.E.S., The Place of Law in an International Organization, (1960) 36 B.Y.I.L., p. 341 et seq.

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Part C – Chapter II

1. Comparability of Domestic Insolvency Regimes Some scholars opposed to an insolvency law derived from general principles of international law have contended that, due to the insurmountable differences between the domestic insolvency orders, it is not possible to establish a common core.3 Indeed, domestic insolvency laws are said to be the national legislator’s favourite subject.4 Thus, Fletcher remarked that: [. . .] it is an observable paradox in relation to bankruptcy treaties that they are most likely to be ratified by a sufficiently large number of participating states only where their concrete provisions are so limited in scope and effect as to endow them with, at best, only a modest practical value.5

The reasons why insolvency law is such a sensitive area for any legislator are demonstrated by Rivera and Roitman, who write: [la insolvencia] compromete a todos los sectores de la economía y expresa las fundamentales conflictos en el corazón de la política capitalista entre trabajo y capital, proprietarios y administradores, deudores y acreedores, el Estado y el mercado.6

Nevertheless, recent developments illustrate that sensitivity on the part of the sovereign states in this area is decreasing. Thus there is a growing tendency for the harmonisation of jurisdictional and mutual-recognition rules, such as can be seen in the UNCITRAL Model Law on Cross Border Insolvency,7 the EEC Bankruptcy Convention8 or EU Regulation (EC) 1346/2000,9 which are mentioned above. Perhaps the best example of a successful multilateral instrument in this area, though, is the Convention between Denmark, 3

4

5

6

7

8 9

Eichengreen, Barry; Portes, Richard, Crisis? What Crisis? Orderly Workouts for Sovereign Debtors, London 1995, p. 42. Malagardis, Antonis N., Ein Konkursrecht für Staaten? Zur Regelung von Insolvenzen souveräner Schuldner in Vergangenheit und Gegenwart, Berlin 1990, p. 65. Fletcher, Ian F., Harmonization of Jurisdictional and Recognitional Rules: The Istanbul Convention and the Draft EEC Convention, in: Ziegel, Jacob S. (ed.), Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 710. Rivera, Julio César; Roitman, Horacío, El derecho concursal en la emergencia, (2004) 1 Revista Latinoamericana de Derecho, p. 382. Benning, Olaf; Wehling, Axel, Das “Model Law on Cross-Border Insolvency” der Vereinten Nationen, (1997) 8 EuZW, p. 618 et seq. Cf. Fletcher, supra n. 5, p. 714 et seq. For a survey on this regulation see e.g.: Wimmer, Klaus, Die EU-Verordnung zur Regelung grenzüberschreitender Insolvenzverfahren, (2002) 55 NJW, p. 2427 et seq.

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Finland, Iceland, Norway, and Sweden regarding bankruptcy, which dates back to 7 November 1933.10 Current differences might therefore have become less significant than at first assumed.11 This finding is underlined by contemporary efforts such as, inter alia, the Worldbank’s Insolvency Initiative, which departs from the finding that there is a growing consensus on the broad underlying principles of effective insolvency and debtor-creditor systems and which aims at identifying those principles.12 As a kind of forerunner to this project in 1999 the IMF released a report on Orderly & Effective Insolvency Procedures.13 The report, which was also based on a comparative study of selected insolvency laws, discussed the key issues that arise in the design and application of such procedures and provided solutions based on this analysis.14 Lastly, it should be noted that domestic insolvency law has to address both cases of insolvency, i.e. liquidation and rehabilitation. Significant differences can arise due to the fact that some systems prefer liquidation while others favour a rehabilitational approach. However, it has been reiterated that “Companies may go down, but governments must not”.15 Liquidation and distribution of a people’s government is out of the question. The more detailed comparison is thus between domestic rehabilitation systems.16 The argument that, on account of the significant differences between domestic legal systems, it would be technically impossible to derive general principles from these systems is consequently not a convincing one. On the contrary, it is these variations that make comparative analysis so useful.

10

11

12

13

14

15

16

Bogdan, Michael, The Nordic Bankruptcy Convention, in: Ziegel, Jacob S. (ed.), Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 701 et seq. Schwarcz, Steven L., Sovereign Debt Restructuring: A Bankruptcy Rehabilitation Approach, (2000) 85 Cornell L. Rev., p. 972. More information about the World Bank Insolvency Initiative is available at: www4. worldbank.org/legal/insolvency_ini/overview.htm. IMF, Orderly & Effective Insolvency Procedures: Key Issues, Washington 1999 (hereinafter: IMF (1999)). See also Deloitte & Touche et al. (eds.), Bankruptcy and a Fresh Start: Stigma on Failure and Legal Consequencs of Bankruptcy, Brussels, July 2002, which is a study produced as part of the EU’s enterprise policy and which provides a comparative analysis of the insolvency and corporate rescue laws of the Member States as well as a report on the US. Macmillan, Rory, Towards a Sovereign Debt Work-Out System, (1995) 16 Northwestern J. Int’l L., p. 74. Schwarcz, supra n. 11, p. 974.

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2. Selection of the Relevant Legal Systems Accordingly, existing differences between domestic insolvency systems shall not be marginalized, nor overemphasized. Instead, these differences have to be taken into consideration when selecting the relevant legal systems. This is particularly important when selecting the relevant legal systems for the present purpose as this selection is limited by the material available17 as well as by linguistic and spatial aspects.18 The approaches toward insolvency law adopted by countries vary in a number of respects. These differences are attributable to differing historical influences (2.1) as well as to the different philosophies on which the respective insolvency laws are based (2.2). Furthermore, there are differences that arise from legal traditions, as well as the economic and socio-cultural background of a country (2.3). 2.1. Historical Influences As to the historical influences on domestic insolvency laws, three basic groups of countries can be distinguished. In the first group, the laws are influenced mainly by the country’s own traditions (2.1.1). In contrast, in the second group the law is based mainly on the traditions of a foreign country (2.1.2) and in the third group the development of the present-day law is largely influenced by a convergence of different national traditions (2.1.3).

17

18

While an amazing amount of information is now available (in particular via the internet) on even fairly ‘exotic’ legal systems, it is usually easier to find reliable information on, say, the US than on Tuvalu. These restrictions need not be a defect of the work as they allow a more detailed discussion, and since comparing a greater number of legal orders does not necessarily result in an improvement of the findings; cf. Zweigert, Konrad; Kötz, Hein, Introduction to Comparative Law, 2nd ed. Oxford 1987, p. 36, p. 40 et seq. Furthermore, the functional approach used here does not aim to find identical rules in the different systems, but seeks instead to consider whether there is any conceptual identity, and to use this as a basis for the development of general principles, as described above. Due to the fact that the development of insolvency law is mainly economy-driven, the chances are high that such principles can also be found in those legal systems that are not analyzed in the present work.


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2.1.1. Laws Mainly Influenced by National Developments England is an example of the first group of countries, whose law is mainly influenced by its own legal tradition.19 The roots of English insolvency law can be traced back to the earliest days of common law. English insolvency law developed slowly but continuously and organically over numerous generations of legislators and judges.20 This process was significantly influenced by the changing needs of the English commercial community.21 In the beginning, insolvency was regarded as a criminal act and the aim of the procedure was thus to punish the insolvent debtor for his wrongdoing.22 However, the sometimes draconian sanctions23 evoked significant protest from among merchant society and led to the first Bankruptcy Act, introduced in 1542 by Henry VIII. English insolvency law was modified further on a number of occasions. From 1861, insolvency laws were no longer restricted to merchants but were also applied to other persons.24 In 1844, the Joint Stock Companies’ Winding Up Act governed the procedure for the liquidation of corporate bodies.25 An independent reorganisation system was eventually introduced by the Insolvency Act 1985, which was consolidated by the 1986 Insolvency Act.26 The main reason for the development

19

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21

22

23

24 25

26

Another example is France; Arnold, Hans, § 1. Einführung, in: Gottwald, Peter (ed.), Insolvenzrechtshandbuch, München 1990, n. 6. Treillard, Jacques, Généralités, in: Rodière, René (ed.), Les procédures collectives de liquidation ou de renflouement des entreprises en droit comparé, Paris 1976, p. 14. Perker, Susanne, Das Reorganisationsverfahren im englischen Insolvenzrecht im Vergleich zur geplanten deutschen Insolvenzordnung, München 1994, p. 5. At the beginning of the 20th century, some commentators still regarded insolvency as “private law death penalty for inefficient entrepreneurs” (Pape, Gerhard; Uhlenbruck, Wilhelm, Insolvenzrecht, München 2002, n. 6). The incarceration of the insolvent debtor could at worst even lead to his starvation; cf. Holdsworth, William, A History of English Law, Vol. VIII, 2nd ed., London 1937, p. 232 et seq. “If one be in execution he ought to live of his own, and neither the plaintiff nor the sheriff is bound to give him meat or drink [. . .] and if others will give him nothing, let him die in the name of God, if he will, and impute the cause of it to his own fault, for his presumption and ill-behaviour brought him to that imprisonment.” Fletcher, Ian F., The Law of Insolvency, 3rd ed. London 2002, p. 7. This had become necessary due to the fact that, also in 1844, the Joint Stock Companies Act for the first time permitted the establishment of companies and thus of corporate bodies (Farrar, John H., Company Law, London 1985, p. 17). Since 1870 the English common law accepts the institution of a ‘floating charge’ which is tightly connected with the procedure of ‘administrative receivership’. This institution

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of this new law was the alarming increase in cases of insolvent companies, which was caused by the economic recession in the 1970s and 1980s. Once again, it was the merchant community that had provided the impetus for the development of English insolvency law. 2.1.2. Laws Mainly Influenced by Foreign Traditions In contrast to this first group, many countries, particularly former colonial states, but also most former socialist countries, have an insolvency law that is inspired largely by a single foreign model.27 Indonesia for instance, after gaining independence from the Netherlands in 1945, provided under Article II of its constitution that all laws and legislation existing under the Dutch colonial administration should automatically become the laws and regulations of Indonesia until such time as they are revoked, repealed or amended.28 As a result, the Indonesian Insolvency Code (Faillissementsverordening) is a duplicate of the Dutch Insolvency Act, which was enacted in 1905.29 The same process of more or less 1:1 transmission of the law of the former colonial powers took place in most other colonies.30

27

28

29

30

can also support the preservation of a liquidity-strapped company. However, this is only a side effect. Its main goal is to achieve the best possible satisfaction of the debts secured by the floating charge (cf. Perker, supra n. 21, p. 9). Most Eastern-Bloc states did not have insolvency laws during communist rule. Even in those countries that had such a law during this period, like Poland, it was of no practical relevance; Zoll, Fryderyk (et al.), Polnisches Insolvenzrecht, Vienna 2002, p. 29. The majority of the new laws in former socialist countries were and are being modelled after Western European or US-American examples (Berkowitz, Daniel et al., The Transplant Effect, (2003) 51 Am.J.Comp.L., p. 164). Little, Peter, Indonesia, in: Tomasic, Roman; Little, Peter, Insolvency Law & Practice in Asia, Hong Kong 1997, p. 203. The Indonesian bankruptcy law is popularly cited as having been enacted in 1906. However, to be precise, the 1906 legislation is a subsequent amendment to the original 1905 version (Schreiber, Michelle, Beyond the Economic Turmoil of the Asian Financial Crisis: Indonesia’s Struggle to Cope with Insolvency, (1999) 12 Transnat’l Law, n. 24). Thus, the insolvency law of Senegal for instance is based on the French code, while the insolvency law of Uganda is based on English law (Pajardi, Piero, Il fallimento nel mondo – Panorama dei sistemi esecutivi concorsuali nelle realtà nazionali, Padova 1988, pp. 887, 947); see critically on the 1:1 transmission in the case of Venezuela: Treillard, supra n. 20, p. 18; critically in general: Berkowitz, supra n. 379, p. 163 et seq.


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2.1.3. Laws Mainly Influenced by a Convergence of Traditions A third group of insolvency codes, such as those found in Germany, are influenced by the convergence of numerous legal traditions. Due to the establishment of the German Reich in 1871, it also became necessary to develop a uniform insolvency code. This was particularly difficult because of the significant differences between the laws applicable in the different Länder.31 The German insolvency act (Konkursordnung) eventually adopted in 1879 was based on an amalgamation of the laws in the different Länder and was also influenced by foreign experiences.32 Commentators saw, and still consider the resulting insolvency law to be an excellent piece of legislation.33 Following amendment in 1935 by the Composition Act (Vergleichsordnung), the Konkursordung itself remained essentially unchanged until 1999, when the German Insolvency Code (Insolvenzordnung or InsO) entered into force. Once again, the enactment of German insolvency law was closely connected to unification; this time between the new Länder of former Eastern Germany and Western Germany. While the Treaty of Unification provided for the adoption of almost all West German laws by the former Eastern states, it was decided that, in view of the special needs of East German enterprises, which were yet to be privatized, there should be a transitional arrangement.34 Furthermore, to deal with the different socio-cultural background in East-German society, some concepts of the former East-German insolvency law (Gesamtvollstreckungsordnung), such as ‘discharge’, were adopted in the InsO.35

31 32 33

34

35

Arnold, supra n. 19, n. 9. Treillard, supra n. 20, p. 19. The German Bankruptcy Act (1879) is regularly referred to as the ‘Perle der Reichsjustizgesetze’ (Pape/Uhlenbruck, supra n. 22, n. 9). That is why until 1999 the old political borders remained intact for insolvency law, whereby in the West the Konkursordnung and the Vergleichsordnung applied, while in the East the Gesamtvollstreckungsordnung was the applicable law; Kamlah, Klaus, The New German Insolvency Act: Insolvenzordnung, (1996) 70 Am. Bankr. L.J., p. 417 et seq. Paulus, Christoph G., The New German Insolvency Code, (1998) 33 Tex. Int’l L.J., p. 143, who also writes that the necessity for a special regulation on discharge was necessary given the over-indebtedness of many families in the East, which were overwhelmed by Western consumer standards; ibid., p. 142.

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2.2. Influences of the Philosophical Foundations of Corporate Insolvency Law Basically speaking, insolvency law “is simply [. . .] a scheme designed to distribute the costs of those at risk.”36 When an insolvency scheme is established, three fundamental questions have to be answered: why, if at all, is such a scheme necessary; for whom shall it be conducted; and to what end.37 At one end of the spectrum of rationales to legitimise insolvency law stands the view that insolvency law provides a framework for creditor wealth maximisation (2.2.1) while at the other end of the spectrum it is argued that the rationale of an insolvency scheme is the protection of debtor interests (2.2.2).38 Between these two poles there are a number of other interests potentially affected by insolvency, such as the interests of managers, suppliers, employees, their dependants, members of the community etc. Finding a compromise between the affected interests is a third option (2.2.3). 2.2.1. Creditor Wealth Maximisation and the Creditor’s Bargain Some commentators argue that the fundamental task of any insolvency law is to provide a tool for debt collection and that the insolvency system should reflect the (hypothetical) bargain that the creditors would have made – as seen from an ex ante perspective – had they had the chance prior to entering into transactions with the insolvent party.39 In line with ideas of economic efficiency, insolvency law is thus seen as a device to maximize the collective return to creditors.40 This philosophy focuses on the debtor’s assets, while the debtor’s interests, as well as those of others that might be affected, are not seen as a concern of the insolvency law.

36 37

38

39 40

Warren, Elizabeth, Bankruptcy Policy, (1987) 54 U. Chi. L. Rev., p. 790. Flessner, Axel, Philosophies of Business Bankruptcy Law: An International Overview, in: Ziegel, Jacob S. (ed.), Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 23. Therefore, some commentators classify the world’s legal systems into pro-creditor and prodebtor systems. However, these labels are very ambiguous, since these terms often have different meanings in different countries. For example it can be argued that ‘pro-debtor’ easy access to a statutory restructuring procedure hinders a voluntary rehabilitation, which might often be more effective; Wood, Philip R., Principles of International Insolvency, London 1995, p. 3. See e.g. Jackson, Thomas H., The Logic and Limits of Bankruptcy Law, Harvard 1986. Baird, Douglas J.; Jackson, Thomas H., Corporate Reorganisation and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy, (1984) 51 U. Chi. L. Rev., p. 97 et seq.


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This approach departs from the consideration that the debtor’s pool of assets is subject to the claims of the creditors and, therefore, in reality belongs to them. However, individual and uncoordinated claim enforcement destroys the overall value of this common pool of assets, to the detriment not only of the debtor, but also of the creditors. Hence, all parties involved can benefit from reduced strategic costs and the administrative efficiency of a co-ordinated insolvency procedure, which increases the aggregate pool of assets.41 The purpose of Bankruptcy law is, according to this overriding goal of value maximisation, to guarantee that claimants receive at least as much from the proceedings as they would have received through an individual enforcement of their claim. To operate most efficiently, such a system must first of all ensure that the reorganisation or liquidation is accomplished at minimum cost. Second, it must encourage insolvent debtors to restructure where their going concern value is greater than the liquidation value and, in turn, it must force them to liquidate where the liquidation value exceeds the going concern value. Third, it must not create incentives for the leadership ranks or others to use the system to generate ex ante private benefit that negatively affects the value of the debtor’s assets.42 In line with the creditor’s bargain theory, English law provides for example that the primary purpose of insolvency procedures is to establish a mechanism for the orderly collection and realisation of assets and the rateable distribution of dividends among creditor claims.43 2.2.2. Debtor Protection The opposite view aims to rescue the insolvent (corporate) debtor ‘at any cost’ by preserving it as a going-concern and eliminating liabilities. The most prominent example of such a system is probably France.44 The philosophy

41 42

43

44

Jackson, supra n. 39, p. 7. Gilson, Stuart C., Methodological Issues in Cross-Country Comparisons of Commercial Bankruptcy Law: Comment on the Paper by Eisenberg-Tagashira and Rajak, in: Ziegel, Jacob S. (ed.), Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 262. Goode, Roy, Principles of Corporate Insolvency Law, London 1997, p. 5; the same philosophy forms the basis for most former Dutch colonies, such as Indonesia (Wood, supra n. 38, p. 4). Another example of a country whose insolvency law focuses primarily on enterprise salvage and employee retention, is Argentina (Goffman, Jay M.; Michael, Evan A., Navigating

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behind this view is that debtors, at least if they have reached a certain size, are so important to the economy that it is justified to use the means of insolvency law to roll back existing creditors’ claims in order to make the debtor attractive for new capital or, if that should be impossible, to set the debtor free to engage in new economic activity.45 This approach is a reflection of the belief that insolvency law is also an instrument to steer the proper development of the domestic economy.46 2.2.3. Balance of Interest A third view sees the insolvency process as a means to establish a forum within which all interests affected by the debtor’s failure, whether directly, monetary, or not, can be voiced.47 Accordingly, commentators understand one of the central aims of insolvency law as being that it should recognize and safeguard the interests of not only the insolvent debtor and its creditors, but also of society in general and all other groups affected by the default.48 In other words, the balancing process taking place when deciding on the future of an insolvent debtor shall comprise interests of directors, shareholders and employees, as well as those whose livelihood depends on the enterprise and the community. While any insolvency undoubtedly involves difficult decisions and will always, to a certain extent, lead to losses,49 these losses can be minimized.50 It is this balancing of multiple values which is seen as the essence of the process.51 Rehabilitation procedures, as well as often being economically

45 46

47 48 49

50 51

Through a Multinational Restructuring: Cross-border Insolvencies, Proceedings and Workouts – A Comparative Examination of Insolvency Law of Industrialized Countries, 050503 ABI-CLE 11, sub XI). Italy, a further example, even introduced a special procedure for large state-owned enterprises, which is designed to avoid liquidation whatever happens and at whatever cost. Flessner, supra n. 37, p. 22. Thus, in France for instance the debtor-oriented approach can also be seen to reflect political fears about rising unemployment (ibid.). Keay, Andrew; Walton, Peter, Insolvency Law, London 2003, p. 26 et seq. Arnold, supra n. 19, n. 23, calls this the “third dimension” of insolvency. In so far, losses are defined more broadly and also include affected interests if they cannot directly be described in monetary terms (cf. Flessner, supra n. 37, p. 24). Cf. Arnold, supra n. 19, n. 24. Finch, Vanessa, The Measures of Insolvency Law, (1997) 17 Oxford Journal of Legal Studies, p. 250 et seq.


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beneficial in the long run,52 can serve a broader societal interest by giving debtors a second chance and, thereby, encouraging the growth in the private sector.53 The fact that Germany, in its 1994 reform of insolvency law, for the first time accepted a general equilibrium between liquidation and rehabilitation procedures can thus be seen as a step towards this approach.54 Another example of the growing importance of a balancing of interests not only of creditors and debtor, is § 218 (3) InsO, which provides that the staff committee, as well as the representative committee of executive employees, have to be heard when drafting the insolvency plan.55 The function of this balancing approach is, on the one hand, to co-ordinate debt collection by providing an appropriate forum and, on the other hand, to organize and rationalize the decision making process.56 2.3. Economic and Socio-Cultural Influences Finally, as discussed above,57 a central element in the division of the world’s legal systems is their legal tradition. It is also possible to distinguish between domestic insolvency laws in this manner. For instance, although a great part of English corporate insolvency law is now statutory, there are numerous regimes entirely governed by common law principles and by the jurisdiction of the court.58 While the influence of non-statutory sources on the legal development in countries belonging to the Roman or German legal system is much less important, the contrary is 52

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55

56 57 58

From the beginning of the 20th century, the finding that liquidation is often not the most efficient solution for an insolvency gained acceptance. See e.g. the statement by Ernst Jäger „Der Konkurs ist ein Wertvernichter schlimmster Art und obendrein das teuerste Schuldentilgungsverfahren“ (idem, Lehrbuch des Deutschen Konkursrechts, 8th ed., Berlin 1932, p. 216). IMF (1999), supra n. 13, p. 11. It should be noted though, that the central goal of German insolvency law remains the provision of a means for achieving the most profitable result for the creditors as a group. Nevertheless, an important change of view was the conclusion that what is best for the debtor is also often best for the creditors. Another example is § 156 (2) InsO, which, in addition to the groups mentioned in § 218 InsO, gives also the right to receive a statement from the responsible professional representation group, of which the debtor is a member. Flessner, supra n. 37, p. 24. See supra Part C, Chapter II, 2.1. For instance much of receivership law is based on those principles (Goode, supra n. 43, p. 9).

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true above all for those legal systems influenced by Islamic law. Thus, adat law, which is an unwritten source of law inter alia in Indonesia, plays an important role alongside the statutes.59 Adat goes far beyond the concept of customary law. It comprises rules, customs, usages, practices and even the personal habits of individuals.60 This alone demonstrates that the concepts and consequently also the solutions achieved under adat law may be very different from those achieved under common law or statutory-based legal systems. Another example of cultural influences on the shape and efficiency of law is the discovery that insolvency workouts, instead of judicial proceedings, are the norm throughout Asia. This is due inter alia to the prevailing Confucian ethic of harmony, combined with the desire to ‘save face’.61 Saving face requires avoidance of the social stigma attached to an insolvency procedure, so that debtor and creditors prefer non-public private settlements.62 Furthermore, work-outs that appear ‘in the shadow of the law’ rather than along its lines are often a consequence of a lack of judicial resources. Unreliable or ineffective legal infrastructure creates an environment unsuitable for formal workouts. Such problems are by no means restricted to Asia. In Brazil for instance, most creditors try to reach out-of court settlements due to the fact that the courts often decide in a ‘pro-debtor’ fashion, e.g. extending fixed statutory time-limits far beyond what is covered by the wording of the law.63 Lastly, the economic situation of a country is an important factor when selecting the relevant legal systems.64 This is particularly true in the present

59 60 61

62 63

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Little, supra n. 28, p. 204. Ibid. Carter, Courtney, Saving Face in Southeast Asia: The Implementation of Prepackaged Plans of Reorganization in Thailand, Malaysia, and Indonesia, (2000) 17 Bankr. Dev. J., p. 312. Ibid. Cf. Dill, Cato, Grundzüge des brasilianischen Konkurs- und Vergleichsrechts, (1986) 32 RIW, p. 25; a recent report by the UN human rights commission stated that the Brazilian judicial system “did not inspire confidence” and that it was “in need of drastic reforms”. This is due not only to a lack of sufficiently trained staff and the lack of independence on the part of the judiciary (FT-Europe, 20 February 2004, p. 4) but also to the fact that “judges often surpass their authority, creating, not applying law” (ibid.). Cf. the resolution of the UN General Assembly concerning the establishment of UNCITRAL, according to which “[t]he General Assembly shall also have due regard to the adequate representation of the principal economic and legal systems of the world, and


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context, as insolvency law is often seen as not a purely legal matter, but as an area substantially influenced by economic necessity.65

3. Domestic Insolvency Orders Using the criteria discussed above, the following five representative insolvency systems have been selected: Argentina, which is an emerging market and whose law, based on a foreign model from the Roman law system, is debtor-oriented (3.1). England, an industrialized common law country with a creditor-oriented insolvency law and a long-standing national legal tradition (3.2). France, an industrialized country from the Roman law family with a debtor-oriented insolvency law that also emerged from a long-standing development process (3.3). Germany, an industrialized country from the Germanic law tradition, whose insolvency law was significantly influenced by a number of legal traditions and which is creditor-oriented, while also giving due regard to debtor and third party interests (3.4). Indonesia, one of the Asian ‘tiger economies’, is at the same time the world’s most populated Islamic country, with a creditor-oriented insolvency law based on the adoption of a foreign model (3.5). 3.1. Argentina 3.1.1. Overview On 20 July 1995, Argentina introduced its new insolvency law, designated as Law 24.522 and commonly referred to as Ley de Concursos y Quiebras.66 The limits and the effectiveness of this law were seriously tested by several years of recession that hit Argentina towards the end of the 1990s and ultimately led to the country’s default on its foreign debt at the end of 2001.

65

66

of developed and developing countries.” UNCITRAL, (1970) 1 UNCITRAL Yearbook, p. 66. Pape/Uhlenbruck, supra n. 22, n. 12 „Die InsO ist kein Juristengesetz, sondern ein Wirtschaftsgesetz.“ Ley 24.522 of 20 July 1995, Ley de Concursos y Quiebras [hereinafter: LCQ]. Its predecessor was Law 19.551, which dated from 1972; for a historical summary of Argentine insolvency law see e.g.: Martorell, Ernesto Eduardo, Tratado de Concursos y Quiebras – Introducción a la Temática General del Concurso y la Quiebra, Buenos Aires 1998, p. 89 et seq.

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To deal with the extraordinary challenges facing Argentina in the wake of the default, a number of emergency measures that aimed at stabilizing the domestic economy against a rapid deterioration were adopted.67 One of these measures was the enactment of Law 25.563,68 which significantly changed the legal framework for insolvency procedures in Argentina, as established by the LCQ. The changes provoked strong criticisms at both the domestic and the international level. In particular, the law was seen as a significant blow to creditor rights.69 The most serious setbacks for creditors under the emergency law included the creation of a moratorium that resulted in the suspension of all executions in the course of insolvency proceedings and the suspension of nearly all individual executions, as well as some precautionary measures for a period of 180 days.70 Furthermore, Article 48 LCQ, the Argentine salvataje or cramdown provision was weakened.71 This article allowed creditors and third parties to negotiate a take-over with the creditors of the reorganizing company if the latter did not obtain the necessary majorities for the proposed insolvency plan. Lastly, the effect and extensions of guarantees which had previously been granted to creditors were limited.72 Article 1 of Law 25.563 provided that its rules should apply during the state of emergency until 10 December 2003. However, on 16 May 2002, a new Law 25.589 was enacted, which repealed most of the emergency measures of Law 25.56373 and reinstated – in part with modifications – the LCQ, as well as introducing some new provisions to Argentine insolvency law.74 3.1.2. Description of the Rehabilitation Procedure Both liquidation (quiebra) proceedings and reorganisation (concurso preventivo) proceedings are governed by the LCQ.75 A change from one to 67

68 69

70 71 72

73 74 75

Johnson, Gordon; Rouillon, Adolfo, Argentina: Insolvency and Creditor Rights, World Bank Report on the Observance of Standards and Codes (ROSC), June 2002, p. 2. Ley 25.563 of 15 February 2002 [hereinafter: Law 25.563]. Cf. e.g. Rivera, Julio César, ¿Qué ley de quiebras para Argentina?, elDia.com, 16 April 2002, available at: http://edec.iespana.es/edec/Articulos/corner9.htm, “[La Ley 25.563] nos saca del mundo y genera un sistema que es verdadera extorsión para los acreedores.” Cf. Article 9 Law 25.563. Article 21 Law 25.563. Cf. Article 8 Law 25.563 concerning suspension of guarantees permitting the transmission of control over the insolvent enterprise. Ley 25.589 of 16 May 2002 [hereinafter: Law 25.589]. Cf. Rivera/Roitman, supra n. 6, p. 396. Articles 5 LCQ et seq. respectively Articles 102 LCQ et seq.


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the other is possible.76 Upon petition by the debtor, judicial reorganisation proceedings are initiated. The power to deal with insolvency matters lies with the judge of ordinary jurisdiction ( juez con competencia ordinaria).77 In contrast to liquidation proceedings, creditors have no right to file a case for reorganisation.78 While the debtor remains in control of the assets and continues to run the business,79 it is supervised by a court-appointed administrator (síndico).80 During the reorganisation, the administrator has the function in particular of collecting and examining the proof of claims filed by the creditors and determining the debtor’s liabilities according to this information.81 The administrator also has to produce a general report (informe general ) in which he has to analyse the probable value of the assets, as well as the management of the insolvent company.82 In addition to the administrator, a creditors’ committee (comité de acreedores) serves as a supervisory body during the reorganisation proceedings.83 According to Article 1 LCQ, the commencement of insolvency proceedings requires the cessation of payments. This prerequisite, though, is eased in the case of reorganisation, as the petition for such procedures is deemed sufficient proof of the debtor’s confession to a cessation of payments.84 However, Article 11 LCQ requires evidence of the fulfilment of numerous formal requirements. Thus, the debtor must give reasons for its economic situation, including the submission of a detailed report identifying its assets and liabilities. Furthermore, various formalistic requirements apply, such as the obligation to enclose an accountant’s attestation to witness the financial possession statement.85

76 77 78 79

80 81 82 83 84

85

Articles 90 LCQ et seq. Article 3 LCQ. Article 5 LCQ. Nevertheless, the debtor’s range of activity is significantly restricted. Apart from certain prohibited actions, such as gratuitous transfer of assets (Article 16 LCQ) the debtor is also subject to travel restrictions. The debtor is not allowed to leave Argentina without prior notification of the judge. Travel abroad for more than 40 consecutive days is even subject to the judge’s authorisation (Article 25 LCQ). Article 15 LCQ. Article 200 LCQ. Articles 41 LCQ et seq. Article 14 (11) LCQ. Dobson, Juan M., Argentina’s Bankruptcy Law of 1995, (1998) 33 Tex. Int’l L.J., p. 103 et seq. Johnson/Rouillon, supra n. 67, p. 14 recommend that the judge should be allowed to

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The commencement of the case automatically suspends all executions and lawsuits against the debtor during the time of reorganisation.86 In the same way, the commencement suspends all interest on loans that the debtor obtained prior to the cessation of payment.87 Furthermore, the debtor’s assets may no longer be disposed of or encumbered.88 The LCQ does not provide rules that support the debtor in obtaining priority financing to fund its ongoing and urgent business needs after commencement of the reorganisation proceedings.89 For a period of 90 days (período de exclusividad ), which the judge can, under certain circumstances, extend for another 30 days, the debtor has the exclusive right to make proposals for a reorganisation plan to the creditors and to obtain their approval.90 The plan shall adequately provide for equal treatment of all creditors within each single class.91 The classification of creditors into different classes is the responsibility of the debtor,92 who must present its proposal to the court for approval.93 The proposal of creditor classification is accepted if it satisfies the ‘reasonableness test’. If the debtor so wishes, it can make alternative proposals for the different groups of creditors. In that case, the creditors have to decide which proposal they want to adopt.94 The debtor has to submit its proposal for a reorganisation plan to the judge before the exclusivity period expires. This proposal must have been accepted by a

86

87 88 89 90 91 92 93

94

open proceedings “when the debtor largely fulfils the formal prerequisites of [Article 11] LCQ.” The suspension may be shorter for secured creditors, who may obtain approval from the judge to pursue their claims outside of the insolvency proceedings; Goffman/Michael, supra n. 44, at XI. Article 19 LCQ. Article 14 (7) LCQ. Johnson/Rouillon, supra n. 67, p. 10. Article 43 LCQ. Ibid. Article 41 LCG. The minimum number of creditor classes that has to be included in the proposal is three. Namely: ordinary unsecured creditors (quirografarios); ordinary privileged creditors that belong to the workforce (quirografarios laborales); and privileged creditors ( privilegiados); ibid. Article 43 LCQ.


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majority of verified95 creditors.96 Article 45 LCQ requires a majority of the creditors within each and every class, and a two-thirds majority in capital within each category.97 Provided that the judge also approves the plan, it is binding on the dissenting minority, too (homologación).98 The judge can even bind whole dissenting classes of creditors if certain conditions are met.99 The main consequence of the court approval is the novation (novación) of all obligations that existed before the commencement of the reorganisation proceedings.100 This means, above all, a reduction in the amount of all debt included in the plan.101 If the debtor does not obtain approval of the plan, the enterprise will go into liquidation except in cases falling under Article 48 LCQ.102 The salvataje103 procedure is devised to salvage the enterprise. In the event that the negotiation of a reorganisation agreement between the debtor and creditors

95

96

97

98 99

100 101 102 103

The process of verification is contained in Articles 32 LCQ et seq. A new provision introduced by Law 24.589 is Article 32bis LCQ. This provision takes into account the growing importance of fiduciaries that administer bonds, debentures and other titles, where there is a huge and diverse (often not publicly known) group of creditors. In those cases Article 32bis now allows the fiduciary to verify the claims in question on his own. The fiduciary is now entitled to claim the verification (in detail: Rivera/Roitman, supra n. 6, p. 411 et seq.). When calculating the majorities, votes by the spouse, as well as near relatives of the debtor, are excluded, Article 45 LCQ. Article 45bis which was introduced by Law 24.589 establishes – similarly to Article 32bis – a rule to simplify the insolvency process in cases where bondholders are involved (cf. Rivera/Roitman, supra n. 6, p. 414 et seq.). Article 52 LCQ. These conditions are: approval of the plan by at least one class of unsecured creditors; creditors representing at least three quarters of the total amount of unsecured claims must have voted in favour of the plan; the plan may not discriminate against the dissenting class(es) and the creditors must be granted a payment by the plan that is not inferior to the amount they would receive in liquidation (Article 52 LCQ). Article 55 LCQ. Johnson/Rouillon, supra n. 67, p. 7. Article 46 LCQ. The common reference to this procedure as ‘cramdown’ is somewhat misleading (cf. Rivera/Roitman, supra n. 6, p. 389). What is understood as cramdown in the U.S. in particular is comparable instead with the Argentine ‘homologación’ (Articles 52 LCQ et seq.). For a more detailed description of the ‘Argentine cramdown’ see: Rovira, Alfredo L., Chapter on Argentina, in: Broude, Richard F. (et al.), Collier International Business Insolvency Guide – Vol. II – Insolvency Laws of Selected Nations, New York 2003, at 13.04[4][b].

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fails, Article 48 attempts to encourage third parties to purchase the debtor’s equity. The resultant take-over of the company shall, on the one hand, supply fresh capital and, on the other hand, assure that more capable management assumes the running of the business and thereby avoid the liquidation of the debtor.104 The central focus of the salvataje procedure is thus to rescue the existence of the enterprise.105 The political idea that influenced the introduction of this “probably most revolutionary aspect” of the LCQ106 to the greatest extent was opening Argentina to the global markets and thereby attracting local and foreign capital to buy the insolvent enterprises.107 In addition to formal insolvency procedures, the LCQ provides for the judicial approval of settlements that were reached between the debtor and its creditors out-of-court (acuerdo preventivo extrajudicial).108 This remedy is available to debtors that have either already ceased to pay, or are in a preinsolvency situation of general economic and/or financial distress.109 As the settlement is governed by private law, the parties are free to agree on any provision they consider appropriate.110 In line with corresponding model proposals by Insol and the IMF, Argentina reformed significant aspects of the provisions concerning out-of-court settlements.111 Thus, an agreement reached out-of-court shall now have the same effect as a reorganisation plan obtained in formal insolvency proceedings. Consequently, it is also binding on dissenting minorities, provided the plan is submitted and approved by the competent judge.112 Furthermore, due to the modifications introduced by Law 25.589, the majorities necessary to obtain a confirmation of the plan have now been adjusted to comply with the requirements under formal proceedings.113 Some commentators therefore already celebrated the reform as a legal landmark.114 Critics, however, note that the limited use of informal 104 105 106 107 108 109 110 111 112 113

114

Goffman/Michael, supra n. 44, at XI. Dobson, supra n. 84, p. 102. Ibid., p. 104. Ibid., p. 103. Articles 69 LCQ et seq. Article 69 LCQ. Article 70 LCQ. Rivera/Roitman, supra n. 6, p. 420. Article 72 LCQ. Cf. Article 73 LCQ which requires per capita majority and two-thirds of the total amount of unsecured debt. Cf. Rivera/Roitman, supra n. 6, p. 421 “Esta reforma verdaderamente copérnica [. . .]


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reorganisation proceedings in Argentina is also due to other factors, such as a lack of appropriate tax incentives or an automatic standstill.115 3.2. England 116 3.2.1. Overview In response to a review of corporate rescue and business reorganisation mechanisms in the United Kingdom in 1999, the Department of Trade and Justice published a White Paper on insolvency law reform in 2001.117 The paper represented the Government’s attempt to fundamentally change the focus of corporate recovery in the United Kingdom.118 Against the backdrop of these considerations, the Enterprise Bill was introduced in the House of Commons on 26 March 2002.119 Following the adoption of the Enterprise Act in November 2002, the rules concerning corporate insolvency entered into force on 15 September 2003.120 After the enactment of the 1986 Insolvency Act, this reform represents the climax of a trend towards a new rescue culture121 as critics had noted that the

115 116

117 118

119

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hace infinitamente más interessante un acuerdo extrajudicial que será más barato, más simple e igualmente eficaz que el obtenido en un concurso judicial.” Johnson/Rouillon, supra n. 67, p. 9. References in this section made to England and Wales, as well as the laws of England and Wales are shortened for matters of convenience to the terms ‘England’ and ‘English law’. Scottish law and the law of Northern Ireland share many similarities with English law, but are nevertheless distinct (cf. Mallon, Christopher; Willock, Sally, Chapter on England and Wales, in: Broude, Richard F. (et al.), Collier International Business Insolvency Guide – Vol. II – Insolvency Laws of Selected Nations, New York 2003, at 13.04[4][b], at 21.01). The resulting particularities are beyond the scope of this work. DTI, Productivity and Enterprise: Insolvency – A Second Chance, Cm. 5234 (July 2001). See in more detail: Tribe, John, The DTI’s White Paper, “Insolvency – A Second Chance”: The End of Administrative Receivership, (2002) 23 Comp. Law., p. 60 et seq. McKnight, Andrew, The Reform of Corporate Insolvency Law in Great Britain – The Enterprise Bill 2002, (2002) 17 J.I.B.L., p. 324 et seq. In contrast, provisions concerning the inability of natural persons to pay due debts (which are referred to as bankruptcy law) entered into force on 1 April 2004. In addition to insolvency issues, the act contained modifications to British competition law (see e.g. Spreng, Nicole, Gesetz zur Änderung des britischen Wettbewerbsrechts: Enterprise Act 2002, (2003) 49 RIW, p. 433 et seq.). Stevenson, Mike, The Enterprise Bill 2002 – A Move Towards a Rescue Culture, (2002) 15 Insolv. Int., p. 51 et seq.

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existing procedures of administration and company voluntary arrangement had failed to support the preservation of enterprises.122 A previous first step had already been the enactment of the Insolvency Act 2000, which established an automatic suspension of creditor enforcement procedures during company voluntary arrangements if certain conditions are fulfilled.123 In re-enforcing this development, the White Paper, however, demanded further reforms of insolvency law to encourage responsible risk-taking in entrepreneurship, the facilitation of the rescue of viable companies, the reduction of the stigma associated with honest failures and the provision of procedures that were more predictable and fair for creditors and other stakeholders.124 Three key alterations followed from those overarching goals: – a restriction on the appointment of administrative receivers; – the abolition of Crown preferences to benefit unsecured creditors; and – modifications to speed up and facilitate the administration procedure and thereby lead to it being used more frequently.125 3.2.2. Description of the Rehabilitation Procedures 3.2.2.1. Administrative Receivership Traditionally, the procedure most commonly used to deal with companies in financial distress was the administrative receivership.126 One of the particularities of this procedure is that it cannot be clearly classified as serving either of the two common aims of an insolvency procedure, i.e. rehabilitation or liquidation. Instead, it primarily aims to benefit one special creditor.127 However, despite this characteristic feature, in practice many administrative

122

123 124 125 126

127

According to statistical data, more than 92 percent of all cases of default between 1987 and 2001 lead to liquidation of the company. In 1992, only one percent of all cases were administration procedures of company voluntary arrangements (Fletcher, supra n. 24, Appendix, at A3–002). Ibid., at 15–006. DTI, supra n. 117, para. 2.1. See: Sections 250 et seq. Enterprise Act 2002. Ehricke, Ulrich et al., Neuerungen im englischen Unternehmensinsolvenzrecht durch den Enterprise Act 2002, (2003) 6 NZI, p. 409. Starnecker, Hermann, Englische Insolvenzverfahren: Administrative Receivership und Administration Order vor dem Hintergrund der deutschen Insolvenzordnung, Frankfurt a.M. 1995, p. 72.


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receiverships result in the rehabilitation of the enterprise.128 The creditors entitled to initiate an administrative receivership procedure are debenture holders,129 whose debenture is secured by a floating charge. A floating charge is a security right over all, or substantially all, of a company’s assets, including future assets, un-called share capital, goodwill, etc.130 The charge is referred to as ‘floating’ since it does not attach until the creditor enforces that charge upon an event of default. While the charge is thus ‘hovering like a cloud’ over the designated assets,131 the debtor is entitled to continue to deal with the assets as if there were no security.132 The parties are free to agree on any circumstance they hold appropriate to trigger an event of default.133 In consequence of such an event, the floating charge crystallizes into a fixed charge on all encumbered assets and the respective creditor can appoint an administrative receiver who will take over control of the company in place of the creditors.134 The powers of the administrative receiver also include the right to sell the business in whole or in part. On account of the fact that a floating charge holder ranks ahead of unsecured creditors, but behind fixed charge creditors and preferential creditors, in practice most major creditors also appoint a fixed charge on the secured assets.135 This powerful position of floating charge creditors was significantly curtailed by the last insolvency law reforms, because the government was

128

129

130

131 132

133 134 135

Reinhart, Stefan, Sanierungsverfahren im internationalen Insolvenzrecht: Eine rechtsvergleichende Untersuchung über die besonderen internationalrechtlichen Probleme liquidationsabwendender Insolvenzverfahren, Berlin 1995, p. 41; according to figures presented by the British Bankers’ Association, around 75 percent of all administrative receivership procedures are meant to lead to a rehabilitation of the enterprise (cf. the quote by Jungmann, Carsten; Bisping, Christopher, Die Reform des britischen Unternehmensinsolvenzrechts durch den Enterprise Act 2002, (2003) 49 RIW, p. 932 n. 44). The term debenture in practice means all claims that are not of a short-term nature. Section 744 of the Companies Act 1985 states by way of example that “debenture includes stock, bonds and any other securities”. In detail: Schulz-Trieglaff, Kai, Grundschuld und Floating Charge zur Absicherung von Unternehmenskrediten, Frankfurt a.M. 1997. Perker, supra n. 21, p. 57. Nevertheless, it is common practice to combine a floating charge agreement with negative pledge clauses, to avoid the attachment of priority securities to the assets already protected by the floating charge. Starnecker, supra n. 127, p. 75 et seq. Section 29 (2) (a) Insolvency Act 1986. Jungmann/Bisping, supra n. 128, p. 932.

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of the opinion that administrative receivership should cease to be a major insolvency procedure.136 In particular, it had been criticized that the administrative receivership procedure only aimed to reach the best possible outcome for one creditor, instead of the creditor community as a whole and that this procedure did not primarily focus on the rehabilitation of companies.137 In addition, it was argued that the procedure was intransparent and that the degree of the courts’ involvement was insufficient. Lastly, it was argued that the rash commencement of administrative receivership proceedings was often the very reason for a company’s financial troubles.138 In response to this critical assessment of administrative receivership, section 72A (1) Insolvency Act 1986, as introduced by Section 250 Enterprise Act 2002, now provides that “[t]he holder of a qualifying floating charge in respect of a company’s property may not appoint an administrative receiver of the company”. Although sections 72B-G Insolvency Act 1986 contain certain exceptions, mainly for capital market arrangements with a volume of at least £50 million,139 administrative receivership was de facto revoked by the insolvency law reforms, since only very few cases fall within the exceptions named.140 3.2.2.2. Administration In partial compensation for the loss of the right to appoint an administrative receiver, the holders of a qualifying floating charge141 were granted the right to appoint an administrator without involvement of a court.142 The opportunity to appoint administrators without court involvement – which is seen as one of the major achievements of the reform143 – is also granted to the company

136 137 138 139 140

141

142 143

DTI, supra n. 117, para. 2.5. Ibid., para. 2.2 et seq. Ibid., para. 2.1. Cf. McKnight, supra n. 119, p. 333 et seq. Keay/Walton, supra n. 47, p. 90 et seq., who also note that this consequence will still take some time to occur in practice, as section 72A (4) (a) Insolvency Act 1986 provides that the prohibition to appointing administrative receivers will only apply to floating charges created on or after 15 September 2003. Pursuant to Schedule B1 para. 14 Insolvency Act 1986 a floating charge is referred to as qualifying if the instrument purports to empower the holder of the floating charge to appoint an administrator or an administrative receiver of the company, or if there is explicit reference to the respective provision. So-called “out of court administration”. Jungmann/Bisping, supra n. 128, p. 936.


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and its directors.144 Due to the fact that the option of administration by an order of the court, as provided under the old law, remains open, there are three ways in which an administration procedure can be initiated.145 As was the case under the 1986 Insolvency Act, for commencement of the proceedings by an order of the court, the judge, upon request by the debtor or the creditor(s), must be satisfied that the company is, or is at least likely to become, unable to pay its debts.146 Furthermore, the court must be satisfied that the debtor is reasonably likely to become unable to pay its debts.147 This way of commencing an administration procedure, though, is now seen as a mere catch-all clause since there is now the straightforward option of appointing an administrator for either the debtor or its creditor(s). Thus, the company or its directors may directly appoint an administrator, without the need for a court order.148 The conditions for such appointment are that the company is, or is likely to become, unable to pay its debts.149 No such appointment may be made within 12 months of a previous appointment by the company or its directors, or by the court on their application.150 This requirement aims to avoid a constant rush to default by the debtor who benefits during the administration procedures from a moratorium suspending all enforcement actions by creditors.151 Schedule B1 para. 26 Insolvency Act 1986 furthermore requires that five business’ days notice be given to

144 145

146 147 148 149

150 151

Schedule B1 para. 22 et seq. Insolvency Act 1986. The significant changes to the administration procedure are not directly incorporated into the Insolvency Act 1986. Rather, section 248 of the Enterprise Act 2002 provides for a single new section 8 to the 1986 Act to be substituted for the whole of the existing provisions of part II of the Insolvency Act 1986, which dealt with the administration of companies. The content of the new section 8 is basically a reference to a new Schedule B1 to the Insolvency Act 1986, which contains the substantive provisions for administration. Schedule B1 para. 12(1) Insolvency Act 1986. Schedule B1 para. 11, 12 Insolvency Act 1986. Schedule B1 para. 27(2) Insolvency Act 1986. Schedule B1 para. 11(a) Insolvency Act 1986. Proof of inability to pay due debts has to be provided by way of an affidavit with an analysis of the financial position of the company (Rule 2.4 Insolvency Rules 2003). In contrast, there will no longer be any need for a ‘rule 2.2 report.’ This extensive report had been criticized for being too costly and difficult for creditors to draw up without sufficient inside information (see the references by Jungmann/Bisping, supra n. 128, p. 934 n. 69). Schedule B1 para. 24 Insolvency Act 1986. Jungmann/Bisping, supra n. 128, p. 936 et seq.

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any person who is, or who may be, entitled to appoint an administrator, i.e. above all floating charge holders to give them the opportunity to pre-empt the debtor’s appointment of an administrator by themselves appointing one.152 Further to this de facto veto right of floating charge holders, those creditors have the right to appoint an administrator on their own initiative. The first condition for the appointment of an administrator by the creditor is that the creditor holds one or more debentures of the company, of which one or more are secured by a qualified floating charge,153 which must form the whole or essentially the whole of the company’s property.154 Furthermore, the floating charge in question must be enforceable.155 Regardless of the way in which the administrator was appointed, the appointing party has to file notice of the appointment with the court. Such notice must include the administrator’s consent and a statement that, in his opinion, the purpose of the administration is likely to be achieved.156 The old Insolvency Act 1986 defined four separate and alternative purposes for an administration.157 The reform has significantly altered this situation. There is now one single overriding purpose consisting of three objectives, which are, in descending order of importance:158 – to rescue the company and to sustain it as a going concern, or, if that is not ‘reasonably practical’, – to achieve a better realisation of assets for the company’s creditors as a whole, than in liquidation and finally, – if neither of the two foregoing objectives is reasonably practical, to realise the property for the benefit of one or more secured or preferential creditors.

152

153 154 155 156 157 158

This privilege for floating charge holders is seen as a kind of indemnification for the loss of the administrative receivership procedure (Ehricke, supra n. 126, p. 414). Nevertheless, “all of this [is] a far cry from the favourable regime hitherto enjoyed by those secured creditors who have been able to appoint an administrative receiver” (McKnight, supra n. 119, p. 326). See supra n. 130 and accompanying text. Schedule B1 para. 14 Insolvency Act 1986. Schedule B1 para. 16 Insolvency Act 1986. Schedule B1 para. 18, 29 Insolvency Act 1986. Cf. Stevenson, supra n. 121, p. 52. See: Schedule B1 para. 3(1) Insolvency Act 1986.


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While commentators note that whether the achievement of one of the two first goals is ‘reasonably practicable’ is open to diverging opinions159 the reform definitely made a clear statement in favour of the rescue of a company.160 The third objective sets a low threshold. In contrast to the important changes concerning the commencement of an administration procedure, the procedure itself remained largely unchanged.161 From the time a petition for the appointment of an administrator is presented, a moratorium is automatically imposed against all creditors of the company.162 There are not, however, any rules providing for super-priority financing.163 The administrator appointed will then become responsible for the management of the enterprise. The administrator will take custody and control of the assets of the company and run its business.164 Furthermore, the administrator must prepare a proposal to the creditors which sets out how the intended purpose of the administration can be achieved.165 If the majority of creditors agree upon the proposal, the administrator has two options for the restructuring of the company. He can choose either a company voluntary arrangement166 or a scheme of arrangement under the Companies Act 1985.167 The company voluntary arrangement is a composition between a company and its creditors. The procedure is commenced by making a respective proposal to the company and to its creditors,168 which must include the appointment of a nominee who, in relation to the voluntary arrangement, shall act either as a trustee or in some other capacity for the purpose of supervising

159 160 161

162 163 164

165

166 167 168

Stevenson, supra n. 121, p. 52. Ehricke, supra n. 126, p. 413. The most notable changes in this connection are related to the time-scales, which were generally tightened in order to speed up the procedure (cf. Jungmann/Bisping, supra n. 128, p. 937). Schedule B1 para. 40 et seq. Insolvency Act 1986. See the critiques by McKnight, supra n. 119, p. 327. To this extent, English insolvency law remains hostile towards the debtor in possession concept, in contrast, for instance, to the US American Insolvency Code (Jungmann/ Bisping, supra n. 128, p. 934 n. 71). Such proposals must now be made within eight weeks (previously 3 months) of initiation of the procedure, Schedule B1 para. 49(5) Insolvency Act 1986. Sections 1 et seq. Insolvency Act 1986. Sections 425 et seq. Companies Act 1985. Section 1(1) Insolvency Act 1986.

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its implementation.169 The nominee, who, in the case of administration, is usually identical to the administrator,170 will set up a plan, which then has to be approved by a creditors’ meeting either in its original form or with modifications171 with a majority in excess of three-quarters in value of the creditors present in person or by proxy and voting thereon.172 For shareholders, a majority voting of 50 percent is required to make the voluntary arrangement binding.173 It is worth noting, though, that a voluntary arrangement may not affect the claims of secured creditors or preferential creditors without their express consent.174 Provided that the necessary majorities are obtained, the voluntary arrangement becomes binding on all creditors given notice, without the requirement for any further court approval.175 Within a period of 28 days, creditors are, under certain circumstances, allowed to challenge the arrangement.176 If the court holds that the voluntary arrangement unfairly prejudiced the interests of a creditor, or that there have been some material irregularities, it can declare the arrangement void.177 Alternatively, the administrator can opt for a scheme of arrangement procedure. The procedure commences when an application to this effect, describing the nature and purpose of the proposed scheme as well as its effects on the creditors, is presented to the court. If the court is satisfied that the scheme is appropriate for presentation to the creditors, the creditors will be informed of its details and summoned for a meeting.178 In that meeting, the creditors will be categorized according to class179 and will vote on the scheme. Approval of the scheme requires a 50 percent per capita majority and a 75 percent majority in value of those voting.180 If the required majorities are obtained, the plan is then subject to approval by the court. Once the

169 170 171 172 173 174 175 176 177 178 179

180

Section 1(2) Insolvency Act 1986. Fletcher, supra n. 24, at 15–012. Section 4(1) Insolvency Act 1986. Insolvency Rules 1986, 1.19. Insolvency Rules 1986, 1.20. Section 4(3), (4) Insolvency Act 1986. Section 5(2) Insovlency Act 1986. Section 6 Insolvency Act 1986. Section 6(4) Insolvency Act 1986. Section 425 Companies Act 1985. In practice this categorisation leads to significant legal difficulties and makes the scheme of arrangement procedure quite impractical. It is therefore almost exclusively used to reorganize solvent companies (Perker, supra n. 21, p. 20 et seq.). Section 425(2) Company Act 1985.


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court approves the scheme it becomes binding on all creditors, whether they attended the meeting or not, and regardless of their status.181 Company voluntary arrangements, as well as schemes of arrangement, can also be used outside of an administration procedure. As such, they provide a legal framework for an out-of-court settlement.182 3.3. France 3.3.1. Overview The French system basically approaches business salvation in two ways. First, under Law No. 84–148,183 which is now incorporated in articles L 611–3 to 612–1 of the French Commercial Code the Code de Commerce (CC), and which aims to prevent insolvency. Second, through Law No. 85–98 on restructuring and judicial liquidation of companies,184 now inserted in articles L 620–1 to L 628–3 CC. Historically seen, those laws are the response to developments in the field of insolvency since 1967. In that year, the era of modern insolvency law in France began with the introduction of Law No. 67–563.185 While, prior to that date, the main objectives of the insolvency procedure had been seen in punishing the debtor for its economic failure,186 leading, accordingly, to a law that was manifestly repressive,187 the perspective of the 1967 law had changed. The decision as to whether or not to liquidate a business was no longer linked to whether or not the debtor had acted in good faith, but was

181

182 183

184

185

186 187

The fact that a scheme of arrangement can be made binding on all creditors is seen as a major advantage compared with the voluntary arrangement; Reinhart, supra n. 128, p. 47. Ibid., p. 47. Loi n° 84–184 relative à la prévention et au règlement amiable des difficultés des entreprises of 1 March 1984, [hereinafter: 1984 law]. Loi n° 85–98 relative au redressement et à la liquidation judiciaire des entreprises of 25 January 1985 [hereinafter: 1985 law]. Loi n° 67–563 sur le règlement judiciaire, la liquidation des biens, la faillite personnelle et les banqueroutes of 13 July 1967 now inserted in articles L 811–1 to L 814–6 CC. This law, though, is of less importance in the given context. It deals essentially with the selection and the status of insolvency professionals such as administrators; cf. on the current changes in this area: Omar, Paul J., The Progress of Insolvency Reform in France: Part 2, (23) 2002 Comp. Law., p. 344 et seq. The French term for insolvency is ‘faillite’. Kremer, Thomas, Unternehmenssanierung in Frankreich, Köln 1994, p. 7 et seq.

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now exclusively oriented towards the debtor’s economic prospects.188 Only viable businesses should be salvaged.189 Creditors had almost no influence on the procedure.190 Against the backdrop of the steadily increasing number of business failures, though, reform proposals were ongoing during the 1970s and early 1980s and eventually lead to the 1984 law and the law of 1985.191 The purpose of the new legislation was explicitly underlined by article 1 of the 1984 law, which announced that: [i]l est institué une procédure de redressement judiciaire destinée à permettre la sauvegarde de l’entreprise, le maintien de l’activité et de l’emploi et l’apurement du passif.

Rescuing the enterprise, preserving jobs and clearance of debts had become the central aims of the French insolvency law.192 In contrast, the payment of creditors was the last of the legislator’s concerns.193 Since the number of insolvencies failed to stop growing, and following the criticisms of creditors, who felt that their rights were not being adequately protected, the French law was modified yet again by the reform of 1994.194 The legislation following this reform,195 which is, with some minor changes, still in force today, therefore aimed to achieve a more equitable

188 189 190

191

192

193

194

195

Ibid., p. 10. Ibid. Koral, Richard L.; Sordino, Marie-Christine, The New Bankruptcy Reorganization Law in France: Ten Years Later, (1996) 70 Am. Bankr. L.J., p. 441. Omar, Paul J., Insolvency Law Reform in France: A Herculean Task, (2003) 14 I.C.C.L.R., p. 205. The great majority of French commentators and courts have concluded that there is a hierarchy of goals, the rescue of the enterprise being regarded as the main concern and the payment of creditors as the lowest priority; Derrida, Fernand et al., Redressement et liquidation judiciaires des entreprises: cinq annés d’application de la loi du 25 janvier 1985, Paris 1985, n. 39; Cour d’appel de Versailles, [1986] Gaz. Pal., p. 570 et seq. Campana, Marie-Jeanne, A Critical Evaluation of the Development and Reform of the Corporate Rescue Procedures in France, in: Gromek Broc, Katarzyna; Parry, Rebecca (eds.), Corporate Rescue: An Overview of Recent Developments from Selected Countries in Europe, The Hague 2004, p. 36. A survey of the main changes under this reform is given for instance by Damman, Reinhard, Das neue französische Insolvenzrecht, (1996) 17 ZIP, p. 300 et seq. Loi n° 94–475 relative à la prévention et au traitement des difficultés des entreprises of 10 June 1994.


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balance between the interests of the debtor and its creditors196 by providing an effective mechanism for the rehabilitation of enterprises (redressement judiciaire).197 3.3.2. Description of the Rehabilitation Procedures 3.3.2.1. The Judicial Rehabilitation Proceedings A case under judicial proceedings ( procédure judiciaire) can be filed either by the debtor,198 or by a creditor, or by the Commerce Tribunal (Tribunal de Commerce) itself.199 The debtor is obliged to apply for commencement of judicial proceedings within no more than fifteen days of becoming insolvent, meaning the debtor’s inability to meet its liabilities from disposable assets.200 Ex officio, the Court will basically initiate proceedings after the failure of an amicable agreement.201 The filing of the case is followed by a hearing, in which the Commerce Tribunal decides which of the three possible procedures – i.e. liquidation, rehabilitation by means of a continuation plan, or rehabilitation by disposal of the firm through sale202 – will be applied.203 In other words, pursuant to this uniform approach, the filing party does not have to choose between the different options. In order to allow the court to adopt the most appropriate solution, the law provides for a period of observation ( période d’observation) so that it is possible to see the firm working.204 During this period, which lasts twenty

196 197 198 199 200 201

202

203

204

Omar, supra n. 191, p. 206. Koral/Sordino, supra n. 190, p. 442. Article L 621–1 CC. Article L 621–2 CC. Article L 621–1 CC. A fourth way of initiating the proceedings is through the Public Prosecutor (Procureur de la République). However, this is only seldom the case; Deloitte & Touche, supra n. 14, p. 245. Of course, this choice requires the judge to make mainly economy-based decisions. However, judges in France seem not to be uneasy with that responsibility (cf. Koral/Sordino, supra n. 190, p. 447). More than 92 percent of the cases filed result in liquidation (Campana, supra n. 193, p. 77). Interestingly, this figure seems to have remained constant over time, as similar figures already were quoted in the 1990s (cf. the statistics by Saint-Alary-Houin, Corinne, Droit des Entreprises en Difficulté, Paris 1995, p. 41 et seq.). No such period is required for cases where the undertaking has ceased all activity or where recovery is clearly impossible (cf. Article L 620–1 CC).

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months,205 a solution to the debtor’s financial difficulties is developed. This task is transferred mainly to the executive organs and supervisors nominated by the Court in its decision on the commencement of insolvency proceedings, namely the insolvency judge ( juge commissaire), the creditors’ representative (représentant des créanciers) and the administrator (administrateur).206 It is the administrator’s task to supervise the firm’s management, or to totally replace it and run the business himself.207 Furthermore, he is responsible for drawing up an assessment of the economic and social situation of the undertaking, in the light of which he shall propose either a plan for rehabilitation or for liquidation.208 As well as detailing the cause, extent and nature of the firm’s difficulties, the administrator shall also state and give reasons for the level and prospects of employment and the social conditions envisaged for the continuation of trading.209 The administrator is supported by the creditors’ representative (représentant des creanciers). In spite of its name, the creditors’ representative is not himself a creditor but rather an executive organ,210 appointed by the court and not by the creditors.211 In his decision he is not subject to any approval by the creditors. Nevertheless, according to Article L 621–39, only the creditors’ representative has the power to act on behalf, and in the interests, of the creditors. The creditors’ representative also has the exclusive right to appeal against the setting out, or rejection, of a rehabilitation plan.212 During the observation period, the debtor is protected by a ‘cocon juridique’.213 Thus, the judgment commencing the proceedings automati-

205

206 207 208 209 210

211 212 213

A shorter observation period applies to small enterprises that are subject to a simplified procedure; cf. Articles L 621–133 CC et seq. Article L 621–8 CC. Article 621–22 (2) CC. Article L 621–54 CC. Ibid. There are lists of creditors’ representatives from which such persons may exclusively be appointed. Furthermore, there are extremely strict selection criteria. Creditors’ representatives may only be persons of French nationality who can provide good character references, who have completed a professional traineeship and passed an examination qualifying them to serve as a creditor representative (cf. Articles L 812–1 et seq. CC). Article L 621–8 CC. Article L 623–1 CC. Cf. the quote by Zierau, Britta, Die Stellung der Gläubiger im französischen Sanierungsverfahren im Hinblick auf die Entwicklung des deutschen Insolvenzrechts, Heidelberg 1991, p. 71 n. 84.


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cally prohibits payments of any debt arising prior thereto.214 On the other hand, in order to enable the debtor to more easily get new funds, creditors whose entitlement arises after opening of the ruling are granted a higher ranking for repayment than previous creditors.215 It is then the court’s task to decide at the end of the observation period how to proceed with the debtor. If it considers the enterprise viable it will issue a judgement as to the determination of the plan.216 This judgment identifies firstly the persons that shall supervise the implementation of the plan. This task can be fulfilled by the administrator or the creditor’s representative.217 Substantial changes or amendments to the plan can only be made by the court in this phase.218 Furthermore, the plan contains what is called the second part of the ‘creditors’ sacrifice’.219 In addition to the creditors’ tightly restricted rights to participate in the procedure, they are also in a comparatively weak situation concerning payment of their credit. So, although the court does not have the power to grant a general discharge or to reduce the debtor’s liabilities directly,220 it can impose payment delays and may set the duration thereof arbitrarily.221 The delays will be imposed on all creditors regardless of any existing privileges.222 As is the case during the time when a delay on payment is imposed, no interest accrues.223 This may effectively result in a reduction of the credit, taking into account respective 214

215 216 217 218 219 220

221

222

223

The off-setting of inter-related debts is excluded from this prohibition (Article 621–24 CC). Article L 621–32 (1) CC. Article L 621–62 CC. Article L 621–68 CC. Article L 621–69 CC. Cf. Campana, supra n. 193, p. 68. The debtors must voluntarily agree to such reductions. The normal procedure is that the creditors’ representative attempts to obtain the agreement of each creditor. If a creditor does not reply to an offer within 30 days, this silence is deemed to imply acceptance (Articles L 621–76 in liaison with L 621–60 sub para. 2 CC). As already mentioned, the Court is also allowed to assign an undertaking (Article L 621–83 CC et seq.). This often means a de facto discharge, as the creditors usually only receive the sale proceeds (Article L 621–97 CC) and do not have recourse to the transferee for any debt of the assigned undertaking (see Zierau, supra n. 213, p. 72 et seq.). The sole exceptions are made for debts arising from a contract of employment (Article L 621–78 CC) and if the debtor sells an asset burdened by a lien or other priority right or mortgage. In the latter case, the creditors that are entitled under such rights receive immediate payment from the proceeds of the sale (Article L 621–80 CC). Derrida, supra n. 192, at 552.

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potential interest gains.224 If the debtor fails to comply with the plan, the court may ex officio, or on application by a creditor, cancel the plan and order the commencement of compulsory liquidation procedures.225 3.3.2.2. The Amicable Settlement Procedure In contrast to the judicial procedures, amicable settlement procedures, as governed by the 1984 law, are conceived as a purely voluntary mechanism, despite the courts’ involvement.226 The main goal of the 1984 Law is to prevent the insolvency of a company. To this end, the legislator introduced various measures to detect financial difficulties and to trigger an alert in good time.227 To resolve such financial problems, a procedure to reach an amicable settlement (règlement amiable) exists. This procedure takes place under a veil of total secrecy, violation of which is subject to criminal law sanctions.228 It is initiated upon the debtor’s request, which, while not being insolvent, has to be in difficulties that cannot be covered by appropriate financing. In this case, the Commerce Tribunal as the competent authority will appoint a conciliator (conciliateur).229 The conciliator does not have the right to participate in the management of the business. The debtor retains control of the business. The conciliator’s mission is merely to facilitate negotiations between debtor and creditor.230 No creditor is obliged to participate in these negotiations meaning that, in practice, only the most important creditors, such as banks or the firm’s main suppliers will attend.231 To facilitate an agreement, the 1994 reform introduced the possibility for the court to order a temporary standstill against creditor enforcement proceedings, which requires an application by the conciliator to this effect to the court.232 The 224 225 226

227 228

229 230 231 232

Campana, supra n. 193, p. 69. Article L 621–82. One might therefore refer to this procedure as a kind of “institutionalized out-of court settlement” (cf. Reinhart, supra n. 128, p. 48). Cf. Campana, supra n. 193, p. 38 et seq. Article L 611–6 CC referring to Articles 226–13 et seq. of the Penal Code (Code Pénal). Commentators, though, remind that confidentiality often remains purely theoretical particularly in small and medium-sized towns (Campana, supra n. 193, p. 53). Article L 611–3 CC. Article L 611–4 (1) CC. Zierau, supra n. 213, p. 56. Article L 611–4 (3) CC.


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content of the agreement is based on a consensual and non-judicial process conducted between the debtor and its creditors.233 The parties are therefore free to include any provision they consider appropriate.234 The effects of the amicable settlement are essentially those of a classical contract. It is binding only on its parties and must be respected only by them, while third parties may continue to sue the debtor.235 If the debtor becomes incapable of complying with or unwilling to respect the agreement, the amicable settlement is deemed to have failed. In this case, the court can pronounce the dissolution of the agreement, resulting in the nullification of any delay or reduction of payment granted by the creditors, and usually leading to the opening of a judicial rehabilitation procedure.236 3.4. Germany 3.4.1. Overview In 1994, the German Parliament adopted the new Insolvenzordnung.237 This law became effective on 1 January 1999. Plans for reform of the German insolvency law, though, date back to the 1970s. In response to increasing criticism, a commission was established in 1978 to prepare reform proposals for the then-existing insolvency law, the Konkursordnung.238 Among the pivotal issues on the agenda for reform was the lack of an appropriate rehabilitation procedure for enterprises under German law. It was argued that liquidation could not be the only instrument in the case of insolvency, as a reorganisation of the debtor could often lead to more efficient results. Economists noted that liquidation frequently destroys important value in enterprises that could be preserved if the enterprise were to continue

233 234

235 236 237

238

Koral/Sordino, supra n. 190, p. 446. This includes e.g. the right to agree on a so-called “clause de retour à meilleure fortune” which allows creditors that granted debt relief to recover their claims in full after the debtor overcame its financial difficulties. Furthermore, creditors can agree on a different debt relief quota (Zierau, supra n. 213, p. 56 et seq.). Campana, supra n. 193, p. 52. Cf. Article 621–3 CC. [1994] BGBl. I, p. 2866 et seq. amended by the Insolvenzrechtsänderungsgesetz of 26 October 2001, [2001] BGBl. I, p. 2710 et seq. Pape/Uhlenbruck, supra n. 22, n. 37.

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as a going-concern.239 Even though the German insolvency law contained provisions for a procedure leading to a composition (Vergleichsverfahren), this mechanism was not comparable to reorganisation procedures, such as those found, for example under Chapter 11 of the U.S. Bankruptcy Code. The main objective of the composition proceedings was to conclude a composition agreed with creditors instead of reorganizing the insolvent debtor.240 Its practical relevance was furthermore undermined by the complicated proceedings and the possibility for secured creditors to receive preferential payments, meaning that those creditors were usually unwilling to accept a composition.241 A composition was further complicated by the requirement that its outcome had to provide for a minimum dividend of 35 percent of claims to all creditors.242 Since the average dividend received by unsecured creditors, however, was not more than 5 percent243 it is no surprise that composition procedures only rarely led to the rehabilitation of the debtor.244 The de facto lack of a functioning rehabilitation system was furthermore aggravated by the fact that more than 80 percent of insolvency cases in Germany had to be dismissed due to insufficient funds.245 The lack of an adequate rehabilitation procedure became increasingly evident in the period since 1991, during which time the number of insolvencies filed in Germany began to grow rapidly.246 As a result, the new German insolvency law provides, for the first time, for a fully-fledged rehabilitation procedure and accepts it as an alternative of equal importance to liquidation.247

239 240 241 242

243 244 245 246 247

Ibid., n. 9. Kamlah, supra n. 34, p. 418 et seq. Häsemeyer, Ludwig, Insolvenzrecht, 1st ed. München 1992, p. 640 et seq. See critically: Häsemeyer, Ludwig, Insolvenzrecht, 3rd ed. Köln 2003, p. 676 (hereinafter: Häsemeyer (2003)); the new InsO contains no such minimum requirement any more. Pape/Uhlenbruck, supra n. 22, n. 25. Häsemeyer (2003), supra n. 242, p. 641. Arnold, supra n. 19, n. 24. Kamlah, supra n. 34, p. 419. Cf. the pragmatic statement of § 1 InsO that the debtor’s creditors can either be satisfied through realisation of the debtor’s assets and distribution of the proceeds or through adoption of an insolvency plan for the rehabilitation of the business.


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3.4.2. Description of the Rehabilitation Procedure 3.4.2.1. The Rehabilitation Procedure The Insolvenzordnung introduced a uniform insolvency system. Thus, while under the previous insolvency law, the person who was about to file a petition for initiation of proceedings had to decide in advance for composition under the Vergleichsordnung, or for liquidation under the Konkursordnung,248 the new Insolvenzordnung replaces these two procedures with a single one.249 An insolvency procedure is initiated by way of application to the local court (Amtsgericht), which has exclusive jurisdiction for this petition.250 The petition can be filed either by the debtor or by the creditor.251 The court will only grant the petition if it is satisfied that there is a reason for doing so and if there are sufficient assets to fund the costs of the proceedings.252 The law states three possible reasons: illiquidity (Zahlungsunfähigkeit),253 imminent illiquidity (drohende Zahlungsunfähigkeit)254 and overindebtedness (Überschuldung).255 These three reasons substantially change the restrictive requirements applicable under the previous Konkursordnung. The case of imminent illiquidity in particular, according to which the threat of an inability to pay debts as they fall due may be sufficient, is said to encourage the debtor to file for bankruptcy at an early stage.256 Proceedings are then 248 249 250 251

252

253

254

255

256

Respectively Gesamtvollstreckungsordnung in the new Länder. Häsemeyer (2003), supra n. 242, p. 686. § 2 (1) InsO. § 13 (1) InsO. To avoid debtor harassment, a creditor may only file if a legal interest in the commencement of the case can be proven. However, there is no minimum threshold to prove such legal interest; cf. Bismarck, Kolja v., Chapter on Germany, in: Broude, Richard F. (et al.), Collier International Business Insolvency Guide – Vol. II – Insolvency Laws of Selected Nations, New York 2003, 23.04[3][b][ii]. §§ 16, 26 InsO. Costs of the procedure are the court fees as well as the remuneration of and expenses incurred by, the preliminary trustee, the trustee, and the members of the creditors’ committee (§ 54 InsO). This is defined as the debtor’s inability to meet his mature obligations to pay. A presumption of illiquidity is made if the debtor has stopped payments (cf. § 17 (2) InsO). A debtor is deemed imminently illiquid if he is likely to be unable to meet his existing obligations to pay on the date of their maturity. See: § 18 (2) InsO. According to § 19 (2) InsO, overindebtedness exists if the assets owned by the debtor no longer cover the debtor’s existing obligations to pay. If the continuation of the enterprise is deemed highly likely, the debtor’s assets shall be evaluated on a going concern, rather than on a liquidation basis. Häsemeyer (2003), supra n. 242, p. 140.

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initiated before the debtor’s assets have been distributed.257 The incentive for debtors to actually make use of their right to file a petition in the case of imminent illiquidity is seen in the (relative to the previous law) improved possibilities for rehabilitation and discharge.258 Once the case has been filed, the court may issue any interim order deemed appropriate to preserve the estate, including an order enjoining the debtor from transferring assets, or the appointment of an interim trustee (Insolvenzverwalter).259 In addition, the court’s order of commencement provides for a general stay of execution concerning the claims of the creditors who can no longer enforce their rights in formal legal proceedings outside of the insolvency proceeding.260 If the court is satisfied that there are grounds for commencing the proceedings, and that the assets are sufficient to cover the costs of the procedure, it issues an order opening the proceedings. The insolvency court’s opening order is to include the appointment of a trustee as permanent administrator of the case.261 The trustee must be an individual with the capacity to deal with the case at hand, in particular a person with experience in business affairs who is independent of the creditors and debtor.262 The opening of the insolvency proceedings transfers the right to dispose of the debtor’s assets to the trustee.263 The trustee continues the business of the creditor.264 He collects the bankrupt party’s claims and realises the assets. While doing so, he may choose the performance of executory contracts to thereby add to the consideration to the assets.265 There are, however, some restrictions. The trustee is required to respect the assets of creditors with a right of ownership against the insolvent company, i.e. the legal owner himself, which will be separated from the debtor’s estate.266 Apart from that, other creditors with a security on movable or immovable 257 258 259 260

261 262 263 264 265 266

Kamlah, supra n. 34, p. 425. Paulus, supra n. 35, p. 145. Cf. § 21 (2) InsO. §§ 88 et seq., §§ 165 et seq. InsO. An exception has to be made for those who, by force of law, or on the basis of an agreement, had a right to set off a claim on the date when the insolvency proceedings were opened; they may set-off whenever they want (cf. § 47 InsO). § 27 (1) InsO. § 56 InsO. § 80 (1) InsO. § 148 (1) InsO. § 103 (1) InsO. §§ 47 et seq. InsO.


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property will have a privileged claim against the insolvent estate at its realisation.267 The trustee finally has to prepare a report detailing the prospects of a rehabilitation of the insolvent enterprise, or at least parts thereof.268 At the first creditors’ meeting,269 this information will then constitute the basis for the decision between liquidation and rehabilitation.270 The rehabilitation procedure is regarded as a key innovation of the InsO.271 Its core is an insolvency plan.272 A proposal for such a plan can be made by the debtor or by the trustee.273 Creditors have the right to request the trustee to draw up an insolvency plan.274 The insolvency plan must contain both a declaratory and a constructive part.275 The declaratory part describes the debtor’s financial situation and the causes thereof. The declaratory part must furthermore describe the proposed measures for the reorganisation of the debtor and must set forth and describe the effects of this on the creditors’ rights.276 For the determination of each respective creditor’s rights, creditor groups are formed. This is done in the constructive part, which contains the

267

268 269

270

271 272 273 274

275

276

§§ 49 et seq., 165 et seq. InsO. In contrast to the previous German insolvency law, there are no more priorities under the InsO. This is regarded as an enormous and beneficial improvement on the previous situation. Particularly the fact that former priority claims are now dealt with on an equal basis with all other unsecured claims increased the prospect of a higher average dividend payable to general unsecured creditors; Kamlah, supra n. 34, p. 434. § 156 (1) InsO. The first meeting of the creditors, the date of which has to be fixed by the court, shall take place six weeks to three months after the opening of the proceedings, § 29 (1) (1) InsO. Cf. § 157 InsO; there are two different rehabilitation procedures: either by transferring assets or by way of an insolvency plan; cf. in more detail: Häsemeyer, supra n. 242, p. 688 et seq. Kamlah, supra n. 34, p. 429. §§ 217 et seq. InsO. § 218 (1) InsO. § 218 (2) InsO. A preceding Government Draft had contained a provision allowing creditors of the debtor to directly submit a plan. This provision was, however, deleted in the course of parliamentary discussions to avoid the possibility of two competing plans. It was argued that the judges, who are not trained to think in purely economic terms, should not be required to make essentially business-type decisions; Kamlah, supra n. 34, p. 430. § 219 InsO. The InsO contains relatively few restrictions on what may or must be included in the plan, giving its drafters a significant degree of flexibility. § 220 InsO.

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actual plan for the rehabilitation of the creditor.277 Creditors are separated into classes,278 which are formed so that creditors with a similar legal status are grouped together. In particular, a distinction is made between secured and unsecured creditors and the various classes of subordinated creditors.279 Creditors must be treated equally within these groups, unless they agree otherwise.280 The constructive part determines the way in which the legal rights of the parties to the plan will be altered by the plan, including rescheduling of debts and discharge of claims. Accordingly, the constructive part may contain provisions for a loan ceiling for loans granted by future creditors, which is to enable a ‘fresh start’ of the debtor and which is granted priority over the other (already existing) creditors.281 After the plan has been drawn up, it has to be submitted to the court for approval. The plan shall only be rejected under the circumstances listed in § 231 InsO. These are, above all, non-compliance with the formal requirements of a plan, and if it is evident that the creditors will not accept the insolvency plan, or that it would be impossible to satisfy the claims granted to the creditors in the constructive part of the plan. If the legal requirements are fulfilled, the court will forward the plan to the creditors’ committee282 as well as to the debtor or trustee, depending on who submitted the plan to the court.283 The creditors will then discuss the plan on a date fixed by the court.284 Following this discussion the creditors vote on the plan. A right

277 278 279

280 281

282

283 284

§ 221 InsO. § 222 InsO. Subordinated claims include claims for interest following the court order, costs and expenses of creditors resulting from the creditors’ participation in the proceedings, fines, claims for a promised gift and claims for delivery of stock in lieu of payment on loans (cf. § 39 (1) InsO). § 226 (2) InsO. § 264 (1) InsO; this is crucial as otherwise priority status for creditors granting additional funds after commencement of the insolvency is dependent on whether there are still unencumbered assets available to provide security for such a loan (cf. Bismarck, supra n. 251, at 23.06[2]). Cf. §§ 67 et seq. InsO. The creditor committee is a body that may be established by the court in advance of the first creditor meeting, or following a decision by the creditors’ assembly. It must adequately represent the interests of the different creditor groups. Its main task is to supervise the trustee in his work and to co-ordinate and consolidate the creditors’ interests. § 232 (1) InsO. § 235 (1) InsO.


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to vote is granted to all those creditors who have filed their claim with the trustee285 and whose claims have been verified by the debtor, the trustee and the other creditors in a special meeting.286 The plan is accepted if each group of creditors adversely affected by the plan gives its approval.287 It is necessary that, within each group, the per capita majority of creditors votes in favour of the plan and that the aggregate amount of their claims constitutes more than 50 percent of the aggregate amount of all claims of the creditors voting in that group.288 In order to prevent obstruction by individual creditor groups, the law contains a cramdown option. According to § 245 InsO a class will be deemed to have consented to the plan if the majority of all classes of creditors has backed the plan and the members of the group that rejected the plan do not suffer a loss compared with their situation without that plan and they are also given an adequate share.289 After the creditors’ vote it is up to the court to confirm the plan. Confirmation shall be denied if a procedural rule has not been observed, or if approval has been procured by unfair means. Unfair means include, in particular, cases in which the debtor afforded one creditor preferential treatment.290 Confirmation is also to be denied if approval would lead to the interests of creditor minorities being insufficiently protected.291 In contrast, it is not the court’s responsibility to assess the feasibility of the plan. Thus, even if the judge were to believe that it would not work, he would not be able to refuse to confirm the plan.292 After the voting and the final action of the court, the insolvency proceeding is completed and the plan enters into force.293 Depending on what the plan provides, execution may

285

286 287

288 289

290 291 292 293

§ 28 (1) InsO. For the case where a debtor subsequently files a claim (see: § 177 InsO). § 176 InsO. Creditor groups that are not adversely affected are not entitled to vote (§ 237 (2) InsO). § 244 (1) InsO. Adequate share means that no other creditor receives full compensation of his claim, nor does a subordinate creditor or shareholder receive anything, nor would another creditor who would, without a plan, rank on an equal footing with the creditors of the rejecting group receive more than the disapproving creditors (cf. § 245 (2) InsO). § 250 InsO. § 251 InsO. Kamlah, supra n. 34, p. 432. § 254 (1) InsO.

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be monitored by the trustee.294 When the obligations under the insolvency plan have been fulfilled, the debtor will be discharged from his residual debts unless otherwise agreed.295 3.4.2.2. Out-of-Court Settlement While there is no special legal framework for out-of-court settlement of an insolvency case, such proceedings are generally allowed under German law. In fact, an estimated 20–30 percent of all corporate restructurings occur ‘in the shadow of the law’ in an out-of-court process.296 This informal process is based on a voluntary agreement between the debtor and its creditors. Either is allowed to start the negotiations, although in practice it is usually the creditors that take the initiative.297 Although there is no such obligation, negotiations are regularly supervised and brokered by a neutral third party in the person of an insolvency advisor or a trustee.298 The parties are free to agree to the terms that they deem to be appropriate. There is thus no strict rule of equal treatment of creditors. Instead, unequal treatment will sometimes be the only means to restrain dissenting creditors from sabotaging the successful conclusion and implementation of a rehabilitation agreement.299 The advantages of this procedure are its flexibility and speed,300 which, in turn, give rise to lower costs during the negotiation process, a higher probability of a successful reorganisation and a better percentage of recovery in favour of the creditors.301 In addition, out-of-court settlements provide more confidentiality than in court proceedings.302 A final advantage for the debtor is that it remains in possession, so that administration of the estate does not have to be transferred to a trustee.303 This may, in turn, raise doubts as to

294 295 296 297 298 299

300 301 302 303

§ 260 InsO. § 227 (1) InsO. Häsemeyer, supra n. 242, p. 680 n. 18. Deloitte & Touche; supra n. 14, p. 189. Häsemeyer, supra n. 242, p. 682. Uhlenbruck, Wilhelm, Gerichtliche oder außergerichtliche Sanierung? – Eine Schicksalsfrage Not leidender Unternehmen, (2001) 56 BB, p. 1645. Häsemeyer, supra n. 242, p. 679. Ibid. Deloitte & Touche, supra n. 14, p. 189. It is true that in a court insolvency proceeding it may similarly be ordered by the judge that the estate may be administered by the debtor. However, he then has to do so, under the supervision of an insolvency practitioner, or supervisor (§ 270 (1) InsO). The debtor is furthermore obliged to obtain the consent of the creditors’ committee with respect to any act that would have a material impact on the proceeding if so required by the credi-


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whether it is really the best decision to let the debtor continue its business, or whether this would be “letting the fox guard the henhouse”, since it was, after all, under the debtor’s management that the insolvency occurred.304 Some German insolvency experts thus remain critical towards the concept of debtor-in-possession administration.305 Apart from this scepticism, German insolvency law does not contain rules to outvote recalcitrant creditors or to suspend legal proceedings against the debtor initiated by them. Neither is there a standstill mechanism, nor do the parties to an out-of-court agreement have the opportunity to subject their agreement to court approval so that it could be made legally binding on dissenting minorities.306 The only way of obtaining the protection of these legal mechanisms is to start formal insolvency proceedings after negotiating a provisional plan (a so-called prepackaged plan).307 3.5. Indonesia 3.5.1. Overview On 22 April 1998, Indonesia’s President Suharto initiated a new era of Indonesian insolvency law by signing the Government Regulation in Lieu of Law No. 1 of 1998 Concerning Amendments to the Insolvency Code,308 which was adopted as of 9 September 1998.309 The regulation took effect as an amendment to the Bankruptcy Code passed by the Dutch colonial

304 305 306 307

308

309

tors (§ 276 InsO). In addition the creditors may at any time apply to the court to replace the debtor in his administrative position by a trustee (§ 272 InsO). On the whole, the debtor-in-possession under German law is subject to much tighter controls than e.g. his US counterpart (Kemper, Michael, Die US-amerikanischen Erfahrungen mit “Chapter 11”. Ein Vergleich mit dem Insolvenzplan der neuen Insolvenzordnung, Frankfurt a.M. 1996, p. 229). Kamlah, supra n. 34, p. 433. Ibid. Uhlenbruck, supra n. 299, p. 1644 et seq. See: Paulus, Christoph G., Ein Spannungsfeld in der Praxis: Sanierung und Insolvenzanfechtung, (2001) 56 BB, p. 430. The full original name of Indonesia’s insolvency law is Peraturan Pemerintah Pengganti Undang-Undang Nomor 1 Tahun 1998 Tentang Perubahan Atas Undang-Undang Tentang Kepailitan [hereinafter: Insolvency Code]. To date, there is no official English translation of the Indonesian Insolvency Code. Unofficial English versions are provided by Hoff, Jerry, Indonesian Bankruptcy Law, Jakarta 1999 and Tabalujan, Benny S., Indonesian Insolvency Law, Singapore 1998. The terminology and references used in this section are largely consistent with the latter translation.

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authorities in 1905.310 Normally, such amendments are carried out by the National Assembly, rather than under a Presidential decree.311 However, the new insolvency legislation was considered to be a matter of urgency. Not only was the old law out-dated – for instance it did not include provisions for the rehabilitation of a business312 – but the need for reform had also become apparent during the Asian Crisis. The devaluation of the Indonesian rupiah during that time gave rise to a significant increase in the debt owed by Indonesian enterprises and, at the same time, a decrease in the value of their assets. It is estimated that as a result around eighty percent of Indonesia’s companies were functionally insolvent.313 In exchange for the bail-out money that the IMF agreed to extend to Indonesia, the country had to agree, under the Fund’s conditionality, to address the inadequacies of its economy. In particular, the IMF set a deadline by which time Indonesia had to amend its insolvency law if it was to receive further IMF funding.314 A new insolvency law was drawn up with the support of experts from the IMF.315 The two most significant pillars of the insolvency system that emerged from that co-operation are the new Insolvency Code316 and the “Jakarta Initiative”.

310

311

312 313 314 315 316

As the 1905 Bankruptcy Code, which was written in Dutch, was never translated into Indonesian, while the amendment, as is the case with all other post-colonial legislation, is written in Indonesian, legal professionals have to deal with two laws in two different languages. It is self-evident that this does not simplify legal interpretation (cf. Kilgus, Stefan; Setiadarma, Monika Yayang, Das neue indonesische Insolvenzrecht, (1999) 45 RIW, p. 48). Sullivan, William A., Brave New World: Indonesia’s New Bankruptcy Law, p. 1, available at: www.lp.findlaw.com/articles/file/00324/005229/title/subject/topic/ Bankruptcy%20Law_other/filename/bankruptcylaw_1_328. Carter, supra n. 61, p. 320. Schreiber, supra n. 29, p. 364 et seq. Sullivan, supra n. 311, p. 1. Schreiber, supra n. 29, p. 368. The Insolvency Code is currently under review again (see: Sullivan, William A.; Ng, Audrey Indonesia’s Bankruptcy Law: What’s Next?, note from 15 October 2003, available at: www.coudert.com/publications/ default.asp? action=displayarticle&id=242). The relevant changes being contemplated in the reform are mentioned in context of the discussion of the applicable law.


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3.5.2. Description of the Rehabilitation Procedure 3.5.2.1. Insolvency Proceedings under the Insolvency Code Insolvency proceedings can be triggered under the Insolvency Code if a debtor with two or more creditors has failed to pay at least one debt that is due and payable.317 The debtor itself can file a petition with the competent court, as can one or more of its creditors or the public prosecutor acting in the public interest.318 Since the 1998 reform, petitions for insolvency have had to be filed with the Commercial Court, the establishment of which is seen as one of the most important aspects of the new law.319 Judges at the Commercial Court are required to possess knowledge regarding insolvency, including other relevant aspects in this respect, as well as to successfully complete a special training programme.320 It is hoped that this will facilitate and speed up future insolvency proceedings.321 In its insolvency declaration,322 the court appoints a supervisory judge who oversees the curator, who is likewise appointed by the declaration.323 The curator takes control of the business and its assets in lieu of the company’s management, which is removed by the court’s insolvency declaration.324 Within five days the curator can appoint a creditors’ committee, consisting of no more than three persons, as advisers.325 With the agreement of 317 318 319 320 321 322

323

324 325

Article 1 (1) Insolvency Code. Article 1 (2) Insolvency Code. Sullivan, supra n. 311, p. 6. Article 283 (2) Insolvency Code. Schreiber, supra n. 29, p. 371. According to Article 6 (4) Insolvency Code, the court shall make its decision within no more than 30 days of the petition being filed. This newly introduced definite time frame for decision making on the declaration of insolvency is also aimed at speeding up insolvency proceedings (Steele, Stacey, The New Law on Bankruptcy in Indonesia: Towards a Modern Corporate Bankruptcy Regime?, [1999] MULR 5 at I). According to the reform proposal, the timeline shall be extended to 60 days (Sullivan/Ng, supra n. 316, p. 3). Article 13 (1) Insolvency Code; the curator is appointed following a suggestion by either the debtor or the creditors. Commentators complain that this selection modus is prone to manipulation, as there is a risk of the debtor and the majority creditors acting in a collusion, selecting a curator to the detriment of the minority creditors. This is generally possible, as a creditor minority cannot object to the appointment of a particular curator (Kilgus/Setiadarma, supra n. 310, p. 48 et seq.). Cf. Articles 12, 19, 22, 24 Insolvency Code. Cf. Article 71 Insolvency Code; a creditors’ committee can also be appointed by the creditors’ assembly on its first meeting (Article 72 (2) Insolvency Code).

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the creditors’ committee or the supervisory judge, the curator is allowed to run the business.326 A suspension of court trials and enforcement actions is granted.327 Within 15 days from the decree of insolvency, the supervisory judge will order the first creditors’ meeting.328 The creditors’ assembly can usually decide upon an issue with a simple majority of the present creditors.329 The curator has to compile a list of accepted and contested claims.330 A creditor whose claim is contested, either by the curator or – during the second obligatory creditors’ assembly – by another creditor, can appeal to a state court.331 During the insolvency proceedings, the debtor has the option to submit a plan for composition to the curator and the creditors’ assembly.332 Even if a majority of more than one-half in number, and at least two-thirds in value, of recognized and attending unsecured333 creditors334 accepts the proposal, the court’s approval is still required; such approval may, however, only be denied under limited circumstances.335 After a judgment in favour of the plan, the debtor can claim “rehabilitation” after fulfilment of the agreed conditions.336 In contrast, if the debtor’s plan is rejected by the creditors’ assembly, or is not ratified by the court, the debtor automatically enters the liquidation stage.337 An alternative to the insolvency procedure is a petition to the court by the debtor for a moratorium with respect to its estate.338 The court will then grant a suspension of payment, during which time a debt-restructuring plan shall be negotiated between debtor and creditors. The debt moratorium affects the enforcement of both unsecured and secured creditors.339 Fur-

326 327 328 329 330 331

332 333

334 335 336 337 338 339

Article 95 Insolvency Code. This period terminates at the most after 90 days, Article 56 A (1) Insolvency Code. Article 77 A (1) Insolvency Code. Article 78 (1) Insolvency Code. Articles 107 et seq. Insolvency Code. Article 118 Insolvency Code. Before this recourse is granted, there is an obligatory mediation under the auspices of the supervisory judge. Articles 134 et seq. Insolvency Code. The reform proposal contemplates to harmonize the voting rights of all creditors, whether unsecured or not (cf. Sullivan/Ng supra n. 316, p. 3). Article 141 Insolvency Code. Article 149 (2) Insolvency Code. Articles 205 et seq. Insolvency Code. Article 168 Insolvency Code. Cf. Articles 212 et seq. Insolvency Code. Article 228 (3) Insolvency Code.


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thermore, the court appoints a supervisory judge and an administrator to assist the debtor in administering its estate.340 However, in contrast to the composition procedure, the debtor remains in control of its business under the moratorium procedure, and is thus potentially able to avoid losses so that, in turn, the creditors’ benefit will increase.341 Due to the suspension of payments order, any creditor is effectively prevented from enforcing its claims against the company.342 3.5.2.2. The Jakarta Initiative So far, experiences with the new Indonesian Insolvency Code have not been very promising. Commentators note a “significant element of unreality”.343 The old law was regarded as of mere academic interest344 and the new law does not seem to go much further. Statistics show that, five years after the code took effect, a total of only 322 bankruptcy petitions had been filed.345 At 59, the number of debt moratorium applications is even lower.346 The issues of concern commonly cited are a lack of certainty and expediency, as well as the absence of transparency in the Indonesian court system.347 The Commercial Court was not successful in establishing a reputation or track record for logical, rational decision-making.348 Confidence in the Indonesian court system is undermined in particular by the high level of corruption in Indonesia.349

340 341 342 343

344 345 346 347

348 349

Article 214 (2) Insolvency Code. Schreiber, supra n. 29, p. 372. Article 228 (1) Insolvency Code. Sullivan, Bill, The Absence of an Effective Legal System and the Impact of the Same on Indonesia’s Debt Restructuring Efforts, 10/05/2003 available at: www.coudert.com/publications/default.asp?actions= displayarticles&id=44 (hereinafter: Sullivan (2003)). Hoff, supra n. 309, p. 2. Ibid. Ibid. Kilgus/Setiadarma, supra n. 310, p. 52. An illustrative example is the Indonesian Bank Restructuring Agency (Ibra), which concluded its work in February 2004. This institution, which had been formed in the wake of the Asian Crisis in 1998 to “take some of the big debtors and bank owners, strip them naked, take their houses, their cars, anything, to avoid them doing it again” turned out to be anything but to achieve this goal. In the first place, the agency’s inefficiency is attributed to the notoriously pliable and corrupt courts (FT-Europe, 24 February 2004, p. 8). Sullivan/Ng/Tardiff, supra n., p. 3. Indonesia is constantly featuring among the most corrupt nations in the Southeast Asian region; Carter, supra n. 61, p. 326.

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Furthermore, the ‘stigma of insolvency’ still prevails in Indonesia, and court proceedings are associated with criminal justice or regarded as a last resort for those who are not capable of ordering their affairs adequately.350 In more general terms, critics also view the reform of the Indonesian insolvency law as a failure to transplant Western-model laws.351 Even if a creditor eventually obtains a judgment, there will, in practice, usually be an insurmountable gap of enforceability, since practitioners claim, for instance, that there is no practical legal way to enforce security devices.352 In order to overcome those obstacles and to stimulate the restructuring of Indonesia’s private sector, the Jakarta Initiative (Prakarsa Jakarta) was brought into being by the Indonesian Government in September 1998. Following the model of the ‘London Rules’,353 the initiative provides for a list of legally nonbinding procedures that shall facilitate out-of-court negotiations between the debtor and its creditors.354 As rules under the initiative are non-binding, the commencement of negotiations is voluntary and requires that both debtor and creditors are willing to submit to the proceedings.355 If both sides agree on negotiations, the Jakarta Initiative calls for the implementation of various standards. To facilitate restructuring negotiations, debtor companies shall employ the services of a financial adviser with expertise in corporate insolvencies.356 In turn, creditors are encouraged to form a creditors’ committee.357 An interim standstill agreement, combined with priority ranking for any new credit extended to the debtor after the beginning of the standstill period, are intended to provide the debtor with a ‘breathing space’.358 The signature of a confidentiality agreement is to guarantee that negotiations

350 351 352

353 354 355

356 357 358

Steele, supra n. 322, at IV A. Ibid., at IV C. Sullivan, (2003) supra n. 343, p. 4. For an overview of the black letter securities law in Indonesia see: Johnson, Darrell R., Chapter on Indonesia, in: Broude, Richard F. (et al.), Collier International Business Insolvency Guide – Vol. II – Insolvency Laws of Selected Nations, New York 2003, at 26.02[2]. Cf. Carter, supra n. 61, p. 313. Schreiber, supra n. 29, p. 375. A special task force was established to broker among the debtor and its creditors; in detail: Sullivan (2003), supra n. 343. Schreiber, supra n. 29, p. 376. Sullivan (2003), supra n. 343, p. 3. Schreiber, supra n. 29, p. 377; Sullivan (2003), supra n. 343, p. 3 also notes the benefit that this agreement ‘legalizes’ a de facto standstill, which occurs when debtors simply cease to make principal and interest payments.


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do not become public.359 The carrying-out of the out-of court negotiations between the debtor and its creditors is overseen and brokered by a specially established Jakarta Initiative Task Force.360 The ideal outcome is that the debtor devises a restructuring plan, which, after submission to and review by the creditors’ committee, is accepted by the majority of creditors.361 In the event that it is not possible to reach a unanimous decision among all creditors, the plan can be submitted for court approval, upon which the plan becomes binding on all creditors.362 The Jakarta Initiative still faces significant scepticism from the creditors, who doubt that it will positively influence the debtor’s attitude towards repayment of the debt. On the other side, debtors, reflecting the reality of the respective bargaining positions of creditors and debtors, are reluctant to co-operate if creditors do not agree on large write-offs of principal and interest.363 Nevertheless, the Jakarta Initiative avoids the necessity of official court proceedings, which are still seen as “part of the problem rather than part of the solution.”364 The Jakarta Initiative is thus regarded as an informal method by means of which it is basically possible to attain ‘win-win’ solutions,365 which, although far from perfect, provides the best solution under the given circumstances.366

4. Comparative Analysis The comparison of the insolvency laws analysed above demonstrates that there are significant conceptual similarities between the systems employed. The existence of such similarities is further supported by other comparative analyses of domestic rehabilitation systems. The result that, although if law makers originally intended to create very different systems, these

359 360

361 362 363 364 365 366

Schreiber, supra n. 29, p. 377. The initiative is made up of senior Indonesian central bank officials, most of whom have already reached the mandatory retirement age, but who have been brought back for this assignment; Sullivan (2003), supra n. 343, p. 2. Schreiber, supra n. 29, p. 378 et seq. Ibid., p. 379. Sullivan (2003), supra n. 343, p. 7. Sullivan/Ng, supra n. 316, p. 4. Carter, supra n. 61, p. 323. Cf. Schreiber, supra n. 29, p. 390.

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systems have, over time, begun to converge can be explained mainly by the fact that these developments are dependant on functional – above all economic – imperatives. Even “[i]f lawmakers do not accommodate these imperatives, participants in the day-to-day operation of the system must find ways of doing so, either through law or in spite of it.”367 The strong interrelationship between insolvency law and the economy is furthermore illustrated by the fact that all domestic systems discussed here were subject to reform quite recently, or are currently being reformed, as is the case in Indonesia. Those reforms also have strong similarities in terms of the tendencies they pursue, whether it is the enforcement of a ‘rescue culture’ in Britain or the ‘rehabilitation of insolvency law’ in Germany.368 The stigma of insolvency is to be substituted by a vision of insolvency as a second chance to help businesses which, through no fault of their own, entered into financial difficulties and which, under different circumstances, could be a viable part of the economic landscape. To achieve this goal, all insolvency systems analysed here provide for at least two stages. In the first stage, the debtor is granted breathing space, to allow him time to obtain an overview of the situation, as well as to figure out alternatives for the resolution of the problems. Furthermore, it is widely accepted that in this period the provision of new resources can facilitate a new start for the debtor. Nevertheless, not all of the systems compared above provide this means to obtain fresh funds qua law. The second important feature found in all the domestic insolvency systems compared in this study is the draft of a plan detailing the way in

367

368

LoPucki, Lynn M.; Triantis, George G., A Systems Approach to Comparing US and Canadian Rehabilitation of Financially Distressed Companies, in: Ziegel, Jacob S. (ed.), Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 110. This analysis is true regardless of the social or cultural setting of an insolvency law. For instance Little, supra n. 28, p. 204, notes that the Islamic law of adat was of comparatively little importance for the area of the development of Indonesian commercial and insolvency law. In fact, it is generally remarkable to see how Islamic countries find solutions to adopt and interpret their Islamic law in accordance with economic needs. For instance, while there is a prohibition of interest payments (riba) in Libya, Article 1 of the law prohibiting riba specifies that only interest payments between natural persons are not allowed. In other words, neither interest on arrears nor interest payments by legal entities, most notably banks, are forbidden. Amereller, Florian, Hintergründe des „Islamic Banking“ – Rechtliche Probleme des riba-Verbotes in der Shari’a und seine Auswirkungen auf einzelne Rechtsordnungen arabischer Staaten, Mainz 1994, p. 174 therefore speaks about mere ‘lip services’ in regard to the riba. A popular figure of speech in this context is the ‘Konkurs des Konkurses’.


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which relations between debtor and creditors shall be modified and how the debtor’s business is best run in the future. This plan, which is usually drawn up by the debtor, with or without the help of a neutral third party, shall provide creditors with the information necessary to decide whether or not they should approve the plan. The necessary majorities for the approval of the plan are usually 50 percent in sum and 75 percent in value. Lastly, a feature common to all of the domestic insolvency systems analysed here is a dualistic approach, which integrates court procedures as well as the possibility to reach a (more or less) informal out-of-court settlement. These procedures are based on a consensual agreement between the debtor and its creditors. Since they fall within the scope of private law, the principle of the freedom of the parties applies in particular. Consequently, rules concerning out-of-court settlements are mostly less detailed or, as is the case in Germany, are completely absent. In general, out-of-court settlements are consensus based and the role of the court is severely limited. The next section will compare the differing national solutions with a focus on those tasks of an insolvency procedure that can be regarded as being of the most importance for an effective sovereign insolvency system. These are: the commencement of the procedure (4.1), administration of the procedure (4.2) standstill on creditor enforcement (4.3), the concept of debtor in possession (4.4) and a plan for the solution of the crisis (4.5). 4.1. Commencement of the Procedure In practice, the first answers an insolvency law has to provide are, from a chronological point of view, who may initiate the proceedings (4.1.1) and which criteria have to be fulfilled in order for proceedings to be commenced (4.1.2). 4.1.1. Who may File Out-of-court proceedings may be initiated by the creditors as well as by the debtor upon entering economic difficulties. While debtors will often start negotiations in order to thereby hinder the commencement of lawsuits and the execution over its assets, creditors will do so to benefit from the enhancement of the value of their claims if the enterprise can continue its work as a going concern. With regard to domestic in-court rehabilitation procedures, there is a general consensus that these can be initiated by the debtor. In contrast, there is less consensus as to who else may file. While in Argentina for instance,

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only a debtor may file for a rehabilitation procedure, this right is granted e.g. in France not only to the creditors but also to the Commerce Tribunal and to the Public Prosecutor. In favour of the latter option, one can argue that debtors often wait too long to initiate proceedings due to the common psychological phenomenon that those responsible are reluctant to recognise their difficulties (and their own mistakes). Consequently, when procedures are finally initiated, it is often no longer possible to rescue the business.369 On the other hand, the success of rehabilitation proceedings depends most of all on the co-operation and the good faith of the debtor, which, in turn, will usually be hampered by an initiation of the proceedings by a party other than the debtor itself.370 4.1.2. Commencement Criterion Out-of-court proceedings are based primarily on the consent of the debtor and the creditors. Therefore, no strictly defined criteria regulate the conditions that have to be fulfilled for a commencement of rehabilitation negotiations. For court proceedings, there is a general consensus that the debtor must face a difficult economic and financial situation. Proof of that may be either a cessation of payments – whether total or to a certain number of creditors, as in Indonesia – or over-indebtedness. In addition, some countries, such as Germany, accept the criterion of imminent illiquidity. In such a situation, the debtor is not obliged to wait until it has completely ceased to make payments, but may open proceedings if it envisages that, within a foreseeable period of time, it will not be able to repay its debts as they become due and payable. The advantage of this rather flexible criterion is that debtors may be encouraged to initiate proceedings at an early stage, meaning that the chances for an effective recovery are still high.371 Creditors are certainly not allowed to refer to imminent illiquidity, as, were they permitted to do so, the creditors would have unfair leverage to harass the debtor by threatening the commencement of insolvency proceedings, which would, in turn, have an adverse effect on the debtor’s willingness to co-operate.372

369 370 371 372

Deloitte & Touche, supra n. 14, p. 210. Ibid., p. 211. IMF (1999), supra n. 13, p. 17. Ibid., p. 18.


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4.2. Administration of the Procedure If the parties opt for an out-of-court settlement, courts generally do not – as the name indicates – play any role. Should this settlement fail, notably because one or several groups dissent, or because vulture creditors sabotage a consensual solution, some states, such as Argentina, provide for the possibility to involve the court and ask for a standstill or a cramdown decision by the judge in out-of court settlements. On the other hand, to the extent that it is not necessary to involve the courts, the parties are free to find a solution on their own without the support of a neutral third person. Nevertheless, it is common practice that, the larger the case, the more often the parties jointly appoint a third person, or a team373 to assist the parties in drafting the plan, running the business and acting as conciliator during negotiations. In contrast, the commencement of in-court liquidation proceedings obligatorily leads to the involvement of the court. All of the domestic legislation analysed here also provides for the appointment of an administrator. Despite the differing terms used to describe this person, he is a central figure in all restructuring procedures. First of all, with the exception of Argentina, the administrator usually replaces the debtor as operator of the business. Furthermore, he puts comprehensive measures in place to prevent the postpetition transfer of assets of the enterprise by the debtor. A disadvantage is nevertheless the administrator’s possible lack of experience with the given circumstances as, at least in some cases, the management of the insolvent company will have the best understanding of the business’s operation. Furthermore, removal of the management might prove to be counter-productive, since it provides a disincentive for the debtor’s management to file insolvency proceedings. Therefore, in recent years, the trend towards a ‘power-sharing’ approach374 has been growing and the option of allowing the debtor to run the business under the administrator’s supervision is increasingly seen as a viable alternative, most notably in the U.S. This method is implemented against the backdrop that a debtor’s temporary financial difficulties do not necessarily have to be due to bad management, but might be the consequence of exceptional circumstances, such as a world economic crisis.375 As well as supporting the management of the enterprise or running the business 373

374 375

The common modus being that each party appoints one member of a committee who will then elect a third person as head of the team. IMF (1999), supra n. 13, p. 20. Cf. Deloitte/Touche, supra n. 14, p. 215.

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itself, the administrator’s task is normally seen in drafting a proposal for the restructuring plan and mediating the negotiations between the debtor and its creditors. 4.3. Standstill Once rehabilitation proceedings have commenced, the debtor’s assets enjoy special protection against actions by creditors, in the form of an automatic standstill on the enforcement of all lawsuits and claims against the debtor, as well as any other actions to obtain possession of the debtor’s assets. The suspension of creditor actions serves the aim of each insolvency procedure, which is to provide a mechanism for the equal distribution of assets among creditors. To therefore avoid the possibility that one creditor can seek execution of its claims before other creditors, an automatic suspension of respective actions is a consequence of the commencement of insolvency procedures in all of the countries assessed here. In a rehabilitation procedure, the stoppage of all enforcement actions is even more important, since a company that is being divided up through the attachment of its assets cannot be rehabilitated. Moreover, the automatic suspension may be regarded as a crucial incentive to encourage debtors to file early for rehabilitation of the business. The efficacy of a suspension of creditor action is underlined by an increasing number of domestic reorganisation orders, e.g. in Indonesia and England, which allow for an application for suspension even in out-of-court proceedings. Differences as to the scope of the suspension occur in particular with respect to secured creditors. While some states, such as Indonesia, exclude secured creditors completely from insolvency procedures, others, like France, do not distinguish between secured and unsecured creditors as to the suspension of creditor actions. The limitation of the first approach mentioned is that it limits the efficiency of the rehabilitation procedure. For instance, the assets securing a claim of a secured creditor may be vital for the successful implementation of a rehabilitation plan.376 The negotiation process for a rehabilitation plan will therefore not succeed if the priority creditor is able to proceed to enforce its rights in those assets. Another difference in the scope of debtor-protection after commencement of procedures is whether, simultaneously to the suspension of creditor actions,

376

IMF (1999), supra n. 13, p. 24.


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interest on the debtor’s debt is also suspended, as is the case in Argentina, or whether it continues to accrue, as in Germany. 4.4. Creditors’ Committee Creditors are regarded as important players in all of the rehabilitation systems assessed in the present study. Accordingly, they are given significant powers to make decisions in key areas. Commentators emphasise the fact that, the less developed an institutional framework for an insolvency procedure is, the more essential is the active participation of the creditors, since otherwise creditors will cease to rely on a fair and independent outcome of the procedures.377 To protect creditors’ rights, the insolvency legislation in all of the countries assessed contains provisions to the effect that special organisations or institutions represent the creditors in cases where, otherwise, due to the sheer number of creditors, creditor coherence and efficiency in the process would appear to be at risk. Thus, German or Argentine laws allow for the creation of creditors’ committees to represent the creditors. In France, this task is fulfilled by a single person, the creditors’ representative. Apart from Indonesia, which limits the number of members of the committee to three persons, the other laws are more flexible as to the details of the creation of the committee to sufficiently take into consideration the creditors’ divergent interests on a case-by-case basis. While the creditors’ committee is intended to facilitate the conduct of negotiations, this organisation has no powers to make final decisions on behalf of the creditors.378 4.5. Priority Reorganisation Financing While some legal systems, such as that in Argentina, do not contain provisions on priority financing, rules to this effect are part of the domestic rehabilitation law in France and Germany, as well as numerous other legal systems.379 This priority status is granted against the backdrop that it might otherwise be difficult to continue to operate the business, due to the fact that it would be impossible to obtain new credit if this credit were not treated

377 378

379

IMF (1999), supra n. 13, p. 30. However, the laws usually contain provisions that important creditor decisions, such as voting on a plan, can be referred to a proxy (see e.g. English Insolvency Rules 1.19). As well as all other EU Member States, also e.g. in the U.S. (Deloitte & Touche, supra n. 14, p. 223).

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preferentially. Moreover, it is asserted that, if the business cannot continue its operations, rehabilitation will be severely complicated.380 4.6. Approval of a Reorganisation Plan All assessed procedures aim at the drafting of a plan, which details how the business shall be reorganized. This plan can be the outcome of either an in-court or out-of-court proceeding. The content of the plan, whether prepared by the debtor or the administrator, shall generally provide creditors with a clear statement of assets and liabilities of the debtor company as well as a complete survey of the proposed recovery measures. To increase the chances that a rehabilitation plan is approved even against the will of some creditors, rules identifying a threshold of support which is considered to be sufficient to bind a dissenting creditor minority are generally accepted by all analysed domestic corporate rehabilitation laws.381 To obtain a positive vote on the plan it is necessary that a per capita majority of creditors votes in favour of the plan. The precise threshold is varying. While e.g. in Germany a simple majority is sufficient, Argentina or Indonesia require a three-quarters majority. Furthermore, the plan must obtain a double majority, i.e. also with respect to the aggregate amount of claims, which must generally constitute more than 50 percent of the aggregate amount of all claims. A further modification is that most laws calculate the percentage of support on the basis of a percentage of those creditors voting. Absentees are considered to have little interest in the proceeding due to their regularly (comparatively) small claims.382 Whether the majority requirement is fulfilled, is assessed for each separate voting class of creditors.383 After the drafting is complete, all legal procedures subject the plan to the vote and approval by the creditors. In in-court proceedings, the plan must in addition be ratified by the court, which can also cramdown dissenting creditor classes. 380

381

382 383

An issue that is less unanimously resolved is the extent of the incentives that the postpetition creditor might be granted (for an overview of the potential range see: IMF (1999), supra n. 13, p. 29). France can be seen as an exception in so far as the decision on the plan is up to the insolvency judge. See: IMF (1999), supra n. 13, p. 25. The way these classes are made up is dependent on the specific case, as well as on the applicable law. While e.g. in England there is only a minimum of two classes, i.e. shareholders and stakeholders, German law requires at least three groups, i.e. creditors with right to separate satisfaction, unsecured creditors and subordinate insolvency creditors.


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4.7. Conclusion As the foregoing analysis demonstrates, there is a general consensus on many issues concerning corporate rehabilitation procedures. Nevertheless, the domestic solutions do not offer a uniform approach. The extent to which one is willing to accept these solutions as general principles of law therefore depends largely on political factors. Thus, it would seem much more probable that the ECJ in a given context accepts the existence of a general principle in the area of insolvency law than an international court, such as the ICJ. Nevertheless, this does not devalue the results obtained so far. Even if one were of the opinion that general principles do not yet exist in this area, the results can be seen as tendencies in domestic law, which precede the finding of a fully-fledged general principle of law.384 One could in so far speak about general principles in statu nascendi. While it may still be too early for these principles to be used as the free-standing and autonomous basis for a judicial decision, they already provide fertile suggestions for the drafting of international legislation, such as a reorganisation system for sovereign debt (RSSD).385

5. Synthesis Against the backdrop and on the basis of the results obtained through the preceding analysis, the next section shall discuss the potential outline of an insolvency system for sovereigns. In order to reach workable solutions for the sovereign context, the findings must first be adapted to reflect the differences between the domestic, corporate level and the international state level.386 One possible method of transferring and adapting the findings to the state context would be to emphasize the solutions chosen by the system that has proven most successful in the national arena. Accordingly, there is an argument in support of referring to the legislation that

384

385

386

Lorenz, Werner, Rechtsvergleichung als Methode zur Konkretisierung der allgemeinen Grundsätze des Rechts, (1962) 17 JZ, p. 273. See also: Meesen, Karl M., Die insolvenzrechtliche Option in der internationalen Schuldenkrise, (1990) 89 ZVglRWiss, p. 260, who rejects the existence of general principles in the area of insolvency law, but discusses the transfer of the basic features of domestic insolvency law to resolve the international sovereign debt crisis. See supra at Part C, Chapter I, 3.2.2.4.

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is most commonly used as a model for reform in the domestic setting. In this context, the U.S. American reorganization law has been suggested as a model.387 It is, however, worth mentioning here, that the factual influence of US insolvency law, notably the reorganization proceedings under Chapter 11, seems to have been overestimated.388 Alternatively, one could also, for instance, advocate the use of the law with the highest reorganization success rate; following this approach, Japanese law, where these success rates are higher than in the U.S.,389 would be the law of choice.390 However, critics of this method note that reorganization success rates are the result of the combination of numerous factors e.g. tax incentives, governmental support etc. meaning that they can only be viewed in terms of a domestic background and are therefore a problematic criterion for comparative issues.391 Due to the lack of any demonstrable ‘superiority’ of a particular domestic system, the synthesis of the RSSD should, in line with the functional approach discussed above, be based specifically on how its objectives can best be achieved.392 Thus, the synthesis first of all requires

387 388

389

390

391 392

Schwarcz, supra n. 11, p. 956 et seq. Peter Terhart explicitly notes “[o]bwohl Chapter 11 ursprünglich für die neue deutsche Insolvenzordnung Pate stand, folgt diese nicht der Idee des amerikanischen Rechts” (idem, Chapter 11 bankruptcy code: eine Alternative für Deutschland?, Frankfurt a.M. 1996, p. 367). Thus, while the German InsO contains some elements of U.S. chapter 11, in that it provides for rehabilitation pursuant to a court-approved plan, significant differences remain between the two laws. Most importantly, the degree of creditor control over the proceedings in Germany is much higher than in the U.S., where the debtor usually remains in control of the business. For a comprehensive overview of the numerous differences between the German and U.S. insolvency law see: Kemper, Michael, Die US-amerikanischen Erfahrungen mit “Chapter 11”. Ein Vergleich mit dem Insolvenzplan der neuen Insolvenzordnung, Frankfurt a.M. 1996. According to data collected by Bradley and Rosenzweig, less than 25 percent of all enterprises that enter reorganization proceedings under Chapter 11 succeed in reorganization. Most cases end in liquidation pursuant to Chapter 7. Furthermore, Chapter 11 is criticized because it usually takes years before enterprises that cannot be reorganized are eventually liquidated (Bradley, Michael; Rosenzweig, Michael, The Untenable Case for Chapter 11, (1992) 101 Yale L.J., p. 1043 et seq.). Eisenberg, Theodore; Shoichi, Tagashira, Should we Abolish Chapter 11? The Evidence from Japan, in: Ziegel, Jacob S. (ed.) Current Developments in International and Comparative Corporate Insolvency Law, Oxford 1994, p. 215 et seq. Gilson, supra n. 42, p. 261 et seq. Discussions concerning the objectives of the RSSD are rarely held explicitly to this end, despite the fact that, or perhaps due to the fact that specific personal interests


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some contemplation of the rationale of the RSSD (5.1.). The next section will then analyse which core features the RSSD ought to contain (5.2.). 5.1. Rationale of the RSSD 5.1.1. Why is there a Need for an RSSD? Sovereign debt reorganisation requires a negotiated settlement between the debtor and the creditors. The outcome of such negotiations depends on the interests of the parties. They will come to an agreement if the costs of disagreement exceed the costs of agreement.393 Moreover, the greater the degree of co-operation between creditors and debtor, the less complicated and protracted negotiations will be. This, in turn, reduces the costs of the proceedings and further enhances the collective benefit for the participants. However, co-operation in corporate debt renegotiations is only worthwhile for creditors if the debtor’s ‘going concern’ value is in fact higher than the liquidation value.394 If this is not the case, creditors will opt to liquidate the enterprise. In contrast, liquidation of sovereigns in financial distress is not an option. A mutually acceptable co-operative settlement of a sovereign’s financial crisis therefore always generates the collectively most beneficial results. Only by reorganising the sovereign debt can the orderly flow of new credit be restored, and losses to lenders avoided.395

393

394

395

frequently play a major role in commentators’ criticism of shortcomings within the current system and in their own respective proposals; Frenkel, Michael; Menkhof, Lukas, Reform Proposals for a New International Financial System, in: KAS, Uneven Architecture: The Space of Emerging Countries in the International Financial System, Rio de Janeiro, 2002, p. 228. Some commentators see the lack of consensus regarding the problems that need to be tackled as one of the main deficits in the current discussion on an insolvency system for states, and also a central reason for the continuing ineffectiveness of the debate. (Scott, Hal S.; Wellons, Philip A., International Finance, 9th ed. New York 2002, p. 1362). This is the fundamental truth of the Theory of Wages (cf. Rahnama-Moghadam, Mashaalah et al., The Clubs of London & Paris: International Dispute Resolution in Financial Markets, (1998) 53 Disp. Resol. J., p. 73). Eidenmüller, Horst, Unternehmenssanierung zwischen Markt und Gesetz: Mechanismen der Unternehmensreorganisation und Kooperationspflichten im Reorganisationsrecht, Köln 1999, p. 25 et seq. Cf. Friedman, Benjamin M., Debt Restructuring, NBER Working Paper No. 7722, Cambridge, May 2000, available at: www.nber.org/papers/w7722, p. 31.

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A priori, this outcome would not require a single legal provision. In fact, all of the legal systems assessed in this study accept debt reorganisations in informal out-of-court proceedings. Sometimes, as e.g in Indonesia and England, the successful outcome of such negotiations is backed by optional judicial support, such as, for example, a cramdown alternative. However, as the example of Germany illustrates, this is not a precondition for successful debt renegotiation. Nevertheless, in all of the countries assessed, such negotiations take place ‘in the shadow of the law’, i.e. if they fail, formal in-court procedures are in place. The existence of formal in-court reorganisation systems is an indication of the fact that, under certain circumstances, a completely unregulated outcome of debt renegotiations might be less desirable. Basically, informal procedures are insufficient where market failures hinder a reasonable solution. Most importantly, in the case of incomplete information of market participants, a typical prisoners’ dilemma arises. Since renegotiations of sovereign debt are typically motivated by the sovereign’s financial distress, creditors that do not co-operate may benefit at the expense of those who do co-operate. The co-operation reduces the sovereign’s debt burden, so that even those creditors that did not co-operate may benefit. The uncooperative creditors will receive a capital gain because those creditors who co-operated thereby made it more likely that the debtor state’s remaining debts will be paid off in full. If this subsidy to the remaining (uncooperative) creditors is high enough, then they will not co-operate. Then, however, every single creditor would reason in this way: each individual creditor wants all the other creditors to co-operate, so that his claim can be paid off in full. Ultimately, none of the creditors co-operate. This is the creditors’ prisoner dilemma, which is also known as the hold-out problem.396 Individual creditors do not co-operate, even if the creditors are better off as a group, if they all continue to hold the country’s debt. Instead, in anticipation of uncooperative behaviour, all creditors will ‘rush to the exits’ when a sovereign crisis unfolds or they may ‘rush to the courthouse’ to attempt to attach assets, i.e. have a first claim on the assets of the debt if they move first, leading to a ‘grab race’.397 Such reactions by creditors facing a problem

396 397

Cf. ibid., p. 19 et seq. See in more detail: Roubini, Nouriel, Do We Need a New International Bankruptcy Regime? Comments on Bulow, Sachs, White, Discussion Paper, New York 4 April 2002, p. 2 et seq.


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of collective action constitute a market failure, against which an adequately drafted legal framework could offer greater insulation.398 5.1.2. The Pro-Creditor Approach It has been argued that current imperfections in the sovereign debt market should be dealt with by way of better protecting creditors’ rights.399 Shleifer argues that debt markets will work best when the rights of creditors are protected most effectively.400 According to this view, the difficulties in sovereign debt restructuring could be eased if creditors’ rights were strengthened. In fact, if creditors were to be granted a guarantee that they would obtain full repayment of their claims, for instance by means of a bailout, this would eliminate the incentives to rush to the courts or to hold out. It would, however, create a new form of moral hazard. Creditors could be sure that their investments were risk-free. Thus they would not assess the credit-worthiness of their debtors, but rather would make their investment decisions based solely on the highest profits. The risk of creditor moral hazard is a real one. Indeed, many investors obviously anticipate that there will be bail-out insurance for their investments in the sovereign debt market. For instance, when Venezuela issued a new $1bn 30-year bond in 2004, bids for the bonds amounted to $3bn. This was despite a government rating with a ‘speculative grade’401 reflecting the poor economic conditions and the political instability in Venezuela at that time.402 This high demand has to be seen against the backdrop of the high yields of the coupon issue and the fact that international bonds already issued by Venezuela had generated returns estimated at about 40 percent in 2003.403 To this extent, the question arises why this yield hunger should continue to be supported by a pro-creditor insolvency procedure. This is all the more the case due to the fact that creditors of sovereign debt, according to a study published by Moody’s, recover an average of 34 percent, even in

398 399

400 401

402 403

Eichengreen/Portes, supra n. 3, p. 4. Shleifer, Andrei, Will the Sovereign Debt Market Survive?, NBER Working Paper No. 9493, Cambridge February 2003, available at: www.nber.org/papers/w9493. Ibid., p. 1. Venezuela was at that time rated by Moody’s Caa1 and by Standard and Poor’s B-minus. FT-Europe, 9 January 2004, p. 31. Ibid.

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the case of a state’s default:404 this is significantly more than creditors get out of insolvency proceedings in domestic cases.405 Furthermore, the high demand for emerging market bonds in fact creates a risk for the stability of the international financial architecture.406 Analysts have already warned that “the question is not if the next [financial market’s] crisis will occur, but when.”407 One might, therefore, tend to argue that high potential gains on the one hand justify high potential losses on the other hand. As some commentators noted “[n]o-one buying bonds from a government [like Argentina’s] that operated a currency board but repeatedly failed to balance its budget should complain when that bet goes sour. Investors will take big losses and they deserve it.”408 It is true that among these creditors are also “retired old folks with little education and modest means who had put their life savings on what they thought were safe investments.”409 Nevertheless, this would mean that consumer protection provisions would have to be improved. In contrast, the rationale of the RSSD should not be to unilaterally protect creditors’ interests. 5.1.3. The Pro-Debtor Approach Does this mean that debtors’ rights should play the lead role when drafting the RSSD? Developing countries and NGO’s usually take such a view, arguing that the main rationale of the RSSD would be debt relief. This view holds that ‘odious debts’, which are the ‘heritage’ of a former colonial regime,410 or

404 405

406

407 408 409 410

Cf. FAZ, 15 January 2003, p. 21. E.g. average recoveries for ordinary debtors in France are at around 5 percent (Campana, supra n. 193, p. 72). International financial stability is generally considered a global public commodity and its preservation is deemed to be in the interest of the international community (Weber, Rolf H., Challenges for the New Financial Architecture, (2001) 31 Hong Kong L.J., p. 241). FT-Europe, 16 January 2004, p. 14. FT-Europe, 2 February 2004, p. 10. Letter to the editor by Vito Tanzi, FT-Europe, 4 February 2004, p. 12. It is indeed true that numerous former colonies were obliged to repay debt of the colonial powers. See for instance: UN, Documents of the 29th Session, [1977] II-1 Yearbook of the ILC, p. 86 et seq.; see also: Art. 38 I of the Vienna Convention on Succession of States in Respect of State Property, Archives and Debts (1983), providing that “[. . .] no State debt of the predecessor State shall pass to the newly independent State, unless an agreement between them provides otherwise” (emphasis added); Silagi, Michael, Staatsuntergang und Staatennachfolge: mit besonderer Berücksichtigung des Endes der DDR, Göttingen 1996, p. 342 et seq.


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of governments like the South-African apartheid regime, were not binding on the state. Other commentators feel that human rights create a duty to restructure and cancel unsustainable state debt and to free sovereign debtors from their debt burden.411 However, in addition to dogmatic critique,412 it is also necessary to make a distinction between different groups of debtors. Some debtors do not pay their due and payable debt because they cannot do so, while others could pay, but seek not to. Moreover, among those debtors that cannot pay, some are in a situation of (short-term) illiquidity while others will not ever be able to pay.413 For those debtors belonging to the latter group, a discharge mode has already been established, namely the HIPC initiative, which provides debt relief to those countries facing ‘unsustainable’ debts.414 Moreover, further to doubts as to the political feasibility of a general debt-relief system for all developing countries,415 this approach contradicts the internationally accepted principle pacta sunt servanda.416 Finally, a debtororiented insolvency law would run the risk of increasing ‘moral hazard’ for the debtor, since states could attempt to gamble for resurrection, expecting absolution for their prior economic ‘sins’.417 5.1.4. The RSSD as a Means to Enhance Co-operation This short summary illustrates that the more weight one side is given, the stronger moral hazard incentives become, and the less probable is an optimal outcome of the debt renegotiations. To find the balance required for good co-operation, incentives must be given equally to debtors and creditors. Only

411

412

413 414

415

416 417

Pieper, Stefan Ulrich, Völkerrechtliche Aspekte eines Internationalen Insolvenzrechts, in: Dabrowski, Martin et al., Lösungsstrategien zur Überwindung der Internationalen Schuldenkrise, p. 254. Human rights can hardly provide a basis to which a state can refer (Auprich, Andreas, Entschuldung, Menschenrechte und das Recht auf Entwicklung, in: Dabrowski, Martin et al., Die Diskussion um ein Insolvenzrecht für Staaten, Berlin 2003, p. 83).The transfer of human rights from an individual to its state is also excluded, because these rights are inalienable (Cf. paragraph I of the Uniform Declaration of Human Rights, available at: www.unhcr.ch/udhr/index.htm). For a discussion of the odious debts doctrine and a critique thereof see supra Part C, Chapter I, 2.1.2. Friedman, supra n. 395, p. 1. See supra Part C, Chapter I, 2.2.2; whether or not HIPC provides sufficient debt relief is beyond the scope of this work. Paulus, Christoph G., A Statutory Procedure for Restructuring Debts of Sovereign States, (2003) 49 RIW, p. 402 (hereinafter: Paulus (2003)). Auprich, supra n. 412, p. 83. Meesen, supra n. 385, p. 264.

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if both sides acknowledge a potential bargain, will they be willing to negotiate in a co-operative manner. The rationale for the RSSD is then to provide the legal incentives that eventually balance the failures of the market418 or, as formulated by Anne Krueger, the rationale for the RSSD is: to facilitate the orderly, predictable, and rapid restructuring of unsustainable sovereign debt, while protecting asset values and creditors’ rights [. . . as well as to] reduce the costs of a restructuring for sovereign debtors and their creditors, and contribute to the efficiency of international capital markets more generally.419

5.2. Core Features of the RSSD 5.2.1. Commencement 5.2.1.1. Who May File? In the sovereign context, there is no question that, as is the case in all domestic laws, the debtor shall have the right to initiate restructuring negotiations.420 It is, however, questionable whether, as in some domestic insolvency systems, that right should also be granted to creditors. One could argue that this would have a disciplining function on the debtor state421 and that creditors should have this right to protect the value of their claims, which could otherwise be destroyed. On the other hand, creditors could use such powers to harass the debtor by threatening to initiate insolvency proceedings.422 The commencement of restructuring measures could have potential negative effects on the country in question. As well as the danger of a stoppage of any further capital and trade flows to that country, it is feared that the state’s sovereignty could be encroached upon, as the state could be pressed into a ‘corset’ of actions, which are, at worst, completely superfluous.423 Furthermore, the debtor is typically the only person with full information

418 419

420 421 422

423

Cf. Terhart, supra n. 388, p. 24. Krueger, Anne O., A New Approach to Sovereign Debt Restructuring, Washington 2002, p. 4. Paulus (2003), supra n. 415, p. 403. Ibid. See: Schwarcz, Steven L., Global Decentralization and the Subnational Debt Problem, (2002) 51 Duke L.J., p. 1202 (hereinafter: Schwarcz (2002)). Paulus, Christoph G., A Legal Order for Insolvencies of States, available at: www.dse. de/ef/sdrm/paulus.htm.


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concerning outstanding obligations, future projects and so on. The debtor thus knows best when restructuring negotiations are most appropriate.424 While this reasoning applies for corporations, it is all the more appropriate with regard to states.425 Hence, the Model Convention proposed at the end of this study will provide that the formal right to commence negotiations for restructuring procedures should be limited to the debtor.426 This, of course, does not preclude the creditors opportunity to ask the debtor for an application to this effect and, in its own interest, the debtor will usually do so, if there are grounds for doing so. Furthermore, the debtor will usually commence negotiations if creditors start to file for judicial enforcement of past due debt. 5.2.1.2. Commencement Criterion The discussion about the reasons for opening a reorganisation proceeding for sovereigns centres mainly on the feasibility of the transfer to countries of insolvency criteria that apply to corporations, and, indeed, whether any conditions should be imposed at all. Criteria suggested are over-indebtedness or a general cessation of payments. While the latter will hardly ever occur,427 the first criterion is almost impossible to prove.428 A possible alternative criterion might be seen in a reference to the ‘unsustainable debt’ ratios, as formulated under the HIPC Initiative. However, as Jeffrey Sachs puts it “[i]t is perfectly possible, under HIPC for a country filled with massive hunger, extreme poverty, and pandemic diseases to service debt on the grounds of formal debt-export ratios, which say nothing about true ability to pay.”429

424 425

426

427 428 429

Cf. Schwarcz, supra n. 11, p. 981. Even rating agencies are often mistaken when assessing the financial situation of a country, as illustrated by the example of Thailand, which was given a non-investment grade only half a year after the start of the financial crisis in 1997 (Kochalumottil, Beena, Verfahren, Methoden und neue Ansätze zur Beurteilung von Länderrisiken, Marburg 2002, p. 66 et seq.). IMF, The Design of the Sovereign Debt Restructuring Mechanism – Further Considerations (27 November 2002), available at: www.imf.org/external/np/pdr/sdrm/2002/112702. pdf., at 84 (hereinafter: IMF (2002)). This restriction is also in congruency with the present customs for Paris and London Club proceedings, which are also only activated upon application by a debtor state; see supra at Part C, Chapter I, 2.2.1. Even Argentina continued to pay public creditors. Paulus (2003), supra n. 415, p. 9. See Professor Sachs’ letter to the editor in FT-Europe, 20 February 2004, p. 12.

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Instead, he suggests the creation of new standards, which should be “based on the ability to [. . .] meet the internationally agreed Millennium Development Goals.”430 In a broader sense, debt is officially understood to become ‘unsustainable’ when there is no feasible set of measures for a debtor state “to keep its total debt under control without unrealistically large corrections in the balance between income and expenditure.”431 Certainly, a sovereign may (in theory) always seek more revenue for debt-servicing by imposing higher taxes.432 Thus, strictly speaking, one could require that all taxpayers be subject to an insolvency proceeding before a debt could be considered unsustainable.433 However, it is common ground that such tax policies reduce growth, and thereby increase the risk of debt unsustainability, rather than reducing it.434 This criterion thus remains unavoidably vague and subject to interpretation. Arguably, imposing any form of insolvency requirement could lead to serious adverse effects because states, trying desperately not to be branded insolvent will postpone the use of the restructuring mechanism and thus continue to accumulate unnecessary debt to the disadvantage of all those involved. In contrast, it was noted that anticipatory debt reorganisation would be beneficial to pre-empt sovereign debt crises.435 Consequently, it is contended that no insolvency criterion whatsoever should be imposed. An application by the debtor is considered to be sufficient. To avoid abuse of the debtor’s right to file, it is suggested that a neutral third person should have the right to check whether the debtor applied in ‘good faith’.436 U.S. insolvency law provides a similar mechanism for municipalities, pursuant to which the court can reject a municipality’s application for insolvency if it is not assessed as being insolvent and did not file

430 431 432

433 434 435

436

Ibid. IMF (2002), supra n. 426, at 7. Euliss, Richard, The Feasibility of the IMF’s Sovereign Debt Restructuring Mechanism: An Alternative Statutory Approach to Mollify American Reservations, (2003) 19 Am. U. Int’l L. Rev., p. 115. Paulus (2003), supra n. 415, p. 404. Euliss, supra n. 432, p. 116. Oechsli, Christopher G., Procedural Guidelines for Renegotiating LDC Debt: An Analogy to Chapter 11 of the US Bankruptcy Reform Act, (1981) 21 Virginia Journal of International Law, p. 337. Schwarcz, supra n. 11, p. 983.


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in ‘good faith’.437 Domestic experiences with such criterion, notably in the U.S. Chapter 9 context, are not very promising. Instead, it is highlighted that hurdles of this kind make insolvency procedures for municipalities in the U.S. almost inaccessible and therefore useless.438 Other problems arise in the sovereign context. First of all, whether a debtor is applying in good faith or not leads to further questions such as the very meaning of ‘good faith’ and the definition of (in)solvency standards for states (which, as discussed above, is extremely difficult) proving the good faith of the debtor. The risk that, at the end of the day, an implicit sustainability-test would be made through the backdoor, with the imminent difficulties mentioned, is high. Even if it were possible to agree on certain criteria regarding these issues, the third person assessing the situation would inevitably be dependent on information from external sources, namely the IMF and the Worldbank.439 Even if it is assumed that those two institutions would adequately provide all necessary information, the debtor and/or the (other) creditors could potentially mistrust the information, as it might be argued that data is given or is not given to obtain results favourable to the public creditors.440 Any doubts regarding the integrity of the information, though, would impair the degree of good co-operation in subsequent negotiations. Furthermore, such assessment, if it is to lead to any reasonably reliable result, needs a thorough analysis, which, in the worst case, would only postpones the commencement of the proceedings, ultimately benefiting no-one. In general, it has to be stressed that an application for an insolvency procedure also entails costs for the sovereign, who suffers not only a loss of reputation and market access, but who must also bear the costs of economic, social, and political disruption.441 As underlined by an IMF report, a default may involve not only a decline in real incomes and in private investments,442 but may also lead to financial sector difficulties, and drainage of

437 438

439 440

441

442

11 USC. §§ 109 (c), 921 (c). McConnell, Michael W.; Picker, Randal C., When Cities Go Broke: A Conceptual Introduction to Municipal Bankruptcy, (1993) 60 University of Chicago Law Review, p. 461. Paulus (2003), supra n. 415, p. 545. This position is explicitly supported by the Emerging Markets’ Traders Association (EMTA) in a Discussion Draft on the IMF’s SDRM proposal (12/6/02), p. 4 (available at: www.emta.org/ndevelop/sdrm.pdf ). Bossone, Biagio; Sdralevich, Carlo, The New Approach to Sovereign Debt Restructuring: Setting the Incentives Right, IMF PDP/02/4, March 2002, p. 10. See Andrew K. Rose concluding in his analysis that, after sovereign default, international

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external reserves when the sovereign attempts to stem pressure from capital outflows.443 This risk is in fact taken seriously by developing and emerging economies; the reluctant stance of those states towards the mere introduction of CACs, due to the associated higher interest rates that could result from insertion if markets were to believe that CACs are used only to facilitate an anticipated default, demonstrates this.444 While the Model Convention should therefore not contain an ex ante good faith test regarding the financial distress of a country, it should require that the debtor draft a plan detailing the reasons for the financial crisis of the debtor and how a debt restructuring is to be carried out.445 From an ex post perspective, the Convention should contain a provision that prevents debtors from frivolous filing for insolvency by requiring that applications may only be made after a certain period of time has elapsed since the last motion.446 5.2.2. Administration 5.2.2.1. Debtor-in-Possession In the event of a default, domestic rehabilitation laws generally include mechanisms forcing the debtor to change its business practices, be it by way of complete replacement of the management e.g. by an administrator, or be it because all central decisions of the management, although it remains in possession, are subject to prior approval. In contrast, in the sovereign context, the IMF can only cajole a pre-crisis country by means of ‘surveillance’ procedures, public reports and so on, into altering its potentially risky policies and can attempt after default to use conditionality to obtain what it considers to be ‘sound’ economic decisions.

443

444 445 446

trade typically falls by statistically significant amounts; e.g. an average eleven percent over fifteen years in the case of Togo (idem, One Reason Countries Pay Their Debts: Renegotiation and International Trade, NBER Working Paper No. 8853, Cambridge, March 2002, p. 25, available at: www.nber.org/papers/w8853). Cf. IMF, Sovereign Debt Restructurings and the Domestic Economy – Experience in Four Recent Cases, 21 February 2002. See supra at Part B, Chapter I, 4.2. Paulus (2003), supra n. 415, p. 10. Paulus, Christoph G., Some Thoughts on an Insolvency Procedure for Countries, (2002) 50 Am J. Comp. L., p. 545, (hereinafter: Paulus (2002)) suggests a period between 2–10 years.


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Commentators have suggested that the RSSD should provide for the appointment of a trustee who assumes responsibility for operations of the debtor business, reviews the debtor’s financial status and assists in the design of a rehabilitation plan. To this end, the powers of the IMF could be extended accordingly.447 In this context, though, it is worth noting that e.g. a municipal debtor in the U.S. Chapter 9 procedures is free to use its assets without any interference and does not need to fear that a trustee will be appointed to take control of operations.448 The reason for this is that, otherwise, a court-appointed trustee would interfere with democratic decision-making.449 The same reasoning must be valid in the sovereign context. Hence, the dismissal of an incompetent government cannot be required and a receiver cannot take control of the power. This is also underlined by the finding that: even if the IMF [or whatever international institution in power], were willing to risk charges of usurping the sovereign prerogative of a country to select its own government, removal of the incumbent government may be the one condition [. . .] that even a country in dire financial straits will not accept.450

The government of the sovereign will therefore remain the ‘debtor in possession’. However, while a dismissal qua legal powers is out of the question, it is important to bear in mind that there are powerful non-legal mechanisms that will almost invariably sweep the government of a defaulting country from office before the conclusion of their reorganisation case. Research undertaken in the U.S. shows that, under the Chapter 11 procedure, despite its quite pro-debtor-in-possession orientation, 95 percent of the chief executives who were in post at the beginning of financial difficulties were no longer in office when the restructuring plan was confirmed.451 Similarly, e.g. in the Argentinean case, social unrest forced the ‘defaulting’ government under Fernando de la Rúa to leave. The lack of a formal dismissal mechanism thus does not mean that the government can continue to govern as if nothing

447 448 449 450

451

Cf. Oechsli, supra n. 435, p. 334. 11 USC. § 904. McConnell/Picker, supra n. 438, p. 435. Tarullo, Daniel K., Rules, Discretion, and Authority in International Financial Reform, [2001] J. Int’l Econ. L., p. 656. Cf. LoPucki, Lynn M.; Whitford, William C., Corporate Governance in the Bankruptcy Rehabilitation of Large Publicly Held Companies, (1993) 141 U. Pa. L. Rev., p. 729 et seq.

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had happened. Therefore, the Model Convention does not have to contain a provision on the replacement of an incumbent government. 5.2.2.2. The Neutral Authority As discussed in the domestic context, the core difference between formal and informal proceedings is that in the first case there is always a neutral third entity, while in the second case, the parties for the most part have to find their way out on their own. While there seems to be widespread agreement that a neutral instance would also be required for the RSSD, the scope of its powers is subject to intense discussions. Powers of the Neutral Authority A first view is to favour mainly self-executing debt-restructuring negotiations, whereby the neutral third party would basically have administrative functions roughly comparable with an administrator in ‘debtor in possession’ cases under domestic law.452 Other proposals aim at the creation of an international mediator, whose role would be “to promote agreement between creditors and debtors” while “the terms of relief would be anything to which the debtor and a qualified majority of creditors agreed.”453 To the extent that inter-creditor disputes or debtor-creditor disputes require adjudication, this body should also have the right to decide on those issues.454 Finally, NGOs in particular favour an arbitration approach, where the neutral third party is empowered to decide on the cancellation of unpayable debts.455 Arbitration, at least as far as the final outcome of the restructuring plan is concerned, may, however, be too far-reaching. Even in France, which arguably grants the courts the most extensive powers, a decision of the judge directly allowing a general discharge or a reduction of the debtor’s liabilities is not admissible.456 Furthermore, the arbitration approach might unnecessarily restrict negotiated agreements between the debtor and its creditors. Negotiation, though, can be seen as the most satisfactory means of reaching

452

453 454 455

456

Paulus, Christoph, Rechtlich geordnetes Insolvenzverfahren für Staaten, (2002) 35 ZRP, p. 384. Cohen, Benjamin J., A Global Chapter 11, (1989) 75 Foreign Policy, p. 125. IMF (2002), supra n. 426, p. 56 et seq. Raffer, Kunibert, Solving Sovereign Debt Overhang by Internationalizing Chapter 9 Procedures, available at: www. studien-von-zeitfragen.net/weltfinanz/Raffer_1., at D. 4. See supra at Part C, Chapter II, 3.3.2.1.


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settlements, since all parties are directly engaged.457 As demonstrated above, the most efficient outcome of restructuring negotiations, meaning the best result in view of financial stability and global economic benefit, will be reached if the parties have equally balanced negotiation powers. This balance, though, does not necessarily have to involve a court decision. Instead, the advantages of a conciliatory settlement in an insolvency case are recognized in the context of domestic corporate insolvencies, which often provide legal frameworks for out-of-court settlements. Moreover, commentators stress that so-called ‘global workouts’ in succession to a multinational corporate debt default sometimes cannot be solved other than on the basis of a mutually agreed restructuring agreement.458 An exception from negotiations should be made only where this approach does not succeed and where existing mechanisms are insufficient. In particular, the verification of claims, provision of information, and the integrity of the voting process have to be mentioned in this regard.459 Verification of claims is closely connected with the RSSD’s aim of establishing a transparent restructuring system that enables the sovereign debtor and its creditors to make timely decisions based on all material information. There will be no confidence between the negotiating parties, and thus no bona fide co-operation, if creditors do not have an understanding of the debtor’s outstanding total debt, as well as the way in which it is intended to restructure this debt under the proposed plan. In turn, debtors will be reluctant to discuss, or even draft, a proposal if they cannot be reassured that all debt is adequately taken into consideration. Both parties must therefore be obliged to provide all information required to obtain an adequate picture of the overall indebtedness of the sovereign. To achieve that goal most efficiently, the IMF suggests a procedure that provides incentives for rapid restructuring as well as for a definitive solution of the case.460 Upon activation of the process, the neutral third party would demand that the sovereign set up a list detailing all known information concerning its indebtedness.461 Creditors would be required to

457 458 459

460 461

Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 919. Uhlenbruck, supra n. 299, p. 1643. Depending on the precise rules of the RSSD, the neutral third party might also be charged with the resolution of disputes arising as to whether the creation of creditor classes was discriminatory, as well as disputes relating to the formation and operation of the creditors committee (IMF (2002), supra n. 426, at 261). Ibid., at 98 et seq. According to the IMF proposal, three different lists would have to be distinguished.

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register their claims with the neutral third party within a specified period (e.g. 30 days after notification of the activation of the system). Creditors that do not register within that period, though, would not be meant to be excluded from the restructuring terms. Instead such ‘sleeping claims’ would also be treated as registered claims for a certain period of time after the final restructuring agreement is reached.462 Thereafter, failing subsequent registration, they would be treated as null and void. The mechanism illustrated provides incentives for the disclosure of all relevant information regarding the overall indebtedness of the sovereign. Creditors would of course need additional information, such as GDP growth, economic forecasts, and so on to be able to make an appropriate decision. In order to evaluate these aspects, the neutral authority should be able to obtain all necessary data from the International Financial Institutions (IFIs), such as the regional development banks and the IMF, and to forward this information to the creditors. Only those claims that appeared on the list provided by the debtor would be bound by the restructuring agreement. At the same time, creditors do not gain from failing to register, as their claim would eventually be declared null and void and they would lose the right to participate in the voting process if they did not register.463 The task of the neutral instance would be to verify those registered claims that were challenged by the sovereign debtor or a creditor. Verification of claims appears particularly important, since creditors might otherwise create fictitious claims to manipulate the voting process. Vote buying, i.e. where undisclosed financial incentives are provided by the debtor to induce a majority to vote in a certain manner, could jeopardise the integrity of the voting process.464 If the sovereign debtor

462 463 464

The first list would contain the subset of eligible claims that the debtor state intends to restructure, the second list would consist of all claims that the sovereign intends to restructure outside the SDRM suggested by the IMF, and the third list should include all claims, which the sovereign does not intend to restructure (IMF (2002), supra n. 426, at 101 et seq.). IMF (2002), supra n. 426, at 106. Ibid., at 107. Häusler, Gerd et al., Sovereign Debt Restructuring Mechanism – Further Considerations, IMF Working Paper, 14 August 2002, p. 27. E.g. the sovereign may attempt to issue securities to an entity that it owns without receiving any value from that entity. Once the entity registers its claims, these can be used to vote in a manner that is disadvantageous for holders of valid claims. Moreover, those creditors would receive a smaller amount under the restructuring agreement, since the fictitious claims would proportionally reduce the amount to be distributed to the individual creditors.


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and its creditors opt for mediation, the neutral authority could provide the necessary infrastructure, such as ‘neutral ground’ for negotiation meetings and expert help if required. Consistency with Domestic Legal Systems – ‘Due Process’ A problem with the Neutral Authorities’ powers might result from due process provisions. Although the Neutral Authority should not have the power to autonomously decide upon a debt reduction, the verification of a claim, for example, might nevertheless affect the (alleged) property rights of creditors. The due process rule, which can be found in national constitutions, as well as in treaties such as the International Covenant on Civil and Political Rights (ICCPR),465 therefore requires that creditors to whom these provisions apply have access to an independent adjudicative body. However, this adjudicative body does not have to be a domestic one.466 Instead, by way of example, the U.S. Supreme Court upheld the executive agreements that brought to an end the hostage crisis in the Teheran embassy, including an order to suspend claims against Iran even if they were already pending in U.S. courts, and approving a transfer of those cases to the international Iran-U.S. Claims Tribunal.467 As a general matter, claims may thus also be adjudicated by an international Neutral Authority for the settlement of sovereign debt dispute. The Forum for the Neutral Authority Generally speaking, there are two types of dispute resolution fora that could be regarded as suitable to cope with the tasks of the Neutral Authority. First, there are permanent courts like the ICJ or the ECJ. Second, there are dispute settlement bodies, such as the International Centre for the Settlement of Investment Disputes (ICSID) or the WTO panels, which only convene in the context of a dispute and whose judges or arbitrators are chosen from a permanent pool of pre-selected experts. An institutionalized solution could, for instance, be the establishment of a specialised insolvency chamber at

465 466

467

See Article 14 ICCPR. Greenwood, Christopher; Mercer, Hugh, Considerations of International Law, in: Eichengreen, Barry; Portes, Richard, Crisis? What Crisis? Orderly Workouts for Sovereign Debtors, London 1995, p. 113. Dames and Moore v. Regan, 453 US 654 (1981).

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the ICJ.468 However, the ICJ only has jurisdiction to hear cases between states.469 The alternative that states might bring a lawsuit against a debtor state on behalf of one of their citizens remains largely unused, as states aim to avoid political interference.470 Even if the ICJ’s statutes were amended to allow the court to hear disputes between a state and its creditors, the court’s procedures are still ill-suited to sovereign debt restructuring cases and would have to be adapted.471 In its first drafts for an SDRM, the IMF proposed that the task of settling disputes should instead be assigned to the IMF itself.472 This was heartily rejected and seen as one of the fundamental flaws in the IMF’s outline for an SDRM.473 As experience demonstrates, and to quote an old saying: “new brooms sweep cleaner”. In other words, the efficient enactment of a new law will always be hampered if the persons working with the law are identical to those who worked under the old system. This is particularly true for systems with a long tradition. Those who have grown up under the old regime, and who have become experts in this area, tend to stick to what they are used to. They will continue to act in the same way as they did before, regardless of which system is actually in force.474 Moreover, it was noted that the IMF, as a direct creditor of debtor nations, cannot, in the same turn, be an unbiased and objective arbiter.475 Indeed, practical experiences with ICSID demonstrate that this organ, since it is still seen as an interior body of the Bank itself, may not be able to gain the confidence of the debtor states, or could at least delay applications to this body. Commentators claim that many states are reluctant to bring disputes to the tribunal because they are afraid that this may cause adverse publicity in circles whose judgment is of utmost importance for a state’s credit rating.476 Those delays, however,

468 469 470 471 472 473

474

475 476

Paulus (2003), supra n. 415, p. 405. Greenwood/Mercer, supra n. 466, p. 113. Schwarcz, supra n. 11, p. 1023 et seq. Greenwood/Mercer, supra n. 466, p. 113. Krueger, supra n. 419, p. 21 et seq. Hilgers, Michael T., Debtor-States and an International Bankruptcy Court: The IMF Creditor Problem, (2003) 4 Chi. J. Int’l L., p. 257 et seq. Paulus, Christoph G., Germany: Lessons to Learn from the Implementation of a New Insolvency Code, (2001) 17 Conn. J. Int’l L., p. 89 et seq. Hilgers, supra n. 473, p. 263. Cf. Seidl-Hohenveldern, Ignaz, Collected Essays on International Investments and on International Organizations, The Hague 1998, p. 373.


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increase costs, both in terms of losses in reserves, as well as in a decline in economic output, and are thus counterproductive to the purpose of a fast and efficient reorganisation system. The IMF took these criticisms seriously and, in its later SDRM proposals, it is recognized that the formal role of the Fund should not be increased under the SDRM.477 The IMF proposes inter alia that to enhance the “perception of the SDDRF’s478 independence from the Fund, the office of the SDDRF could be located in a city other than Washington, D.C.”479 However, other remarks, such as the suggesting of treating SDDRF members as “officers of the Fund for purposes of immunities and privileges”480 or the appointment of the panel members by the IMF’s Managing Director481 make it unclear why the IMF does not go one additional step and allow the Neutral Authority to become completely independent.482 To avoid any impression of a lack of independence, it is suggested that a completely autonomous new body should be established. This could be achieved by way of the creation of a judicial body competent to hear cases between states and private debtors. While there are not many examples of this, there are nevertheless various tribunals that adjudicate cases between states and private claimants: notably the Iran-U.S. Claims Tribunal,483 the Iraq Compensation Commission484 and, probably the closest parallel to date, the ICSID.485 ICSID hears investment disputes between sovereigns and nationals of other states and was created under the auspices of the World Bank.486 When a dispute occurs, the parties agree on one or more arbitrators from a pool of arbitrators that shall be competent, impartial, independent and representative of the principal legal systems of the world.487

477 478

479 480 481 482 483 484 485 486 487

IMF (2002), supra n. 426, at 14. SDDRF is the acronym for Sovereign Debt Dispute Resolution Forum, which is the IMF’s title for a neutral third party in sovereign debt reorganisation. Ibid., at 229. Ibid., at 257. Ibid., at 233. Cf. EMTA, supra n. 440, p. 6. www.iusct.org/index-english.html. www.unog.ch/uncc. www.worldbank.org/icsid. See also supra Part C, Chapter I, 2.1.3.4. Cf. Articles 13 et seq. ICSID Convention (1965).

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The IMF proposal contains an extensive section on the organisation of, as well as the appointment to, this pool of arbitrators.488 The appointment process to the panel is striking. This process must adequately take into account the competence and impartiality of the panel members.489 To assess the competence, the selection panel490 should take into consideration in particular whether the nominee “had expertise in the laws that govern international sovereign debt generally.” It seems reasonably fair to assume that creditors, as well as potential debtor state governments, can assure an adequate representation of their views by nominating such competent legal experts. There are, however, concerns as to whether the interests of the population of the debtor state are sufficiently taken into account when appointing the members of the arbitrating court. These concerns are even more well-founded in light of the fact that the governments of many debtor states do not necessarily take the population’s interests into account. Human rights supporters therefore argue that, less important than legal or economic competency is a composition of those bodies that also considers the interests of broad parts of the debtor state’s population.491 More specifically, other commentators claim that such interests will be given due consideration by making the approval of restructuring agreements dependent on positive developments concerning the infrastructure in the debtor country.492 However, the Neutral Authority, as proposed here, does not provide the

488

489 490

491

492

As these issues are of a technical nature, reference to the general principles of law is, in so far, not possible, as such principles cannot be deducted from provisions of a merely functional nature (cf. Weiß, supra n. 245, p. 407). Nevertheless, technical domestic rules might be a helpful guide in establishing a smoothly working international framework. The specific outline of such technical procedural issues, like the appointment to the neutral authority, or the funding of this institution, should be set forth in administrative rules adopted by the Neutral Authority. IMF (2002), supra n. 426, at 240. As to the designation of the selection panel, it is suggested that the IMF’s Executive Board should choose 7–11 representative member countries and ask the authorities of those countries each to select one judge (ibid., at 234). Cf. e.g. Morgan-Foster, Jason, The Relationship of IMF Structural Adjustment Programs to Economic, Social, and Cultural Rights: The Argentine Case Revisited, (2003) 24 Mich. J. Int’l L., p. 643 et seq., arguing for a solution based on the International Labour Organisation’s tripartism that should involve creditors, official debtor country representatives and human rights experts to protect the interests of the debtor state’s population. See: Ebenroth, Carsten Thomas, Rescheduling of the Sovereign Debt: A New Role for the Paris Club, (1995) 19 J.I.B.L., p. 292.


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right platform for such considerations. The decisions taken by this body are intended to increase transparency and predictability, i.e. they are not to be the result of inevitably protracted negotiations between human rights supporters, economists and lawyers. Instead, they shall solve the issues according to a fixed legal framework. Therefore, it is important, as far as possible, to avoid political influences on the selection of the panelists. Competency in the area of sovereign debt should be the outstanding criterion. The Model Convention should thus provide for a Neutral Authority in the form of a newly established and independent individual body, whose main task would be to verify claims and control of the integrity of the voting process. The members of this body should be elected in a manner that guarantees an adequate representation of debtors and creditors, as well as a high standard of competency in the area of sovereign debt reorganisation, with the emphasis on the legal aspects. 5.2.3. Standstill In the domestic context, there is a general rule that the commencement of insolvency proceedings means, at the same time, an automatic standstill for all creditor enforcement actions.493 Although it would thus appear the obvious choice to also apply a similar mechanism in the sovereign context – at least under the preconditions of the state of necessity doctrine – this view has generated considerable controversy. The views presented range from an analogous treatment in the case of sovereign debt restructurings, to a suspension upon approval by a third party, to the opinion that no suspension at all should be granted. The last approach, which is explicitly favoured by Schwarcz, and shared by many market participants, basically argues that the policy reasons for a standstill in the corporate insolvency context do not apply to sovereign debt restructurings,494 as this mechanism is not necessary to prevent a creditors’ grab race. The standstill would thus be an unnecessary interference with the general sanctity of contracts. This line of argument is based on the assumption that states possess only relatively few assets located in other jurisdictions, since it is unlikely that the state debtor would enforce a judgement against itself under its own jurisdiction. A loss of those limited assets would not significantly aggravate the sovereign’s financial

493

494

Paulus (2002), supra n. 446, p. 546 refers to the automatic standstill as a “characteristic of insolvency procedures under private law”. Schwarcz, supra n. 11, p. 985.

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situation and a disintegration of the state would not have to be expected.495 It is added that the state’s unilateral decision to suspend payments would produce almost the same results as a stay, except regarding the said assets in other jurisdictions.496 However, this reasoning can be disputed. First, a suspension with a de jure approval within the framework of a RSSD helps to mitigate damage to the reputation of a state compared with the potential losses of reputation in the case of a unilateral decision of a sovereign to suspend its debt payments.497 Moreover, as the Argentine crisis illustrates, there are far greater threats to a state than the seizure of its foreign assets.498 For example, there were claims inter alia to use outstanding national annual payments to the IMF,499 as well as loans granted by other nation states to Argentina as compensation for Argentine bond debts.500 Consequently, there is a danger of a state being cut off from new loans. Even though these threats to Argentina have not been implemented, it could only be a question of time and imaginativeness before the claiming ‘vulture bonds’ find a well-meaning court to grant a judgement in their favour.501 Due to such litigation by sovereign debt creditors, debtor

495 496 497 498

499

500 501

Ibid. Ibid. Cf. Eichengreen/Portes, supra n. 3, p. XVII. These are not restricted to embassies and similar assets as shown e.g. by German creditors of Argentine bonds who tried to seize the Argentine navy school ship “Libertad” during a stay in Bremerhaven (see: Die Zeit, 21 November 2002, p. 33). In the meantime, numerous other creditors are claiming their money back from Argentina in the German courts. This situation has even led Argentina’s president, Nestor Kirchner, to reject an invitation to hold a speech at the Ibero-America-Day, for fear of seizure of Tango 01, the president’s official plane (see: FAZ, 2 October 2003, p. 23). This was in spite of the fact that a decision of the Federal Constitutional Court concerning the question of whether Argentina was acting in a state of necessity was pending at that time, so that procedures before all other courts were suspended and, consequently, seizure was basically excluded. Die Zeit, 21 November 2002, p. 33, citing the case of a claim by Italian creditors in Rome. Die Welt, 12 August 2002, 9. Notorious cases that are regularly quoted as examples, where a ‘vulture bond’ already successfully sued a debtor country for repayment are CIBC Bank & Trust Co. (Caiman) Ltd. v. Banco Central do Brasil, 886 F. Supp. 1105 (S.D.N.Y. 1995); LNC Investments, Inc. v. Republic of Nicaragua, No. 96 Civ. 6360, 1999 US Dist. LEXIS 1846, at 1 (S.D.N.Y. 19 February 1999) and Elliot Associates v. Banco de la Nación and the Republic of Peru, 194 F.3d 363 (2d Cir. 1999). In all three cases, the plaintiffs received millions of dollars either by award or settlement (see: Miller, Jessica W., Solving the Latin American Debt Crisis, (2001) 22 U. Pa. J. Int’l Econ. L., p. 703).


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nations will be left in a position of “paying judgments with money that they do not have” and “[i]nstead of allowing debtor nations time to settle their fragile economies these nations are left in worse positions than before.”502 Even if creditors do not ultimately succeed in attaching any of the sovereign’s valuables abroad, such litigation has a distinctly negative influence on negotiations. First of all, it is costly, not only for the creditors but – most of all – for the debtor. Furthermore, due to the continuously rising number of bondholders, it is certain that the number of recalcitrant creditors and the number of claims by this group will rise in the future. Second, it disrupts trustful relations between debtor and creditors, as well as between creditors inter se. The debtor’s will to co-operate understandably decreases, as more creditors try to enforce their claims in court. Nevertheless, a valid counter-argument against an automatic standstill, after activation of the RSSD by the sovereign debtor, could be the inefficiency of this means, i.e. if the benefits of debtor protection were outweighed by the ‘costs’ for the creditors who cannot enforce their rights. It is said that a standstill would tempt debtors to default on their payments unjustifiably, knowing that such standstill makes them immune against legal pressures from their creditors.503 It has already been mentioned that default entails high costs for the sovereign debtor.504 As a result, commentators note that, while there might be ways for a debtor state to insulate its cashflows by means other than a standstill, these would become more cumbersome and costly, at least if the number of lawsuits were to increase. In consequence of such developments, the likely market reaction would be a further fall in debt prices of the respective country, and a stagnation of the reorganisation discussions in the following months until a judgment in such lawsuits.505 Moreover, due regard should be given to the fact that the standstill mechanism can provide a valuable incentive for reaching sovereign debt reorganisations more rapidly, as this tool can be used as leverage on the creditors’ side. So, while it is quite difficult (or even impossible) to assess whether a sovereign debtor is filing in good faith, it will be much easier to determine whether

502 503 504 505

Ibid., p. 704. Macmillan, supra n. 15, p. 95. See supra Part C, Chapter II, 5.2.1.2. Cf. Credit Suisse/First Boston, Argentina’s Dubai Proposal: Worse than already Lowered Expectations, Emerging Markets Sovereign Strategy Daily (23 September 2003); available at: www.emta.org/keyper/Argentina0923.pdf.

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negotiations are undertaken in good faith.506 Provided that negotiations on the debtor’s side were not carried out in good faith, it would be possible to terminate the standstill to a given date507 and to make a prolongation of the standstill dependent on a favourable majority vote by the creditors.508 If the debtor refused to co-operate, creditors could thus threaten to deny approval of a new period of enforcement suspension in the event that the debtor does not change its attitude. That ‘stick’509 would be even more powerful if the standstill were combined with a stoppage of interest-accrual, since the debtor could then achieve ‘gains’ that would make co-operative behaviour worthwhile, even if there were no suits pending against the sovereign debtor abroad. Other methods proposed as an alternative to a standstill are the use of ‘claw-back’, and ‘hotchpot’ rules. Claw-back rules nullify certain preferential transactions ex post following commencement of an insolvency procedure by requiring creditors to surrender recoveries gained in other proceedings to the insolvency estate to enforce equalisation among creditors. The hotchpot rule leaves individual collections with the creditors but, even if they were able to obtain a judgment prior to the reorganisation agreement, their residual claim is reduced according to the amount necessary for all other creditors to be proportionally satisfied.510 Both measures, though, have their disadvantages. Thus, the hotchpot rule, on the one hand, provides negative incentives for an assets grab race511 according to the first-comes-first-served principle. Some commentators oppose this view, to the extent that because states could not be liquidated they were likely to repay ‘over time’.512 However, although the dogma of inviolability of sovereign entities has not been seriously challenged thus far,513 it is doubtful whether defaulting states will 506

507 508 509 510 511 512 513

Potential criteria could be whether the debtor complies with the agreed timetables or whether it provides the information necessary to work out a reorganisation agreement, as already discussed in the context of claim verifications (see supra Part C, Chapter II, 5.2.2.2). Perhaps six to twelve months (cf. Paulus (2003), supra n. 415, p. 405). Paulus, supra n. 423, p. 11. Or ‘carrot’, depending on the individual position. For an illustrative example see IMF (2002), supra n. 426, p. 35 n. 17. Paulus (2003), supra n. 415, p. 405. Schwarcz, supra n. 11, p. 1000. Even commentators considering a dissolution of sovereign entities for efficiency reasons (cf. McConnell/Picker, supra n. 438, p. 481 et seq.) concede that this proposal might prove


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remain a rare exception. The popular opinion that states should default on ‘illegitimate and odious debts’,514 as well as the realisation that default “might not necessarily be such a bad option”,515 would tend to indicate the opposite. At least, experiences in the Argentine case might tempt other debtor states to stop debt repayment in a similar fashion and then try to ‘holdout’, hoping that creditors will, in order to avoid protracted negotiations, consent to significant reductions in their claims in subsequent reorganisation agreements. Creditors, afraid of coming too late and potentially being left empty-handed in a debt reorganisation, would therefore, despite a hotchpot provision, ‘rush to the courthouses’ to grab as much as possible if there is no automatic standstill following activation of the RSSD.516 The alternative suggestion of a claw-back rule, on the other hand, would require the exercise of substantial legal force, and therefore, similarly, would not seem to be appropriate for a largely self-operating RSSD based on the voluntary co-operation of the parties.517 Consequently, the Model Convention ought to provide for an automatic standstill after the debtor has initiated the proceedings. Following a period of time of between 6–12 months, the extension of the standstill should be subject to the creditors’ approval. 5.2.4. Creditors’ Committee The enormous amount of creditors makes it unavoidable that, for the sake of an efficient RSSD, creditors’ committees, as in the domestic context, will need to be established. The main point of discussion in the sovereign context is whether such committees should be appointed officially. It has been stressed that official committees would unnecessarily increase adjudicatory

514 515 516

517

unworkable (ibid., p. 494). The ‘liquidation approach’ favoured by White, in particular to provide incentives for reaching a consensual reorganisation agreement, is restricted to the country’s assets held abroad and explicitly excludes those assets that are covered by sovereign immunity (White, Michelle J., Sovereigns in Distress: Do They Need Bankruptcy?, Paper for the Brookings Panel on Economic Activity, 5 April 2002, p. 22). See, for a discussion of the odious debts doctrine, supra Part C, Chapter I, 2.1.2. Miller, supra n. 501, p. 691. Creditors trying to access their money before the restructuring negotiations end might furthermore severely harass the debtor and increase the pressure on the already distressed state. Cf. IMF (1999), supra n. 13, p. 37.

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discretion in appointing the committee and in supervising its ongoing costs and expenses.518 Instead, it is contended, that, following a sovereign default, at least de facto creditors’ committees emerge in any case, due to a choice to this end by the creditors.519 Indeed, in the Argentine context, the Global Committee of Argentina Bondholders (GCAB) was formed without official interference and brought together a substantial number of international retail and institutional investors.520 However, Argentina refused to negotiate with the GCAB, arguing that its representatives lacked formal negotiation powers.521 To receive formal recognition of its status,522 the GCAB tried to get the IMF’s stamp of approval.523 The question remains, however, whether this route should be recommended as a feature for the RSSD. First of all might be the question of whether a single creditors’ committee would be sufficient, or whether it would be preferable to establish various committees representing the different interest groups of creditors, such as retailand institutional bondholders. In the latter case, communication would again become more difficult and procedures would be more protracted. To ensure that there is no complete fragmentation of creditor interests, which could block rational negotiations, one might consider introducing a certain minimum amount of claims represented by a committee. It would also be possible to reject individual committees on the grounds of not being representative if they did not agree on a steering committee.524 A further issue is who should appoint the committee. One option would be for the Neutral Authority to select the creditors’ representatives.525 The advantage of this method would be that decisions could be made quickly, without the need to consult the large (and usually anonymous) number of creditors to ask them to elect their representatives.526 The financial market’s potential loss 518 519 520

521 522

523 524 525 526

Schwarcz (2002), supra n. 422, p. 1219. Schwarcz, supra n. 11, p. 1002. FT-Europe, 23 February 2004, p. 3; historical examples of the role of creditors’ committees are given by Macmillan, supra n. 15, p. 88 et seq. FT-Europe, 23 February 2004, p. 3. As to the usefulness of such approval, see also Eichengreen/Portes, supra n. 3, p. 48, noting that in the absence of official accreditation “a confusing proliferation of committees can spring up”. FT-Europe, 23 February 2004, p. 3. IMF (2002), supra n. 426, at 161. Paulus (2003), supra n. 415, p. 405. Macmillan, supra n. 15, p. 91, discussing an appointment by national governments (of creditor countries).


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in confidence could be avoided if, in a crisis situation, there were a quick and transparent process for the establishment of a creditors’ committee. Nevertheless, this committee might be vulnerable, as it would not possess the legitimacy of a committee directly elected by creditors.527 This would be particularly disadvantageous, as it would be the creditors’ committee’s task to convince the creditors represented to vote in favour of a reorganisation plan as negotiated by this committee. Such approval, in turn, will become increasingly unlikely, the more the creditors feel that their interests are not being represented adequately by the committee.528 It would therefore seem appropriate to subject the election of the creditors’ committee to a subsequent vote of (dis-)approval by the creditors to be represented by the respective committee.529 On account of the fact that the sustainability of a debt reorganisation agreement requires in-depth knowledge of the legal, economic and social problems that have to be tackled, the committee should employ experts, such as law firms and economists, to advise creditors. The Model Convention should provide for the establishment of creditors’ committees. These committees should be established upon request by the Neutral Authority and must adequately represent the different interests of all creditors. In the case of disapproval, creditors shall be allowed to form their own creditors’ committees, if they obtain sufficient support from the creditors’ community. 5.2.5. Priority Financing It is argued that, without priority financing, i.e. without a special procedure that allows debtor states to obtain fresh money from the capital markets, insolvent countries would probably fail to receive further financial support, due to the information asymmetry between the state and potential creditor, and also because new creditors do not want to be ‘taxed’ by the claims of existing creditors.530 Furthermore, it is suggested that the ‘fresh money’ required should be provided by private lenders, in order to reduce pressures

527 528

529 530

Cf. ibid., p. 92. IMF (1999), supra n. 13, p. 31, underlining that “[t]he chances of a successful rehabilitation increase to the extent that a plan attempts to capitalize on the different economic interests of creditors. For this reason, it is important that the makeup of the committee reflects these interests.” Cf. e.g. §§ 67, 68 InsO. Schwarcz, supra n. 11, p. 986.

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on the IMF to fund bail-outs.531 This connection makes evident that, at the end of the day, priority financing can be seen as a mechanism to shift the ‘bail-out-burden’ from the public to the private sector. However, a critical issue concerning bail-outs is moral hazard, because it distorts the view among both governments and investors that portfolio investments are ventures they enter into at their own risk.532 Scott argues that priority-based lending “should not be needed if restructuring does its job” and adds that “[t]he major objective of a restructuring mechanism should be to let countries deal with their problems by restructuring debt, not by getting [new] funds.”533 Priority financing can effectively decrease the value of creditor claims in the case that overinvestment occurs – above all if the priority funds are invested in projects that are less valuable than the proceeds, or are otherwise misused.534 While this does not necessarily signify a direct embezzlement of the funds by the governing elite, one might think, for example, about financing an election campaign to remain in power, despite the country’s default, or increasing any other expenses in favour of a prolonged period of government Furthermore, such risks of overinvestment are not limited by the risk assessment of the new lenders, as their priority usually ensures repayment despite overinvestment.535 With regard to current developments on the emerging economies’ debt market, it can be assumed that a group of new creditors would eagerly try to obtain ‘priority debt instruments’ issued by the state, so that a significant amount of fresh money would flow to the debtor country. This amount of money could not be made dependent on the existence of unencumbered securities, as occurs in the domestic context,536 due to the lack of such assets abroad. As ‘old’ creditors are, moreover, generally too dispersed and do not have the information necessary to scrutinize, and possibly object to excessive priority financing, this monitoring could only be carried out by a special supervisory authority.537 This approach corresponds with current IMF conditionality. However, experiences with this

531 532 533

534 535

536 537

White, supra n. 513, p. 17. Macmillan, supra n. 15, p. 62 et seq. Scott, Hal S., A Bankruptcy Procedure for Sovereign Debtors, (2003) 37 Int’l Law, p. 127. Schwarcz (2002), supra n. 422, p. 1209. Sachs, Jeffrey, Do We Need an International Lender of Last Resort, Frank D. Graham Lecture, Princeton University, 20 April 1995, p. 12. See e.g. for priority financing in Germany: Bismarck, supra n. 251, 23.04[3][b][ii]. Schwarcz (2002), supra n. 422, p. 1210.


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mechanism demonstrate that it works only with ‘weak’ debtor countries. The Argentine case, in contrast, exemplifies the limits to its efficacy in cases where a determined government refuses to follow the guidelines set up by the IMF.538 This recalcitrant attitude towards Fund conditionality is unlikely to relax in the future. Instead, Argentina’s alliance with Brazil against rules imposed by the IMF indicates that, at least with regard to key creditors – and Argentina and Brazil together accounted at that time for roughly 50 percent of the Fund’s outstanding loans – the conditionality mechanism will not work.539 Instead of steadily providing new funds, and thereby increasing a country’s debt burden, the situation, which for most governments is new, of being compelled to operate within the constraints of a balanced budget might turn out to provide the more sustainable solution.540 Certainly, one has to consider that public funds in particular are not always granted for purely economic reasons. Thus it may be entirely rational, from a political point of view, to subsidise economies in financial difficulty where this can, for instance, lend support to an essential ally as is the case in the Muslim world with regard to Turkey.541 Under these conditions it is, however, hard to see why such loans shall yet be supported by granting them a senior status.542 On balance, therefore, it is recommended that the Convention should not include a feature enabling the debtor to obtain priority financing if the creditors do not explicitly agree on such support measures. 5.2.6. Approval of a Reorganisation Plan As is the case in corporate reorganisations, the reorganisation of a state and its debts requires a plan, the adoption of which should be made dependent on creditors’ approval. However, experience, notably with bondholders, demonstrates that a unanimity requirement for the consent to a reorganisation plan is not feasible, since it would mean that recalcitrant creditors could undermine all reorganisation efforts.

538

539 540

541 542

It is also argued that the granting of priority financing can influence existing creditors’ claims. Any decision thereon should thus not be made without their approval (IMF (2002), supra n. 426, at 171). Cf. FT-Europe, 17 March 2004, p. 6. Some financial relief would already be provided if the standstill were to be extended to interest accrual. Scott, supra n. 533, p. 128. Scott even suggests that such loans should be ranked junior to other debt (ibid.).

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5.2.6.1. Majority Voting Majority voting can solve this problem. Thus, in the domestic context, a general principle underlying all reorganisation laws is that a majority decision is also binding on dissenting creditors. Certainly, one might object that, in the domestic context, majority decisions are still subject to survey by a court, to protect legitimate interests of minority creditors. This protection can also be guaranteed, however, by setting the threshold of approval appropriately high. The subsequent question, therefore, is what this voting threshold should be. While, theoretically, a majority of between 51 and 99 percent is possible543 a generally accepted level seems to be 75 percent. Not only do most domestic rehabilitation procedures choose this threshold, but it is also the threshold relied upon in sovereign bonds including CACs.544 This threshold, which has been proven in practice would thus appear to be adequate to balance the need to resolve collective action problems on the one hand, and to provide sufficient protection for the interest of minority creditors on the other. Accordingly, the Convention should provide for majority voting with a 75 percent threshold. 5.2.6.2. Creditor Classes In the domestic context, creditors are usually divided into classes. For that reason, commentators suggest that creditors of sovereign debtors should be classified in a similar manner.545 In domestic law, a key distinction is made

543 544 545

Paulus (2002), supra n. 446, p. 550. See supra Part B, Chapter I, 1.1.2. In her proposal for a SDRM, Krueger argues that, due to the special role of international financial institutions – i.e. notably their function to provide credit to financially distressed sovereigns on a preferred basis at rates lower than could be obtained from the private capital market – their claims should be privileged and not subject to the SDRM (Krueger, supra n. 419, p. 17). This complete exclusion is questionable with respect to several aspects. First, if a significant portion of debt is excluded, this is likely to provoke strong resistance from those subject to the reorganisation against the proposed reorganisation terms and its underlying legal reorganisation framework (EMTA, supra n. 440, p. 3). Second, a sovereign’s flexibility may be severely limited if a large amount of the ‘negotiation mass’ is a priori out of range. Third, sovereigns might continue to rely on such public financing – rather than the adoption of sound macroeconomic policies to attract private capital. Lastly, the asserted reason for a ‘preferential status’ will become unnecessary as soon as the international institutions cease to grant loans at preferential rates, as was already suggested above (in favour of an inclusion of public debt see also Paulus (2002), supra n. 446, p. 550).


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between secured and unsecured creditors. With regard to sovereign debtors, however, this difference is of little importance, due to the scarcity of attachable assets abroad, which means that most sovereign credit is effectively granted unsecured.546 A differentiation suggested in the sovereign context is between trade and financial credit. The difficulty lies, however, in how to draw a clear, justiciable line between these two forms.547 This, in turn, increases the risk of protracted and costly litigation. In fact, as illustrated, for example, by domestic experience in Argentina, the division of creditors into classes is one of the issues that is most regularly disputed. A division into classes of domestic and foreign debt is similarly problematic.548 The transparency of the procedures would suffer in particular. With regard to the task of getting a good overview of the actual financial situation of the debtor, which is in any case difficult, this task would be even more difficult if restructuring negotiations between the debtor and its domestic and foreign creditors were dealt with in two different fora. The potential danger that the debtor would manipulate the voting process by unduly influencing its domestic creditors can basically be eliminated if all creditors’ claims are aggregated.549 All things considered, the classification of creditors is always prone to ‘hold-out classes’, which can stymie the achievement of a complete aggregation of all claims under the reorganisation.550 In fact, one might argue that reorganisation is also possible

546

547 548

549

550

Within the limits in which such securities exist nevertheless, reorganisation of such claims should take place outside the RSSD. IMF (2002), supra n. 426, at 66. Commentators have noted that efforts to exclude domestic debt could be driven by the realisation “that politicians in industrial countries [where most debt is issued subject to the domestic laws] would not support the SDRM treaty if domestic debt were subject to treatment under the mechanism” (EMTA, supra n. 440, p. 4). It is also argued that if domestic debt holders are excluded, the incentive for more populist governments to regard default as a method to create space in the fiscal account to pursue social goals might increase (EMTA, supra n. 440, p. 6). Indeed, it is at least remarkable that e.g. Argentina’s President Kirchner regularly spoke about Argentine bondholders as foreign investors, ignoring the fact that 40 percent of the debt was held domestically (FT-Europe, 13/14 March 2004, p. 2). Once again, high voting thresholds can thus be utilised to avoid abuse and to protect creditor minorities. EMTA, supra n. 440, p. 5.

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without a creditors’ classification. Thus, it is often the case that there is only one class of unsecured creditors in Chapter 9 reorganisations.551 Nevertheless, the advantages of a ‘class-free’ reorganisation have to be balanced against the disadvantages. A classification of creditors might be helpful in two respects. First, it could avoid the possibility of some creditors, whose interests are fundamentally different to those of the majority, being unfairly treated by the majority. Second, the debtor can negotiate different reorganisation terms as appropriate for the different classes to facilitate the restructuring process.552 Therefore, the Convention should provide that creditor classification might be possible, but only as a second choice. 5.2.6.3. Cramdown If classes are established, it becomes necessary to reflect on how to tackle the issue of dissenting classes. To this extent, a cramdown mechanism might be an option. However, this would, in turn, be very intrusive to creditors’ rights. It is also a quite sensitive issue, due to the fact that, in the domestic context, the exercise of cramdown powers generally requires an assessment of the value that a creditor would receive in the event that the plan were not accepted, i.e. in liquidation. Yet since liquidation is out of question in the sovereign context, it appears difficult to judge the merits of a plan on the basis of other adequate criteria.553 On balance, the Convention should therefore not include a cramdown provision.

551 552 553

Cf. Scott, supra n. 533, p. 125. Cf. IMF (2002), supra n. 426, at 184 et seq. Scott, supra n. 533, p. 130 et seq. suggests the development of a methodology to determine the ‘minimum restructured value’. In view of the domestic difficulties in determining the liquidation value of an enterprise, it seems certain that any such decision is mainly of a hypothetical character and thus has to be dependent on the approval of the concerned creditors, not of a third party (see also Häsemeyer, supra n. 242, p. 707 doubting the constitutionality of the respective domestic provision in German insolvency law).

Chapter III Enforcement Measures The credibility of the RSSD is closely connected with its ability to protect the parties against uncooperative behaviour by other parties and to enforce solutions obtained in the reorganisation process. Automatic standstill and rules providing for majority voting are valuable tools against disruptive litigation by creditors. However, these devices do not tackle the problem of uncooperative debtor behaviour. For instance, since Argentina defaulted on its debt in December 2001, private bondholders tried in vain, to negotiate a reasonable solution of the case. Despite their efforts, the only reaction by the Argentine Government was its so-called “Dubai Proposal”. In this proposal, the government indicated that it was targeting a reduction of the face value of eligible debt by 75 percent. As the Government additionally aimed at repudiating 100 percent of past-due interest, accruing between the default in December 2001 and the eventual deal date, the write-off in net-present-value (NPV) terms was put well above 80 percent.1 Some analysts even calculated an NPV loss equivalent to more than 90 percent.2 Accordingly, creditors initially rejected this proposal almost unanimously, considering it not to be serious. In the end, however, more than 75 percent accepted the offer.3 In contrast to this ‘draconian’ proposal, Argentina’s economic growth since 2003 reached 7.3 percent – far more than any other Latin American country.4 Since 2004, economic growth in Argentina has been around 9 percent per year5 and unemployment rates have fallen from 21.5 percent 1

2 3 4 5

Credit Suisse/First Boston, Argentina’s Dubai Proposal: Worse than Already Lowered Expectations, Emerging Markets Sovereign Strategy Daily (23 September 2003) available at: www. emta.org/keyper/Argentina0923.pdf (figures as of 23 September 2003). FT-Europe, 23 February 2004, p. 3. FT, 17 May 2005, p. 20. FT-Europe, 19 December 2003, p. 4. SZ, 13 June 2006.

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Part C – Chapter III

to 10.1 percent.6 Tax receipts rose significantly and the Merval, Argentine’s share price index, also rose to record heights.7 While it is certainly true that those statistics, most of all, reflect recoveries from losses the Argentine economy had to bear in the previous years, when Argentina’s real GDP fell by more than 20 percent,8 it nevertheless remains doubtful whether creditors alone should pay for a default that was significantly due to mistakes by the debtor. In particular, the financial system in Argentina was inadequately regulated9 and the IMF is still – thus far more or less in vain – demanding further restructuring of the banking sector.10 Furthermore, since 1991, the Ley de Convertibilidad established a currency board, which strictly pegged Argentina’s currency to the US-dollar.11 Despite significant negative sideeffects from the very inception of the board, the Government has refused to abandon or even relax this mechanism.12 While Argentina is an example of a recalcitrant sovereign debtor, the problem is neither new, nor does it seem that likely that it will not occur in

6

7 8

9

10

11

12

On the basis of these figures German courts decided that there is no longer a state of necessity in Argentina (Cf. e.g. OLG Frankfurt a.M., Judgment of 13 June 2006, 8 U 107/03, (2006) 59 NJW, p. 2931 et seq.). Die Welt, 31 December 2003/ 1 January 2004, p. 19. The economic process occurring in Argentina is that, due to the devaluation of the peso and the associated fall in real wages, a one-off competitive boost was provided, which helped to produce a significant trade surplus (FT-Europe, 22 December 2003, p. 10). Previously uncompetitive industries, such as textiles or shoes, were again able to produce for the domestic market at a profitable level and also had the spare capacity to take advantage of these altered circumstances. The current growth rates are thus overwhelmingly due to the still existing output gaps – i.e. the difference between current production levels and installed capacity. Once capacity is fully utilised, productivity will decline along with growth. Consequently, the current approach will not lead any further without access to new credits. Rather, it will only raise the prospect that the debt burden will again become unmanageable. As an Argentine economist opined, the quicker Argentina grows, the faster will it hit the limit of installed capacity. (FT-Europe, 19 December 2003, p. 4). The measures taken after the ‘tequila crisis’, which already considerably damaged the Argentine economy, to – above all – prevent capital flight, were apparently insufficient; cf. IADB, La Saga de Argentina, (2001) 16 Politicas Económicas de América Latina, p. 4. FT-Europe, 31 July 2003, p. 3; the pressure by the IMF has decreased since Argentina paid back its dues to the Fund in the beginning of 2006 (cf. FT, 5 January 2006, p. 20). See: Hanke, Steve H.; Schuler, Kurt, A Dollarization Blueprint for Argentina, (1999) 52 Cato Foreign Policy Briefing, p. 3; available at: www.cato.org/pubs/fbriefs/fpb52.pdf. Baer, Werner et al., The Achievements of Argentina’s Neo-liberal Economic Policies, (2002) 30 Oxford Development Studies, p. 67 et seq.

Enforcement Measures

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other sovereign debtor-creditor relations. The following section will therefore summarise the tools available under domestic private law (1) as well as public international law (2) to sanction such un-cooperative behaviour.

1. Domestic Private Law Sanctions Creditors who no longer want to wait years to recoup (at least some of ) their money under such circumstances, and who are frustrated by Government offers that cannot considered to be serious, as well as by the ineffectiveness of international efforts13 to convince recalcitrant debtor states to negotiate in good faith, have the option of initiating court proceedings. However, this is not an easy option due to legal obstacles (1.1) and because of practical difficulties (1.2). 1.1. Legal Obstacles A first approach for dealing with such recalcitrant debtors is to apply to a domestic court for enforcement against sovereign assets located abroad, such as, for instance, embassy bank accounts, the assets of foreign central banks abroad or the ambassador’s residence. It is, however, difficult to obtain a favourable court judgment with respect to those state-owned assets. In particular, sovereigns have attempted to avoid enforcement by reference to their sovereign immunity (1.1.1), the Act of State doctrine (1.1.2) and international comity (1.1.3). 1.1.1. Sovereign Immunity A first refuge sought by sovereigns as a defence against debt collection actions, was their sovereign immunity. As already explained in the beginning, jurisdictional immunity does not preclude application to a court in cases including sovereign debtors.14 Nevertheless, the non-existence of sovereign immunity from jurisdiction does not necessarily mean that there is no immunity against measures of execution (immunity from attachment). In particular, numerous developing countries are still reluctant to surrender their immunity from 13

14

Specifically, the lenient position of the IMF has repeatedly been subject to criticism, as it continues to disburse new loans to Argentina despite the government’s ‘take it or leave it’ approach regarding its creditors. See supra Part A, Chapter I, 1.2.2.

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attachment.15 In a more recent decision, the local court (Amtsgericht) Berlin thus referred a case to the German Federal Constitutional Court (Bundesverfassungsgericht) despite the fact that the debtor state, – the Republic of Argentina – had included in its bond documentation a general waiver of its sovereign immunity with respect to its jurisdictional immunity, as well as its immunity from attachment. The local court’s question was whether or not such a general waiver is sufficient for a decision in favour of the claiming creditor.16 In fact, international customary law, as expressed in the ILC Commentary on Article 7 (I) of the Draft on Jurisdictional Immunities of States and Their Property17 stresses that the “unwillingness or absence of consent [to waive immunity] is generally assumed, unless the contrary is indicated.”18 That means it will be up to the creditors to prove consent in the specific case. To this extent it is true that, according to Articles 18 (1) (a), 19 (2) ILC Draft, execution against bank accounts of the diplomatic mission is possible if express consent to such measures is given. The ILC Commentary on Article 19 (2) of the Draft, however, specifies, that “[a] general waiver [. . .] without mention of any of the specific categories, would not be sufficient to allow measures of constraint against property in the categories listed in [Article 19] paragraph 1.”19 The Federal Constitutional Court has not yet decided on the issue. In the meantime, it will be interesting to see how other jurisdictions solve this question. For example, U.S. courts awarded more than 15 temporary injunctions against assets owned by Argentina to bondholders of Argentine titles.20 The FSIA’s provisions on attachment21 basically correspond to the rules on jurisdictional immunity and allow post-judgement attachment of the debtor’s assets where a waiver of immunity is included in the debt contract.22 In contrast to the ILC Draft though, no distinction is made between implicit or explicit waivers. Commentators thus anticipate that, where a sovereign’s assets in the U.S.

15 16

17 18 19 20 21 22

Langkeit, Jochen, Staatenimmunität und Schiedsgerichtsbarkeit, Heidelberg 1989, p. 101. AG Berlin-Mitte, Vorlagebeschl. of 10 September 2003 – 32 M 4833/03, (2003) 18 NJWRR, p. 1713 et seq. Hereinafter: ILC Draft. 1991 (2) YILC, p. 26. Ibid., p. 59 (emphasis by author). FT-Europe, 17 February 2004, p. 32. 28 USC §§ 1609 et seq. 28 USC § 1610.


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are sufficient, sovereign immunity, as protected by the FSIA, is unlikely to hinder attachment of those assets by a litigating creditor.23 1.1.2. The Act of State Doctrine Another defence is the Act of State doctrine,24 according to which courts are prevented from judging the validity of official acts of an independent sovereign that are performed within the borders of the sovereign’s own territory.25 The courts must abstain from deciding cases in which they are required “to sit in judgement on the acts of another [state] done within its territories.”26 The main rationale of the doctrine is said to be to keep the judiciary from interfering in the conduct of foreign relations, a responsibility that is to remain with the executive branch.27 Since the doctrine requires that the challenged act must have been performed within the sovereign’s territory, debtor states have argued as a defence to sovereign debt collection actions that, because any decisions not to pay obligations were made within their own respective territory, any resulting default would constitute a non-justiciable act. However, in Allied Bank International v. Banco Credito Agricola de Cartago, the U.S. Court of Appeals boldly rejected this interpretation.28 Specifically, the court determined that in cases of sovereign default, the taking involved is a taking of the right to receive payment.29 As the debt in the Allied case had been partially negotiated in New York, and was payable in New York in U.S. dollars,30 the court concluded that the taking had occurred in the U.S. and, thus, not within the borders of the defaulting state.31 The Allied

23

24

25 26 27 28 29 30 31

Silverman, Ronald J., Deveno, Mark W., Distressed Sovereign Debt: A Creditor’s Perspective, (2003) Am. Bankr. Inst. L. Rev., p. 188. The roots of the Act of States Doctrine can be traced to the English cases Blad v. Barmfield, 36 Eng. Rep. 992 (Ch. 1674) and Duke of Brunswick v. King of Hanover, 9 Eng. Rep. 993 (H.L. 1848). A summary of the Act of State Doctrine and its relevance for sovereign default cases in England is provided by Petzold, Eckart, Die internationalen Gläubiger-SchuldnerBeziehungen im Recht der Staateninsolvenz, Konstanz 1990, p. 205 et seq. Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 162 et seq. Underhill v. Hernandez 168 US 250 (1897). First National City Bank v. Banco Nacional de Cuba, 406 US, 765 (1972). Allied Bank International v. Banco Credito Agricola de Cartago, 757 F.2d, at 520. Ibid. at 521. Ibid. Ibid.

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decision means that, in the U.S. at least, the Act of State doctrine is basically excluded as a defence for sovereign debtors.32 1.1.3. International Comity In contrast to sovereign immunity and the Act of State doctrine, international comity is not considered to be legally binding.33 It is a rule of practice, convenience and expediency, not one of law.34 It can be defined as “the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation.”35 Therefore, courts may refrain from deciding a case where such a decision is in opposition to the laws or action of a foreign sovereign. They will not, however, do so if deference would lead to results that are themselves inconsistent with the laws and policies of the country in which the court is located.36 So, in the Allied case mentioned above, the court held that the unilateral suspension of debt repayments by the Costa Rican Government was contrary to U.S. policies.37 While the court had dismissed the action in a first decision, 38 it later departed from its original opinion and remanded the case for entry of summary judgment in favour of the claimant39 after the U.S. Justice Department had submitted an amicus curiae brief, which pointed out that the unilateral suspension of debt repayment by Costa Rica was inconsistent with U.S. policy.40 Several

32

33 34 35 36 37

38 39 40

Power, Philip J., Sovereign Debt: The Rise of the Secondary Market and Its Implications for Future Restructurings, (1996) 64 Fordham L. Rev., p. 2737. Shaw, supra n. 25, p. 2. Power, supra n. 32, p. 2738. Hilton v. Guyot, 159 US 164 (1895). Cf. Silverman/Deveno, supra n. 23, p. 189. Allied, supra n. 28, at 522. Power, supra n. 32, p. 2739 notes that the duty to determine whether or not the act of a foreign sovereign is still consistent with U.S. policies, and is thus covered by comity can put the court in a somewhat awkward position, as this question may occur even before the executive branches have formulated their policy in the case at hand. Allied, 733 F.2d 23 et seq (2d Cir. 1984). Allied, supra n. 28, at 523. Ibid., at 519. Critically with regard to comity in general, and in particular with regard to the Allied case, it was noted that it would be almost inconceivable that a continental European court would reverse a decision on grounds of (foreign) policy considerations, as this would probably evoke a conflict with the right to have justice administered (Reinisch, August, Anmerkung zu LG Frankfurt/M., Urteil v. 14 March 2003 – 2–21 O 509/02, (2003) 58 JZ, p. 1015 et seq.).


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years later, another U.S. court held that, due to the fact that restructurings are entered into voluntarily, creditors have to be allowed to continue pursuing individual (in-court) remedies.41 Consequently, supporting a sovereign’s efforts for unilateral debt restructurings without the consent of the creditors is inconsistent with current U.S. policy.42 So far, there is no known decision in which courts have extended comity to the unilateral imposition of exchange controls, nor to the default by a sovereign debtor.43 Whether or not there will be a change in future litigation depends mainly on which policies are followed.44 This will be particularly interesting as far as the attachment of assets under diplomatic immunity, such as the ambassador’s residence, is concerned. At the end of the day, this issue, which is highly sensitive due to the involvement of diplomatic relations that could be severely damaged by this kind of action, will be determined not least against the backdrop of reciprocity. As Shaw writes, quite often actions will not be pursued, despite their potential short-term gains, “because it could disrupt the mesh of reciprocal tolerance which could very well bring long-term disadvantages.”45 1.2. Practical Problems However, until such policy changes occur, neither sovereign immunity, nor the Act of State doctrine, nor international comity is likely to provide viable defences for defaulting creditors. Nevertheless, the success of future litigation efforts to enforce against state assets located abroad may prove difficult to achieve, because it is argued that, usually, only relatively few assets of the debtor state are located in other jurisdictions, compared with the enormous amounts of debt in question.46 Consequently, only a ‘happy few’, if any, will receive reimbursement of their outstanding claims by enforcement against

41

42

43 44 45

46

See the decision of the District Court for the Southern District of New York in Pravin Banker Ass., Ltd. v. Banco Popular del Peru 895 F. Supp. 665 et seq. (S.D.N.Y. 1995). Silverman/Deveno, supra n. 23, p. 190. In contrast, multilateral restructurings in accordance with the majority of creditors appear compatible with U.S. policies, which favoured, and indeed still favour the insertion of CACs into sovereign bond contracts. Power, supra n. 32, p. 2741. Silverman/Deveno, supra n. 23, p. 190. Shaw, supra n. 25, p. 7; see also: Meesen, Karl M., Die insolvenzrechtliche Option in der internationalen Schuldenkrise, (1990) 89 ZvglRWiss, p. 263. Eichengreen, Barry; Portes, Richard, Crisis? What Crisis? Orderly Workouts for Sovereign Debtors, London 1995, p. 31.

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a sovereign’s foreign assets. Later litigants will often find little or no assets, even if they obtained a favourable judgment.47 Therefore, some creditors have attempted to abandon the ‘classical resources’ in favour of trying to enforce their claim via the attachment of interest payments48 as they are to be made by the debtor state on restructured debt, or to creditors such as the international financial institutions, which have a de facto priority status. In fact, in the Elliot case for instance, a New York Court ordered Peru to pay $56m for principal and past due interest, after Elliot had refused to join any restructuring agreement. In this case Elliot then obtained a judgment from a Brussels Court by means of which it could attach interest payments that were to be made on the restructured debt itself via Euroclear bank accounts in Brussels.49 Nevertheless, comparable cases are still rare and, in reality, success depends on the interpretation by the respective court of the pari passu clauses in the bond in question.50 Furthermore, alterating pari passu clauses, e.g. by means of exit consents, in the sense of the application of the pari passu principle with respect to priority but not to payment, can basically avoid judgments like that in the Elliot case. A final means to hinder recalcitrant creditors such as Elliot from enforcing their claims to the disadvantage of the creditors’ majority is to insert CACs. As well as this legal uncertainty, politicians tend to plead absolute immunity of payments made to international financial institutions to avoid defaulting debtors otherwise being completely cut off from funding.51 Furthermore, in the event that those payments could also be attached, the risk that the

47 48

49

50

51

Silverman/Deveno, supra n. 23, p. 191. Cf. e.g. Credit Suisse/First Boston, supra n. 1, writing that “[a]t present, the most available assets to attach are the Euroclearable Boden coupons [i.e. coupons of newly issued bonds].” A detailed analysis of the case is provided by Gulati, G. Mitu; Klee, Kenneth N., Sovereign Piracy, (2001) 56 Bus. Law., p. 635 et seq. Contemporary efforts in the case of Argentina to get judges to interpret pari passu clauses in a favourable sense – ensuring equal treatment among bondholders – have so far failed in the lower courts (FT-Europe, 8 March 2004, p. 11). In contrast, it is reported that a ruling of a Brussels court in September 2003 held that holders of Nicaraguan defaulted debt can invoke the pari passu clause to stop a debtor’s payments on other external current debt (Citigroup, Impact of the Recent Legal Decisions, Economic and Market Analysis: Country Analysis and Commentary Argentina, 16 September 2003, available at: www. emta.org/keyper/keyindustry0916.pdf ). Ibid., writing that “[t]he US government could legally side on behalf of debtors arguing US foreign policy priorities and could stop these threats [to attach or stop such payments].”


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debtor will cease to pay completely, and that, due to the lack of resources from foreign creditors, its financial and economic situation will deteriorate even more, is high.

2. Public International Law Sanctions On balance, while creditors de lege lata are entitled to claim the seizure of sovereign assets, practical problems hinder the enforcement of their claims. Recourse might thus be taken to the system of sanctions under public international law. Those sanctions can be applied if the debtor defaulted on a debt that is subject to public international law, as is often the case with loans granted bilaterally, or by international financial institutions.52 Moreover, international law sanctions can be applied if a state exercises diplomatic protection of its citizens and pursues the claims on their behalf.53 Various international law sanctions have been used in the past to enforce creditors’ claims against sovereign debtors, ranging from measures of reprisal, such as military intervention (2.1) to retorsion, above all in the form of economic retaliation (2.2). 2.1. Reprisals Reprisals are defined as “acts which are in themselves illegal and have been adopted by one state in retaliation for the commission of an earlier illegal act by another state.”54 The classical case is military intervention. As discussed above, this has historically been a common means to make defaulting debtors pay.55 In light of the prohibition on the use of force posited by Article 2(4) UN Charter, military intervention is now interpreted as being excluded from the potential means of reprisal. However, other reprisals short of force can still legitimately be undertaken. Thus, commentators have argued in favour of a mechanism for the takeover of domestic finances by an international

52

53

54 55

Leyendecker, Ludwig, Auslandsverschuldung und Völkerrecht, Frankfurt/M. 1988, p. 341. For this form of mediatisation in international law see e.g. Société Commerciale de Belgique (PCIJ, Series A/B, No. 78 (1939), p. 160 et seq.). Shaw, supra n. 25, p. 1023. See supra Part A, Chapter I.

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authority in the case of the initiation of a reorganisation procedure56 according to similar examples seen in the 19th and 20th century.57 Alternatively, it was suggested that countries should pledge their natural resource export revenues as a substitute for the seizure of collateral.58 However, due to the significant restraints that these measures would impose on a state’s financial and economic sovereignty, this “throwback to gunboat diplomacy”59 is for the most part rejected as being unrealistic.60 2.2. Retorsion In contrast to reprisals, retorsion is “the adoption by one state of an unfriendly and harmful act, which is nevertheless lawful, as a method of retaliation against the injurious legal activities of another state.”61 Exemplary measures are reducing the level of diplomatic staff, preventing persons from those states from participating in international sporting events or suspending scientific and technical cooperation and cultural exchanges and visits with those states.62 In the sovereign debt context, though, the most important measure is still seen by many commentators in the stoppage of further financing of the recalcitrant debtor state. Most notably, the IMF could withhold the provision of ‘fresh money’ in consistency with its lending into arrears policy.63 This method had some impact in the past,64 and still has with regard to most economically weak LDCs. However, the limits of this approach become obvious in cases such as Argentina. Not only, would such retorsion, contrary to most intentions, once again increase the formal role of the Fund under the reorganisation system, it might, moreover, also exceed the Fund’s financial

56

57 58 59 60 61 62

63

64

Shleifer, Andrei, Will the Sovereign Debt Market Survive?, NBER Working Paper No. 9493, Cambridge February 2003, available at: www.nber.org/papers/w9493, p. 10. Leyendecker, supra n. 52, p. 343. Shleifer, supra n. 56, p. 9. Scott, Hal S., A Bankruptcy Procedure for Sovereign Debtors?, (2003) 37 Int’l. Law., n. 92. Leyendecker, supra n. 52, p. 346. Shaw, supra n. 25, p. 1022. Cf. e.g. Security Council Resolution 757, UN Doc. S/RES/757 (1992) against Serbia and Montenegro. IMF, The Design of the Sovereign Debt Restructuring Mechanism – Further Considerations (27 November 2002), available at: www.imf.org/external/np/pdr/sdrm/2002/112702. pdf. (hereinafter: IMF (2002)), at 220. Leyendecker, supra n. 52, p. 349 et seq.


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capacity. That is to say, the Fund could find itself in a rather uncomfortable position. In 2004, for instance, Argentina owed $15.8bn to the Fund and was thus the Fund’s third-largest single debtor. Hence, a default by Argentina vis-à-vis the Fund, which would have been the consequence of a stoppage of new loan disbursements by the Fund, would have left the Fund with substantial defaulted debts on its books, for which the IMF might have been under-funded. Commentators claimed that the Fund was therefore “at the mercy of its biggest borrowers” and that “Argentina has proved brilliant at exploiting its knowledge of the IMF’s vulnerability.”65 This vulnerability was significantly increased by an alliance between Brazil and Argentina, which started to encourage the IMF to relax its rules66 and whose outstanding debts amounted to 60 percent of the Fund’s total outstanding debt. If, under these circumstances, the Fund had stopped lending, this might have had some impact on the economic viability of Argentina and Brazil. In contrast, the subsequent stoppage of debt repayment by those two countries would have had a far worse impact on the economic viability of the Fund.

3. New Approaches Traditional means of sanctioning recalcitrant debtors therefore often fall short. A point of departure for new approaches could be the finding that there are, despite statements to the contrary, usually significant assets of foreign states located abroad. Much more important (in terms of the pecuniary value) than diplomatic premises are foreign bank accounts and security custody accounts of the defaulting state, as well as the assets of state-owned enterprises.67 3.1. The Use of Looted Funds While, as discussed above, the attachment of these assets will often be impossible if the sovereign autonomy of the debtor state is to be respected, this difficulty is excluded by recourse to looted funds – also referred to as dictator assets – i.e. values that a person in an important official function

65 66 67

FT-Europe, 10 March 2004, p. 13. FT-Europe, 17 March 2004, p. 4. Scott, supra n. 59, p. 117.

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derived from a misuse of these functions, or through corrupt practices, for private enrichment.68 As first suggested by former World Bank Vice President Jean-Loup Dherse, those looted funds could be used as compensation for a country’s outstanding debt.69 An alternative proposal put forward was to freeze those assets when a country comes into financial difficulties and use them as a lever70 to achieve co-operative behaviour of the debtor country’s government in the debt renegotiations, as well as in the adaptation of an economic adjustment program.71 Indeed, the transfer of looted funds to safe havens is one of the key factors leading to sovereign financial crises.72 Due to the sums involved,73 they could play a central role in servicing outstanding debts in many cases of sovereign default.74 Court decisions have underlined that sovereignty of state

68

69

70

71

72 73

74

Richter, Dagmar, „Potentatengelder“ in der Schweiz: Rechtshilfe im Spannungsfeld der Menschenrechte von Tätern und Opfern, (1998) 58 ZaöRV, p. 541. Dherse, Jean-Loup, A Solution to the Debt Problem, The Banker, 19 May 1999, available at: www.odiousdebts.org/odiousdebts/index.cfm?DSP=content&ContentID=65; see also: Scott, supra n. 59, p. 117 and n. 18, highlighting the importance of looted funds as a major group of assets available for seizure in the case of sovereign default. The potential leverage of frozen assets is illustrated by the precedent of the Iran-U.S. Claims Tribunal. This tribunal was established to rule over claims resulting from circumstances surrounding the hostage crisis in the U.S. embassy in Teheran. To get the necessary leverage to at first secure the release of the hostages, U.S. President Carter ordered that all Iranian bank accounts in U.S. banks be frozen, irrespective of the country in which the funds were located (Executive Order 12170 of 14 November 1979), affecting some $12bn. $1bn were then transferred to a special interest-bearing security account. This account was later exclusively used to ensure payments of awards of the Iran-United States Claims Tribunal. Furthermore, Iran was obliged to maintain a minimum of $500m in the account until all claims had been satisfied (Mapp, Wayne, The Iran-United States Claims Tribunal, Manchester 1993, p. 16). Raffer, Kunibert, Solving Sovereign Debt Overhang by Internationalising Chapter 9 Procedures, available at: www.studien-von-zeitfragen.net/weltfinanz/Raffer_1. Cf. corresponding statements by IFI’s, such as the IMF (FT, 8 May 2003, p. 19). The sums in question range from some million dollars up to estimated several billions of dollars (see the reports by Transparency International available at: www.globalcorruption.org). An option to further increase the pool of those assets is to introduce into the RSSD a right of avoidance with regard to dictator transactions. Accordingly it is argued that, when a country applies for debt reorganisation, all transactions where the ruler has used public funds in private interest, for instance to buy a private yacht, should be made recoverable (cf. Paulus, Christoph G., A Legal Order for Insolvencies of States, available at: www.dse. de/ef/sdrm/paulus.htm, p. 13).


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officials, or concepts such as the Act of State doctrine, are not a hindrance when those assets are to be frozen or retransferred.75 Modern anti-corruption instruments furthermore acknowledge that illicit enrichment (meaning the significant increase in the assets of a public official, which he cannot reasonably explain in relation to his financial circumstances) represents a form of political corruption that must be penalised.76 Moreover, modern money laundering abatement laws, such as the USA Patriot Act77 provide the tools necessary to detect looted funds and to seize and confiscate them.78 3.2. Is There a Duty to Return Looted Funds? However, the proposal to use looted funds as compensation for outstanding debts raises the question of whether there is a genuine right of the debtor country to recover the money and to decide as to the use of the money according to its own intentions. In other words, is there a legal obligation for a country in which looted funds are located to return such funds? First of all, it must be emphasised that the state in which the funds are detected and frozen does not intend to incorporate the assets into its treasury. Even if the funds were distributed among creditors, they would eventually benefit the state whose dictator misused them by reducing the outstanding debts of that country. Therefore, the freezing of assets does not amount to unjust enrichment.79 Second, it should be mentioned that there is no general rule in international law pursuant to which any duty of a state to immediately return property claimed by another state would arise. While such a duty may exist for assets that are protected by sovereign immunity, such as embassy accounts,80 the situation of a state claiming any fiscal assets is the same as that of a private person; i.e. the state may be obliged to claim restitution in the domestic courts of the country in which the assets are located.81

75 76

77 78

79 80 81

See: Hokema, Grit, Immunität von Staatsoberhäuptern, Frankfurt a.M. 2002. Henning, Peter J., Public Corruption: A Comparative Analysis of International Corruption Conventions and United States Law, (2001) 18 Ariz. J. Int’l & Comp. L., p. 793 et seq. US PATRIOT ACT. Cf. Rueda, Andres, International Money Laundering Law Enforcement & the USA Patriot Act of 2001, (2001) 10 MSU-DCL J. Int’l L., p. 141 et seq. Richter, supra n. 68, p. 591. Cf. BVerfGE 46, p. 342 et seq. Richter, supra n. 68, p. 592.

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Whether such a claim to recover looted funds would be successful is, however, doubtful, since the claiming state will rarely be in a position to prove that specific assets belong to it. This inability is usually due to the circumstance that looted funds stem from a variety of sources and are, in the absence of any accountancy obligation for government officials, almost impossible to trace back.82 It is true that, even if no title can be proven, international law imposes obligations to return property such as stolen cultural goods.83 These special cases cannot however form the basis for a general rule for all stolen or displaced assets that might belong to a country. Accordingly, a state will usually not claim ‘its assets’, but instead the exclusive competence to adjudicate the distribution of the dictator assets. One argument one could mention in favour of a distribution of the assets by the claiming state is that this state is ‘nearest to the potential claims’ and ought, therefore, to be in the best position to shed light on who is the rightful owner of the assets. On the other hand, there is a common interest in the international community of states that the assets are not returned to a corrupt government that may misuse them again, but only to a state that can guarantee rightful adjudication.84 Rightful adjudication, however, is at the least doubtful when a state already refuses in the international context, i.e. before the eyes of the international community, to follow the rule of law and does not co-operate e.g. in the reorganisation of its debt. 3.3. Sovereign Defaults as ‘Threats to the Peace’ Nevertheless, the potential consequences of a freezing of looted funds can lead to a politically induced reluctance not to freeze the assets with regard to the government of the state in which the looted funds are located. Thus, governments are fairly reluctant to freeze any assets of a dictator.85 Even in cases where a dictator has been overthrown once and for all, governments often refuse to act because the new regime is considered to still be related to the old one.86 It is argued that the relations with the other country might

82 83

84 85 86

Ibid., p. 593. Art. 7 UNESCO Convention on the Means of Prohibiting and Preventing the Illicit Export and Transfer of Ownership of Cultural Property. Cf. Richter, supra n. 68, p. 599 et seq. Cf. Richter, supra n. 68, 560 et seq. Ibid., p. 569 et seq.


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suffer if the assets were frozen without an official request by the respective government for legal assistance.87 Due to diplomatic interference, unilateral actions therefore do not seem to be appropriate within a Convention that aims at the consensual solution of sovereign default. Instead, the UN would appear to be better suited to deal with recalcitrant debtor states. This is because, firstly, the UN maintains a degree of legitimacy, credibility and objectivity as the most representative international organisation in the world. Secondly, it also retains a high level of organisational competence to handle cases involving looted funds. The UN is active in the area of developing anti-corruption measures,88 as well as the freezing of such assets. Such enforcement actions may generally be taken by the UN Security Council pursuant to its powers under Chapter VII of the UN Charter if it determines that a particular behaviour constitutes a ‘threat to the peace, breach of the peace or act of aggression’.89 The Security Council’s interpretation of these terms has changed over time. During the Cold War era, the Council interpreted these terms in a rather narrow manner, restricting its mandate to direct trans-border aggression. However, with the arrival of glasnost and perestroika, it has considerably broadened its view of a ‘threat to the peace’.90 The Security Council determined that the repression of the Kurds in Iraq in the aftermath of Iraq’s expulsion from Kuwait,91 the deteriorating situation in Somalia involving the heavy loss of human life and widespread material damage,92 and the continuation of hostilities in (former) Yugoslavia constituted threats to international

87 88

89 90 91 92

Richter, supra n. 68, p. 569. Inter alia, the United Nation’s General Assembly approved the first internationally negotiated treaty against corruption on 31 October 2003, namely the UN Convention against Corruption (available at: www.undoc.org/pdf/crime/convention_corruption/signing/Convention-e.pdf ). This convention covers topics including public procurement, bribery, illicit enrichment, embezzlement, misappropriation, money-laundering, freezing of assets and co-operation between states. Prior to the Convention, the UN had already taken efforts to ensure the elimination of governmental and institutional corruption by formulating the 1996 Declaration against Corruption and Bribery in International Commercial Transactions (cf. Landmeier, Lisa M., et al., Anti Corruption International Legal Developments, (2002) 36 Int’l Law., p. 590). Cf. Article 39 UN Charter. See in general: Shaw, supra n. 25, p. 1084 et seq. Security Council Resolution 688, UN Doc. S/RES/660 (1991). Security Council Resolution 713, UN Doc. S/RES/713 (1991).

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peace and security.93 Haiti94 and East Timor95 are further examples for the Security Council’s expanding view in this direction.96 The nature of what constitutes a threat has thus significantly evolved from a narrow sense of military threat to broader humanitarian contexts.97 The scope of situations potentially covered by these terms is still increasing rapidly. Accordingly, in Resolution 1368, the Security Council adopted the view that terrorist acts also constitute threats to international peace and security.98 In view of these increased activities of the Security Council in addressing non-traditional breaches of peace, commentators have no doubt that it holds the legal authority to respond to other catastrophes, such as environmental disasters.99 Consequently, an economic disaster like a sovereign default might also be considered to be within the scope of the Security Council’s actions. The logical leap from humanitarian intervention due to a threat to peace, as in Somalia, to a sovereign default that threatens peace is not necessarily that insurmountable. Both may threaten the community with comparable effects in terms of human suffering and economic damage. The Security Council’s authority to act in economic crises and threats to international (financial) peace is arguably all the more important due to the fact that its repertoire of reactive measures is not limited to military intervention. Instead, it is empowered to impose those sanctions that it considers to be necessary, allowing a gradual adoption of the sanctions depending on the seriousness of the violating state’s behaviour. The first step is always the Security Council’s declaration, under Article 39 UN Charter, that certain behaviour – in the case of a sovereign financial crisis, the refusal to co-operate

93 94 95 96

97

98

99

Security Council Resolution 733, UN Doc. S/RES/733 (1992). Security Council Resolution 940, UN Doc. S/RES/940 (1994). Security Council Resolution 1264, UN Doc. S/RES/1264 (1999). Cf. Bothe, Michael, Friedenssicherung und Kriegsrecht, in: Vitzthum, Wolfgang Graf (ed.), Völkerrecht, 2nd ed. Berlin 2001, p. 633. See also: Murphy, Sean D., The Security Council, Legitimacy, and the Concept of Collective Security After the Cold War, (1994) 32 Colum. J. Transnat’l L., p. 210 (hereinafter: Murphy (1994)). Security Council Resolution 1368 UN Doc. S/RES/1368 (2001); this view was reaffirmed by Resolution 1373 UN Doc. S/RES/1373 (2001). Murphy, Michael K., Achieving Economic Security with Swords as Ploughshares: The Modern Use of Force to Combat Environmental Degradation, (1999) 39 Va. J. Int’l L., p. 1197; see also Beyerlin, Ulrich; Marauhn, Thilo, Rechtsetzung und Rechtsdurchsetzung im Umweltvölkerrecht nach der Rio-Konferenz, Berlin 1997, p. 84 n. 52.


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in finding a consensual solution for the debt reorganisation – constitutes a threat to international peace. The first effect of such an authoritative statement highlighting the seriousness of particular circumstances is to focus international attention on the event, thereby encouraging the parties to seek an expeditious resolution by mutual agreement.100 Simultaneously, the Security Council’s authority to pursue its enforcement powers according to Chapter VII is triggered. In the context of a sovereign debt crisis, the most valuable means that come to mind as a second step will certainly be the Security Council’s power to order the freezing of assets. The precedent set by the Council in this respect was its order to freeze the proceeds owed to the Government of Iraq from the sale of oil in 1990.101 It is noted that the seizure of financial assets of a state102 that is threatening peace will usually be a valid option as far as economic sanctions are concerned, given the nature of international capital and investment flows.103 Such economic sanctions are most efficient under the auspices of the United Nations, as they are not solely restricted to the assets located in a specific country or region, but are imposed on an international level. Economic sanctions can be a very effective incentive to accelerate a consensual resolution of a (debt) crisis. The penalties imposed on the uncooperative behaviour of a recalcitrant debtor state is, so to speak, as the third and final step, reinforced by the Security Council’s power to liquidate the frozen assets to compensate damages arising from the debtor state’s behaviour.104 The Iraq Compensation Commission, as established in 1991 by Security Council Resolution 705, set a precedent in this regard.105 The Council decided in this resolution that

100 101

102

103 104 105

Murphy (1994), supra n. 97, p. 210. Security Council Resolution 778, UN Doc. S/RES/778 (1992). Here, the UN was asked by the U.S. and the U.K. to also mandate a freezing of Iraqi entities’ assets for an investigation into alleged corruption surrounding the multi-billion dollar oil-for-food programme (FT-Europe, 19 March, 2004, p. 7). Sanctions by the Security Council do not necessarily have to address a state. Thus, Resolution 1373, which was adopted in response to the 09/11 terrorist attacks, mandated all countries to impose a freezing of assets as well as a travel ban on individuals and groups associated either with Al-Qaeda or the Taliban (Cf. Drumbl, Mark A., Victimhood in Our Neighbourhood: Terrorist Crime, Taliban Guilt, and the Asymmetries of the International Legal Order, (2002) 81, N.C.L. Rev., p. 17). Murphy (1994), supra n. 97, p. 238. Ibid. UN Doc. S/RES/692 (1991).

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up to 30 percent of the proceeds obtained from Iraq’s oil exports should be used as compensation for claims against Iraq. Iraq, however, refused to co-operate, so that Resolution 778 called on states to transfer assets that had previously been frozen as proceeds of Iraq’s oil sales. Those funds had to be transferred to a special escrow account. 30 percent of the funds were then to be used for the compensation of claims.106 The result was that Iraq began to co-operate.107 This overview illustrates that actions of the Security Council are not per se excluded in the case of a sovereign default. However, it is somewhat doubtful whether the UN would decide to act in cases of sovereign default. At the end of the day this will always be a political question, which will, without doubt, be subject to serious and time-consuming disputes and discussions. Sanctions by the UN Security Council therefore cannot be expected to provide a short- or even medium-term solution for dealing with recalcitrant sovereign debtors. Moreover, the question is whether such action is at all desirable within the framework of the Convention suggested here. First of all, an extension of the term ‘threat to the peace’ to include sovereign defaults and subsequent actions might be tantamount to breaking a butterfly on the wheel. Secondly, a restrictive interpretation of the term ‘threat to the peace’ is necessary, since the impact of the Security Council’s actions upon such threats could otherwise deteriorate in the long run. Lastly, such potential sanctions might be an important reason for states not to ratify the Convention. This, in turn, would hamper the implementation of the Convention. On balance, therefore, the Convention should not provide for an active role for the Security Council to act on behalf of the international community to sanction uncooperative debtor states, nor should it provide any corresponding sanctioning system.

106 107

UN Doc. S/RES/778 (1992). Shaw, supra n. 25, p. 948.


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4. The Limits of Traditional Sanctions – The Case for a Compliance Control Mechanism in International Financial Relations Instead, preventative measures should be taken,108 since “[f ]or financial crises, as for health maintenance, prevention is the better part of cure.”109 Indeed, one of the pivotal reasons why current procedures fail to deliver adequate results is the inadequate level of crisis prevention.110 Prevention is the main goal of a compliance control oriented approach, which attempts to avoid financial crises instead of simply reacting to them. Compliance control can be defined as the institutionalised and formalised surveillance of states by an international organ with regard to their compliance with duties under a treaty.111 Based on certain pre-agreed standards, such as debt to Gross Domestic Product (GDP) ratio, or annual inflation, such as in the European Stability and Growth Pact (SGP), compliance controls provide a means not only of hindering the very outbreak of a financial crisis, but also of avoiding the ‘stigma’ still connected with all forms of insolvency procedures.112 Compliance control mechanisms do not nullify traditional (repressive) sanctions. Rather, they could be used together in a gradual process, beginning with compliance control and leading to repressive sanctions should the co-operative measures fail.113 4.1. The Asian Crisis and the Lack of Sufficient Compliance Control One might argue that the creation of the RSSD alone would be sufficient to achieve the objective of prevention, as the mere existence of this procedure

108

109

110 111 112

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Cf. Gianviti, François, The Reform of the International Monetary Fund (Conditionality and Surveillance), (2000) 34 Int’l Law., p. 108 noting that the general objective of reform, which is necessary to the international financial architecture, is to prevent the recurrence of major financial crises. Eichengreen, Barry, Toward a New International Financial Architecture – A Practical PostAsia Agenda, Washington D.C. 1999, p. 10. Eichengreen/Portes, supra n. 46, p. 4. Beyerlin/Marauhn, supra n. 99, p. 95. Cf. in general: Marauhn, Thilo, Nachhaltiges Schuldenmanagement: Völkerrechtliche Rahmenbedingungen für ein zwischenstaatliches Insolvenzverfahren, in: Dabrowski, Martin et al.; Die Diskussion um ein Insolvenzrecht für Staaten – Bewertungen eines Lösungsvorschlags zur Überwindung der Schuldenkrise, Berlin 2003, p. 296 (hereinafter: Marauhn (2003)). Cf. Beyerlin/Marauhn, supra n. 99, p. 91.

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would have a disciplining effect on all participants.114 However, reference to domestic insolvency laws reveals that this disciplinary effect is not sufficient to avoid insolvency. This is particularly unfortunate since, although insolvency systems are intended to provide fast solutions to each case,115 even the most developed insolvency laws prove that the more complex a case is, the longer the process will take. Restructuring procedures under U.S. Chapter 11 for instance often take years.116 Significant damage to the financial architecture may, however, already have been caused during this period. The insolvency of any business will undoubtedly have an impact on the economic situation in a country, or even internationally. However (to this extent, the comparison between corporations and states once again does not apply) sovereigns are different due to the fact that, if they fail, they can trigger public unrest, manifested for example in a run to the exits or a run to the courthouse, and, in the worst case, in the total meltdown of a financial system. In this respect, the closest comparison can be made between states and banks. As with banks “one failure in a global financial market may affect the entire structure of that market”,117 i.e. spill-over effects are possible. A well-known example of spill-over in the sovereign context is the Asian Crisis. A closer look at the Asian Crisis demonstrates, first of all, how such crises emerge (4.1.1). Next, the more profound reasons for the outbreak of Asian-style financial crises will be discussed (4.1.2). 4.1.1. The Asian Financial Crisis 4.1.1.1. Genesis of the Crisis The Asian crisis first surfaced in Thailand in July 1997, moved to Indonesia three months later and hit South Korea in November of the same year.118 Until that time, East Asia’s so-called ‘tiger-economies’ were seen as models

114

115 116 117

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Paulus, Christoph G., Some Thoughts on an Insolvency Procedure for Countries, (2002) 50 Am J. Comp. L., p. 534, describing this effect as ‘peace through deterrence’. Häsemeyer, Ludwig, Insolvenzrecht, 3rd ed. Köln 2003, at 2.08. The Economist, 15 December 2001, p. 35. Gruson, Michael, The Global Securities Market: Introductory Remarks, [1987] Colum. Bus. L. Rev., p. 307. Head, John W., Global Implications of the Asian Financial Crisis: Banking, Economic Integration, and Crisis Management in the New Century, (1999) 25 Wm. Mitchell L. Rev., p. 941.


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of economic success119 because they encouraged and achieved prudent fiscal policies and high private saving rates.120 To support their, almost meteoric, rise in economic growth,121 the ‘tigers’ opened their capital markets to foreign portfolio investment and encouraged their enterprises to borrow abroad. The crisis was triggered by a drop in confidence in Thailand’s currency, the baht. This loss in confidence led to a major reduction in value, as well as a sharp decline of the values on the Thai stock market.122 These events affected Thailand’s competitors as, due to the declining value of the baht, exports from Thailand became cheaper to buy using other currencies.123 As a consequence, other Asian currencies came under pressure and declined, in turn making it more difficult for borrowers in those countries, who were most often indebted in foreign currencies to service their debts, in particular short-term debts.124 Furthermore, the Thai financial crises prompted investors to take a closer look at other Asian economies. The first victim of this intensified scrutiny was Indonesia.125 In Indonesia, as previously in Thailand, banks had taken up considerable loans in foreign currencies, and had also extended loans to domestic enterprises that were exposed to similar foreign borrowings.126 When this short-term foreign currency lending was suddenly withdrawn, and the Indonesian rupiah simultaneously fell steeply, the Indonesian banking system was threatened with collapse, leading to the culmination of the Asian crisis: the economic fall of Korea.127 However, even

119

120 121

122

123

124 125 126

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Lichtenstein, Cynthia C., Dealing with Sovereign Liquidity Crises: New International Initiatives for the New World of Volatile Capital Flows to and from Emerging Markets, (1998) 29 McGeorge L. Rev., p. 808. Ibid. Thailand’s per capita income, for instance, had increased fivefold in the thirty years prior the crisis, (cf. Fischer, Stanley, Address at the Midwinter Conference of the Banker’s Association for Foreign Trade on 22 January 1998, available at: www.imf.org/external/np/ speeches/1998/012298.htm). IMF, IMF Approves Stand-by Credit for Thailand, 20 August 1997, available at: www.imf. org/external/np/sec/pr/1997/pr9737.htm. Walker, Christopher W., Contagion: How the Asian Crisis Spread, (1998) 30–4 Asian Dev. Bank Rev., p. 10 et seq. Ibid., p. 11 et seq. Ibid. IMF, IMF Approves Stand-by Credit for Indonesia, 5 November 1997, available at: www. imf.org/external/np/sec/pr/1997/pr9750.htm. Korea had by this time become the eleventh-largest economy in the world, illustrating that not only economically less significant countries were affected by the Asian crisis

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after that point, the risk of contagion128 was acute, as the cases of Japan – which then started to suffer its most serious recession since World War II129 – and Brazil130 prove.131 4.1.1.2. Domestic Failures that Led to the Crisis The following factors can be identified as having been of major importance in the development of the crisis: There is widespread agreement that weak banking systems were a central factor for the emergence of the Asian crisis132 and that better supervision could have prevented it. Thailand’s regulator,133 for instance, supported the Bangkok Bank of Commerce up to its failure in 1996, despite the fact that the bank had bad debts of $3bn and blatantly disregarded the laws.134 Furthermore, banks were allowed to borrow heavily in foreign currencies, which were then invested by the private sector, notably in real estate and equities.135 Due to the excessive exposure to the real estate area, real estate values declined enormously, leaving the banks with under-collateralised and ultimately non-performing bank loans.136 Another major flaw in the system of banking supervision was the lack of transparency. Thus, monetary authorities did not realise in good time

128

129

130 131

132

133 134

135

136

(cf. IMF, IMF Approves SDR 15,5 Billion Stand-by Credit for Korea, 4 December 1997, available at: www.imf.org/external/np/sec/pr/1997/pr9755.htm). Contagion is defined as “a significant increase in cross-market linkages after a shock to an individual country (or group of countries) as measured by the degree to which asset prices or financial flows move together across markets relative to this co-movement in tranquil times” (Tarullo, Daniel K., Rules, Discretion, and Authority in International Financial Reform, [2001] J. Int. Econ. L., p. 623 n. 22). Yerkey, Gary G. et al., 1999 Outlook: International Trade, (1999) 16 Int’l. Trade Rep., p. 110. N.Y. Times, 15 February 1999, p. A1. There was even a risk that world capital markets in general could be ‘infected’ (Tarullo, supra n. 128, p. 614). Coats, Warren, The Asian Meltdown of 1997: The Role of the Financial Sector and Bank Exit Policies, (1999) 23-SPG Fletcher F. World Aff., p. 79 et seq. I.e. the Central Bank of Thailand (BOT). Commentators speak about ‘cosy arrangements’ between regulators and banks in Thailand in this regard (cf. Jacque, Laurent L., The Asian Financial Crisis: Lessons from Thailand, (1999) 23-SPG Fletcher F. World Aff., p. 90). Goldstein, Morris, The Asian Financial Crisis – Causes, Cures, and Systemic Implications, Washington D.C., 1998, p. 7. Coats, supra n. 132, p. 78.


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the level of non-performing loans, nor did they detect the banks’ undercollateralisation.137 The main incentive for the investment in real estate was that, in the years preceding the financial crises, the tiger economies had experienced huge capital inflows, which, however, for the most part were not utilised for productive investments due to the lack of corresponding opportunities;138 this created a bubble.139 Most of the capital inflows came to the Asian countries in the form of loans to banks and companies. Both, banks and companies, borrowed largely in U.S. dollars on account of the pegged exchange rates of the national currency to the dollar. As a result, the private sector bank credit growth increased in excess of the GDP year by year prior to the crisis. The inherent risk of such a development is that, if one side stops lending, the other cannot afford to repay.140 Two factors aggravated that risk even more. First, the lack of confidence in the respective pegged currencies, which ultimately forced the responsible authorities to abandon the system of pegged currency, and secondly, the fact that most foreign loans were provided to the Asian companies and banks only on a short-term basis.141 4.1.1.3. The Global Transferability of These Factors The factors mentioned above are not applicable only to the Asian economies. The same elements can be seen when analysing other financial crises in emerging markets. Mexico, which in 1994 suffered from the so-called ‘tequila-crisis’ can be mentioned as a harbinger of Asian-type crises.142 The factors that lead to the

137

138 139 140 141 142

Roller, Andrea D., Thailand’s Banking Crisis and Subsequent Reform – Could Thailand Benefit from an International Standard, (2001) 24 Suffolk Transnat’l L. Rev., p. 420. Cf. Jacque, supra n. 134, p. 89. Head, supra n. 118, p. 942. Roller, supra n. 137, p. 421. Cf. Head, supra n. 118, p. 946. Chun, John H., “Post-Modern” Sovereign Debt Crisis: Did Mexico Need an International Bankruptcy Court?, (1996) 64 Fordham L. Rev., p. 2654; a recent example in which a sovereign’s financial troubles were intimately linked with its insufficiently-regulated banking sector is the Dominican Republic, which was teetering on the brink of default in 2004. The Dominican Republic’s problems began with the collapse of Baninter, its second largest commercial bank. However, due to the relatively small amount of debt owed by the Dominican Republic, any potential default was not expected to be contagious (FT-Europe, 12 February 2004, p. 31).

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crisis there were essentially similar. First, there was a lack of a functioning system of bank supervision.143 Second, prior to the crisis, massive amounts of foreign capital flooded into the country, creating a bubble effect.144 Third, Mexico had also tied its currency to the dollar by way of a ‘crawling peg’ system.145 The crisis in Argentina is yet another example of this new type of sovereign financial crisis. Here also, the financial system was inadequately regulated146 and the International Monetary Fund (IMF) is still – thus far more or less in vain – demanding further restructuring of the banking sector.147 Furthermore, due to massive foreign investments, the annual growth of Argentina’s general domestic product between 1991–2000 was 4.15 percent on average, with a peak of 8.1 percent as recently as 1997.148 Finally, the Ley de Convertibilidad established a currency board, which has strictly pegged Argentina’s currency to the US-dollar since 1991.149 Mexico and Argentina were only able to protect their exchange reserves from the effects of capital flight by allowing their domestic currencies to float,150 as well as by strict capital restrictions and a temporary closure of banks.151 4.1.2. Lack of Creditor Confidence and Unregulated Budgetary Spending as Origins of the Debt Crises While insufficient banking compliance control, excessive capital inflows and pegged exchange rates can undoubtedly be identified as the important factors for a loss of creditor confidence and a subsequent run in most sovereign financial crises, two questions nevertheless arise: first, why is creditor confidence

143 144

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147 148 149 150 151

Cf. Naim, Moses, Mexico’s Larger Story, (1995) 99 Foreign Pol’y, p. 115 et seq. Nearly $60bn in foreign investments came to Mexico between 1989 and 1993 (IMF, World Economic Outlook, Washington D.C. May 1995, p. 91). Ibid., p. 90. The measures taken after the tequila crisis, above all to prevent capital flight, and which already caused significant harm to the Argentine economy, were apparently insufficient (cf. IADB, La Saga de Argentina, (2001) 16 Politicas Económicas de América Latina, p. 4). FT-Europe, 31 July 2003, p. 3. Ibid. See: Hanke/Schuler, supra n. 11, p. 3. Chun, supra n. 142, p. 2658. In part, those capital restrictions were subsequently declared unconstitutional by Argentina’s Constitutional Court (cf. SZ, 4 February 2002, p. 12).


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so important in the sovereign context? And second, why did the affected countries not have the necessary resources to bail out their private sectors, which, in turn, would have limited the loss in creditor confidence? 4.1.2.1. The Emergence of Runs and the Importance of Confidence in the Markets There are four basic reasons why confidence is such an essential part in the relationship between creditors and sovereign debtors: First, debtor states are often engaged in long-term obligations. In contrast, sovereign creditors are usually more short-term oriented. Since the 1990s in particular, the (until then dominant and relatively stable) syndicated bank loans have been replaced by highly flexible international bonds and portfolio investments.152 While commercial banks stopped lending to developing countries, portfolio investors started to pour money into those countries.153 The speculative nature of short-term capital, combined with the technological innovations that enable financial transactions to be processed in the briefest of times, subject countries to the dangers of a volatile market, notably the risk of sudden runs on their currency, due to capital flight by thousands of investors.154 Second, the urgency of these runs is increased further by information asymmetries. Creditors generally do not possess the information and the expertise necessary to assess the creditworthiness of a sovereign debtor. Even the international rating agencies, as the experts in this field, rated all the countries affected by the Asian crisis far too optimistically and, furthermore, those countries were given non-investment grades far too late.155 Third, bondholders and other state creditors only hold relatively small claims.156 This, combined with the high complexity of sovereign finances means that compliance control

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153 154 155

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Commentators suppose that one of the pivotal reasons for that change was to make it (even) more difficult for sovereign debtors to restructure their debt (Dieter, Heribert, Globalisierung ordnungspolitisch gestalten – Die internationale Finanzarchitektur nach den Finanzkrisen, Das Parlament, 27 January 2003, p. 22). Ibid. Naim, supra n. 143, p. 125. E.g. Thailand was not given a non-investment grade until December 1997, i.e. half a year after the crisis began (Kochalumottil, Beena, Verfahren, Methoden und neue Ansätze zur Beurteilung von Länderrisiken, Marburg 2002, p. 66 et seq.) The average Italian retail bondholder of Argentine bonds has claims that amount to $39,000, compared with $142,000,000,000 total outstanding Argentine debts, FAZ, 20 June 2003, p. 21.

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of states by individual creditors is therefore excluded. Finally, due to their small claims, bondholders may not have sufficient influence to enforce adequate compliance control, even if they wanted to. In consequence of these factors, sovereign creditors generally have to leave their money with the state on the basis of confidence.157 The results of misplaced confidence in states are then sudden runs. 4.1.2.2. Unregulated Budgetary Spending Such runs can undoubtedly be avoided, or at least their impact softened, if a state has sufficient resources to ward off tendencies of this kind. However, governments are often reluctant to stockpile exchange reserves and instead tend to accumulate state debt. The term ‘competition democracy’ encapsulates this common trend. For instance, analysts commenting on the reasons for Argentina’s default note that the budgetary deficit of the province of Buenos Aires, which, due to the Argentine system of financial adjustment (coparticipación) has a direct impact on the federal budget,158 increased from 7 percent in 1996 to 25 percent in 1999 because of a political rivalry between the then governor of Buenos Aires, Duhalde, and the former Prime Minister, Menem, which the two sought to settle via financial donations.159 Menem in turn increased public spending by the exchequer by 100 percent in the period from 1993 to 1999.160 As this example demonstrates, democratically elected governments try to influence macro-economic variables to win the support of the voters and to increase their chances for re-election. It is true that state debt is just another form of prolonged tax payment, as the market value of bonds issued

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The same situation is characteristic for the relationship between creditors and banks (cf. e.g. Garcia, Gillian; Deposit Insurance: Obtaining the Benefits and Avoiding the Pitfalls, IMF Working Paper, Washington D.C. 1996, p. 15 et seq.) Due to the co-participation mechanism, revenue has to be shared between the national government and the country’s 24 provincial administrations; in detail: Jones, Mark et al., Política, instituciones y comportamiento fiscal de las provincias argentinas, in: Cárdenas, Mauricio; Montenegro, Santiago (ed.), Economía Política de las finanzas públicas en América Latina, Colombia 1999, p. 71 et seq. Burmann, Julia, Der Einfluss politischer Institutionen auf die Wirtschaftsentwicklung am Beispiel Argentiniens unter Menem, (2003) 6/03 KAS-AI, p. 52. Corrales, Javier, The Political Causes of Argentina’s Recession, Washington 2001, available at: www.ics.si.edu/fellows2000/corrales/recession.pdf.


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at current must correspond exactly to the value of interest and redemption subsequently paid thereon by means of tax-payers’ money.161 However, in contrast to direct taxes, the accumulation of new state debt is a virtually unrecognised process. Using state debt, public expenditure can be raised, while the cost of this additional financial relief by the present government has to be borne by future generations and other politicians.162 Using the money derived from new state debt not only increases a ruling government’s chances of being re-elected, but also enables it to influence some state variables that can affect the policy implemented by the successor government.163 An important variable for the increase of state debt is the process by which the state budget is negotiated. In these negotiations, a ‘right of veto’ for the minister concerned against cuts in his or her department, far-reaching competencies of the parliament to change budgetary decisions, a lack of consideration of long-term effects of state projects and discretionary scope when executing the budget all facilitate an extension of new state debt.164 In contrast, the tendency to accumulate new debts is reduced by a strong position of the prime minister in the budgetary process,165 the duty to accept or to reject the budget as a whole and the execution of the budget without discretionary scope.166 These correlations have been affirmed by the results of empirical analysis.167 Altering political systems in order to make them less vulnerable to the temptation of new state debt is an extremely arduous task. Other approaches for mechanisms to restrict state debt accumulation are constitutional limits and the proposal to subject the state budget to external controls. Internal restrictions, such as constitutional limits, have not to date prevented

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Weizsäcker, Robert K. v., Spezielle Aspekte der Staatsverschuldung, in: Hagen, Jürgen v.; Stein, Johann Heinrich v., Geld-, Bank- und Börsenwesen: Handbuch, Stuttgart 2000, p. 194. Ibid., p. 195 et seq. Person, T.; Svenson, L.E.O., Why a Stubborn Conservative would Run a Deficit: Policy with Time-inconsistent Preferences, (1989) 104 Quarterly Journal of Economics, p. 326. Sutter, Matthias, Der Stabilitäts- und Wachstumspakt in der Europäischen Währungsunion, Baden-Baden 2000, p. 53. In this respect the ideal constellation would be Barro’s ‘benevolent dictator’ (cf. ibid., p. 52). Ibid., p. 54. Cf. Advisory Commission on Intergovernmental Relations, Fiscal Discipline in the Federal System – Experiences of the States, Washington D.C. 1987.

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excessive new debts, as the experience with Art. 115 of the German Basic Law demonstrates.168 4.2. The Procedural Framework for a Compliance Control Mechanism However, a well-established external and neutral control mechanism could, arguably, sidestep the failures of domestic policies, such as unrestricted capital inflows and exchange pegs. A credible control mechanism could also enhance creditors’ confidence, thereby reducing the risk of runs. Moreover, it could effectively limit excessive borrowing by governments. Therefore, as a first step, an overview of the procedural steps that can generally be found in international compliance control systems will be provided (4.2.1). As a second step, the study will focus in more detail on compliance control in international financial relations (4.2.2). 4.2.1. The Procedural Framework of Compliance Control in International Law In contrast to traditional enforcement mechanisms, compliance control aims at confidence-building rather than adversarial dispute resolution.169 Such mechanisms furthermore defuse potentially explosive situations in international relations due to the fact that these procedures are institutionalised. Thus, instead of the traditional bilateral settlement of a dispute between two states, relations between the state party concerned and the institutional body are most important.170 To avoid the potential draw-backs of an adversarial procedure, compliance control mechanisms furthermore do not usually aim at a clear and binding judgment, but rather at a factual evaluation.171

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Weizsäcker, supra n. 161, p. 197: Germany’s state debt rose from € 598bn in 1991 to € 1,269bn in 2002 (Figures as of September 2002, cf. Der Spiegel, 19 May 2003, p. 25). In Germany, the state debt ratio in relation to the gross domestic product rose from 21.09 percent in 1950 to 60.13 percent in 1996, despite the safeguards in Article 115 of the German Constitution (Weizsäcker, supra n. 161, p. 188). These developments are not restricted to Germany and can be seen in all OECD states (ibid., p. 189). Marauhn, Thilo, Towards a Procedural Law of Compliance Control in International Environmental Relations, (1996) 56 ZaöRV, p. 698 (hereinafter: Marauhn (1996)). Marauhn, Thilo, Die Durchsetzung von Rüstungskontroll- und Abrüstungsvereinbarungen: Zugleich ein Beitrag zur Effektivität des Vertragsvölkerrechts in Fragen der internationalen Sicherheit, (1999) 74 Die Friedens-Warte, p. 174 (hereinafter: Marauhn (1999)). Ibid., p. 184.


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To gather the information necessary for such evaluations, there are, broadly speaking, two types of procedures that form the core of each compliance control system. On the one hand, there are ‘implementation review mechanisms’, which, in reference to the term used in disarmament law, are described as routine procedures.172 On the other hand, there are ‘non-compliance procedures’, which are used on an ad hoc basis.173 Routine procedures are to a considerable degree inspired by reporting systems in the way in which they first developed in human rights instruments.174 As the name suggests, these are conducted at regular intervals. In contrast, ad hoc procedures, which are a rather new mechanism,175 are initiated only upon request. Since this may also be other states’ parties, abuse is normally avoided by way of the obligation to submit ‘corroborating information’ justifying the examination.176 While routine inspections are meant to provide a positive incentive, ad hoc inspections provide negative incentives.177 4.2.1.1. Information Gathering Confidence building, which is one of the core aspects of compliance control, requires reassurance of the parties, and thus makes a continuing flow of information on the parties’ performance and on the general situation in the regime’s field of operation obligatory.178 Therefore, reporting requirements are included in international agreements of this kind almost without exception.179 Usually, there is an obligation to submit an initial report, which has to be presented within a specified period of time after becoming a party to the treaty. The data contained in

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See e.g. for a description of the relevant mechanism in the Chemical Weapons Convention of January 1993: Marauhn, Thilo, Der deutsche Chemiewaffen Verzicht: Rechtsentwicklungen seit 1945, Berlin 1994, p. 350 et seq. This terminology is also borrowed from disarmament law (cf. Marauhn (1999), supra n. 170, p. 183). Partsch, Karl Josef, Reporting Systems in International Relations, in: Bernhardt, Rudolf (ed.), Encyclopedia of Public International Law, Vol. IX Amsterdam 1986, p. 326 et seq. Marauhn (1996), supra n. 169, p. 699. See ibid., quoting the examples of the 1987 Montreal Protocol on Substances that Delete the Ozone Layer and of the 1994 Oslo Protocol to the 1979 Convention on Long-Range Transboundary Air Pollution on Further Reduction of Sulphur Emissions. Marauhn (1999), supra n. 170, p. 182. Chayes, Abram; Handler Chayes, Antonia, The New Sovereignty: Compliance with International Regulatory Agreements, Cambridge 1995, p. 154. Ibid.

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the initial report is used as a baseline for the future implementation of the agreement.180 In addition to the initial report, further reports are to be submitted at regular intervals.181 However, the more data states have to provide and the more regularly reports have to be submitted, the more difficult it becomes for states to comply with those obligations. Developing countries in particular will often be unable to cope with the requirements due simply to a lack of qualified personnel.182 Furthermore, extensive and frequent reporting requirements have to be balanced against the cost-efficiency of those measures.183 Moreover, while self-reporting might increase transparency and build confidence, the reliability of information obtained in that way is limited. A state will rarely be willing to report information showing it to be in breach of its obligations. In other words, the inherent danger in a self-reporting system is that there might be a complete failure to report fully and on time, or that the data reported might be inaccurate. Hence “[s]elf reporting is only the beginning, not the end of the data-gathering process.”184 Other sources of information for the assessment of a state’s compliance with agreed standards are submissions by other state parties or NGO’s and on-site inspections.185 While other national governments are often hesitant to comment critically on the behaviour of a fellow state, the wide range of economic data that is generated by business groups and private organisations can be an essential source of information.186 Most importantly, they can play a role by demonstrating a counterweight to the information provided by states.187 However, the influence of such groups and organisations is currently limited under most compliance control instruments, since these do not contain provisions explicitly specifying the role of NGOs in the reporting procedure.188

180 181 182

183 184 185 186 187 188

Marauhn (1996), supra n. 169, p. 699. Ibid. This is not surprising in view of the often extreme complexity of reporting obligations. For instance, a special handbook had to be published to explain the obligations under the Chemical Weapons Convention (Marauhn (1999), supra n. 170, p. 178). Beyerlin/Marauhn, supra n. 99, p. 99. Chayes/Handler Chayes, supra n. 178, p. 162. Beyerlin/Marauhn, supra n. 99, p. 99. Chayes/Handler Chayes, supra n. 178, p. 164. Beyerlin/Marauhn, supra n. 99, p. 100. Marauhn (1996), supra n. 169, p. 710.


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On-site inspections constitute another important source of information. This mechanism is well-known from disarmament law and arms control.189 On-site inspections can provide valuable insights, as the visiting inspectors set foot on the territory of the state party concerned, and are thus able to learn more about a particular issue with their own eyes. 4.2.1.2. National Sovereignty v. Objectivity of Information – Procedural Principles in International Compliance Control While they are, without doubt, a valuable source of information, such onsite visits are at the same time a sensitive issue. Most importantly, on-site inspections are the means that interfere most with national sovereignty. Indeed, inspections contain an element of intervention, not only because the inspectors enter the party’s territory, but also because the inspectors may find information that the member state does not want to reveal, or that it is at least not eager to make known.190 Consequently, it is customary for this form of information gathering to be undertaken only upon invitation by the party concerned.191 Moreover, to give due respect to the sovereign’s rights, a quasi judicial set of procedural principles, comparable to the principles in sovereign debt reorganisation, is emerging in the area of international compliance control.192 Marauhn mentions five fundamental procedural principles: – the principle of procedural co-operation: this is almost self-evident, as compliance control is to be used as a means for confidence-building. The activities of the supervisory body thus may not be an end in themselves, but enhance the confidence between the parties.193 – the right to be heard: this right flows from the principle of procedural co-operation and guarantees that a state has the opportunity to respond to accusations and to submit further information.194

189 190 191

192 193 194

For respective examples see e.g.: Marauhn (1999), supra n. 170, p. 180 et seq. Ibid. The body responsible for the compliance control will of course be allowed to request such ‘invitation’; cf. Marauhn (1996), surpa n. 169, p. 712, describing the mechanism in the 1987 Montreal Protocol on Substances that Deplete the Ozone Layer. For disarmament and arms control see: Marauhn (1999), supra n. 170, p. 181. Marauhn (1996), supra n. 169, p. 724. Ibid., p. 725 et seq.

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– the principle of equal treatment: this principle can be found inter alia in instruments such as the Charter of the United Nations.195 Nevertheless, an explicit acceptance of this procedural principle in compliance control instruments is desirable.196 – the principle of proportionality: this principle is a traditional element of customary international law, for instance concerning the appropriateness of reprisals and self-defence.197 Particularly in view of the concept of sustainable development,198 its central purpose is to avoid the hampering of a state’s economic and technological development.199 – the principle of protection of confidential information: to some extent there is an unavoidable conflict between the principle of protection of confidential information and the principle of transparency.200 Transparency was already considered to be an essential element of confidence building in compliance control procedures. Nevertheless, it has to be restricted, so that no sensitive public or confidential business information is made publicly available, since this could cause ‘counter productive’ results, most notably all sorts of ‘runs’. 4.2.2. Compliance Control in International Financial Relations The following section will provide a comparison of two compliance control mechanisms in international financial relations: on the one hand, the IMF’s consultation mechanism pursuant to Art. IV IMF Agreement,201 which demonstrates in almost exemplary fashion the features of a traditional compliance control instrument (4.2.2.1); on the other hand, the surveillance scheme established under the European Monetary Union’s (EMU) Stability and Growth Pact

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Article 2 (1). Beyerlin/Marauhn, supra n. 99, p. 109. Shaw, supra n. 25, p. 1031 et seq. The goal of sustainability is obviously disregarded under most of the present restructuring efforts, as evidenced by the fact that numerous (notably developing) countries in the meanwhile restructured their debt ten or more times (see: Miller, Jessica W., Solving the Latin American Debt Crisis, (2001) 22 University of Pa. J. Int’l. Econ. L., p. 684). Marauhn (1996), supra n. 169, p. 728. Ibid. Available at: www.imf.org/external/pubs/ft/aa04.htm.


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(SGP),202 which can be described as an advanced regional derivative of the international compliance control model will be summarised (4.2.2.2). 4.2.2.1. IMF Surveillance under Article IV IMF Agreement The IMF can be regarded as the most important institution in international financial relations. It was established as part of the Bretton Woods System in 1945. The IMF is funded by quota subscriptions, which are paid by member countries.203 These quotas not only determine the amount of financing each member country can receive from the IMF, but also its voting power in the IMF board of directors.204 The U.S., for example, has a high quota subscription and therefore significant voting power on the board. Together with the World Bank, the IMF was established to reduce worldwide poverty and to create stable economies. While the World Bank’s role has traditionally been to grant loans and provide programs that seek to encourage poverty-reduction measures, mostly through social services, the IMF nowadays increasingly focuses on helping states to develop (and/or sustain) sensible macroeconomic policies and enact structural reforms where necessary.205 The IMF has several tools at its disposal for this purpose. On the one hand, the IMF, in lending money, supports reforms that will correct underlying problem by way of domestic economic policies. As such, loans to countries are made contingent upon acceptance of a plan for moving toward a sustainable economic system (conditionality).206 On the other hand, the IMF is also allowed, and indeed obliged, to monitor and consult member countries in the course of the surveillance procedures under Article IV IMF

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One might argue that the increased homogeneity among member states of the EMU, or its differing means of enforcement compared to the IMF, make inappropriate a comparison of these schemes. But on the contrary, a new surveillance scheme to deal with the sovereign debt crises will undoubtedly be influenced by both of these schemes and the new scheme will therefore only benefit from the different experiences that its ‘predecessors’ have undergone. See: IMF, What is the International Monetary Fund?, Washington 2002, available at: www. imf.org/external/ pubs/ft/exrp/what.htm. Ibid. Cf. Asp, David, Argentina’s Mystery of Capital – Why the International Monetary Fund Needs Hernando de Soto, (2003) 12 Minn, J. Global Trade, p. 387. Weigeldt, Klaus, Die Konditionalität des Internationalen Währungsfonds in ihrem Verhältnis zur Staatssouveränität und zu den Menschenrechten, Aachen 1999, particularly p. 30 et seq.

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Agreement.207 This article stipulates in section 1 that “each member undertakes to collaborate with the Fund to promote exchange stability” in order to ensure the effective operation of the international monetary system.208 This mandate is interpreted broadly209 so that the IMF’s assessment of exchange rate policy requires a comprehensive analysis of the general economic situation and policy strategy of each member country.210 IMF surveillance covers a wide range of policies, including monetary and fiscal issues, as well as financial sector policies or institutional issues, such as central bank independence or policy transparency and accountability.211 Since 1994, routine consultations have usually taken place once a year in each member country, regardless of its economic and financial situation.212 Ad hoc controls, known as ‘special consultations’, are conducted at the instance of the managing director of the IMF, if developments warrant it.213 The process begins with the internal draft of a ‘mission brief ’ by the relevant IMF area department, subject to review by other departments concerned,214 and the submission for final approval by the management.215 The second stage is an on-site visit of about two weeks duration by a team

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See: IMF, IMF Surveillance – A Factsheet, available at: www.imf.org/external/np/exr/ facts/surv.htm. Ibid. Selmayr, Martin, Das Recht der Währungsunion – Band I: Die Vergemeinschaftung der Währung, Baden-Baden 2002, p. 73. Cf. Executive Board Decision No. 5392, 29 April 1977; some commentators refer to an extensive interpretation of Art. IV Section 3 (b) (cf. Steinhauer, Bettina M., Die Auslegung, Kontrolle und Durchsetzung mitgliedstaatlicher Pflichten im Recht des Internationalen Währungsfonds und der Europäischen Gemeinschaft, Berlin 1997, p. 61). Cf. the comprehensive list given by the IMF, supra n. 207. This equal treatment of member states has been part of IMF Article IV consultations since 1993. Before, only those economies that had borrowed from the Fund or which were considered to be of particular importance for the global economy were inspected annually, while other states were only inspected biannually (Steinhauer, supra n. 210, p. 62 et seq). Furthermore, the mechanism of self-reports plays a role concerning the information that members are obliged to submit to the Fund within the limits of Article VIII (5) IMF Agreement, notably in connection with the on-going need for justification of capital controls pursuant to Article VIII (2) (a) IMF Agreement. Crow, John et al., External Evaluation of IMF Surveillance: Report by a Group of Independent Experts, Washington D.C. 1999, p. 24. I.e. the Managing Director or one of the Deputy Managing Directors.


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of IMF staff members,216 during which the team will gather information mainly through co-operation with officials from the finance ministry, the central bank and other ministries involved in the formulation of economic policy.217 There may also be meetings with the private sector and NGOs.218 After returning to headquarters the team will prepare a staff report, which represents the final view of Fund staff and management regarding the country.219 It summarises the economic situation of the member state, points out deficits pertaining to foreign trade and recommends possible amendments.220 Inflation is usually the main focus of these reports.221 Since 1997, a summary of the staff reports has been made publicly available, provided the member country does not object on the grounds that, in its judgment, market sensitive information should not be disclosed.222 The protection of confidential information thus remains guaranteed. Following approval by the management, the report is submitted to the Executive Board, where it is discussed by the Executive Directors. These discussions include comments, criticisms, and suggestions for policy changes. The member countries’ right to be heard is accommodated by the representation of the member countries in such discussions by ‘their’ Executive Directors.223 In respect of the principle of proportionality, the discussion ends with a conclusion on the economic situation in the member state, which is regarded as a “compendium of views on the member’s position” rather than a “collective judgment of an organ of the fund”.224 While legally non-binding, Article IV consultations provide resources for the member country, allowing it to objectively assess its economy and existing undesirable trends and, in turn, positively influence future domestic economic policies.

216 217 218 219 220 221 222

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Usually four to five staff members. Crow, supra n. 214, p. 25. Ibid. Ibid. Steinhauer, supra n. 210, p. 60. Stiglitz, Joseph, Globalization and Its Discontents, New York 2002, p. 267. The reports are published in so-called Public Information Notices (PIN). They are available at: www.imf.org/cgi-shl/create_x.pl?pn. It is worth mentioning, however, that the views expressed in the PINs do not speak for the Fund and do not necessarily correlate with the views of the Executive Board, which speaks for the Fund (Gianviti, supra n. 108, p. 109). Steinhauer, supra n. 210, p. 60. Ibid., p. 61.

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4.2.2.2. Compliance Control under the SGP While the IMF, with its 184 member states, can be seen as a truly global surveillance institution, compliance control under the SGP is restricted to the region of the EMU member countries. The SGP contains an advanced variant of compliance control, with an elaborated modus of gradual sanctions intended to enhance the preventative effects. As a precondition to participation in the third and final step of the EMU, member countries had to comply with the convergence criteria established by Article 121 (3) EC.225 A central objective of the EMU is the creation of a zone of long-term macroeconomic stability,226 notably by means of price stability.227 To this end, the SGP was adopted in 1997 as a package of one political declaration228 and two regulations.229 The surveillance procedure under the SGP can be divided into three steps: prevention, dissuasion and sanctions.230 First, each EMU participant is required to submit reports – so-called ‘stability programs’ – to the Commission on an annual basis.231 The Commission then assesses the budgetary discipline of each member state on the basis of these programs.232 In doing so, it considers two main criteria, namely whether the ratio of the actual or planned government deficit to GDP exceeds the reference value of 3 percent of GDP and whether the ratio of government debt to GDP exceeds a reference value of 60 percent of GDP.233 If a member state breaches one or both of these criteria, and in the absence of special circumstances, the

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In more detail: Peters, Michaela, Die Konkretisierung des Art. 104 EG durch den Stabilitäts- und Wachstumspakt und dessen Vereinbarkeit mit dem EG-Vertrag, Bonn 2002, p. 9 et seq. EC, Council Regulation EC/1466/97 consideration 1. Cf. Herdegen, Matthias, Price Stability and Budgetary Restraints in the Economic and Monetary Union: The Law as Guardian of Economic Wisdom, (1998) 35 CML Rev., p. 15. EC, Council Resolution 97/C 236/01 of 17 June 1997. EC, Council Regulation 1466/97 of 7 July 1997; Council Regulation 1467/97 of 7 July 1997. Konow, Christian, Der Stabilitäts- und Wachstumspakt, Baden-Baden 2002, p. 29 et seq, mentions, as a fourth step, the lifting of sanctions. EC, European Economy 3/2000, p. 47, non-participating EU member states must submit ‘convergence programs’, (Lembergen, Werner van; Wachenfeld, Margaret G., Economic and Monetary Union in Europe, (1998) 22 Fordham Int’l. L. J., p. 32). As to verification rights by the Commission in general cf. Steinhauer, supra n. 210, p. 154 et seq. Principle of equal treatment. EC, Public Finances in EMU 2003, p. 42.


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Commission shall, in accordance with Article 104 (3) EC prepare a report. On the Commission’s initiative, and taking into account the observations of the member state concerned,234 the Council, in the form of the Ecofin Council, decides whether there is an excess deficit.235 The identification of an excess deficit leads to the second, dissuasive, step of the surveillance mechanism and triggers a sequence of graduated responses.236 Within defined time limits, the Council will issue a confidential recommendation, publish the recommendation and issue a final warning.237 The recommendations are made with a view to remedying the excessive deficit within a given period.238 Should there be no action by the member country in response to the recommendations, the Council can make them public.239 If the member state continues to ignore the recommendations, the Council may require the state to submit additional information in accordance with a fixed timetable.240 In the event that the country still fails to correct its excessive deficits, sanctions will eventually be adopted in accordance with Article 104 (11) EC, requiring the member state to make a non-interest-bearing deposit of an appropriate size with the EU,241 possibly supplemented by other measures, such as additional document disclosure for debt issues and restrictions on lending from the European Investment Bank (EIB).242 Pursuant to Article 104 (13) EC, decisions are passed by a two-thirds majority excluding the member country against which action is to be taken. In order to take into account exceptional circumstances with a major impact on the country’s

234 235

236

237 238 239 240 241

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Implementation of the procedural right to be heard. Hahn, Hugo J., The Stability Pact for European Monetary Union: Compliance with Deficit Limit as a Constant Legal Duty, (1998) 35 CML Rev., p. 88. Principle of Proportionality (Meyers, Jan; Levie, Damien, The Introduction of the Euro: Overview of the Legal Framework and Selected Legal Issues, (1998) 4 Colum. J. Eur. L., p. 330). Art. 104 (7)–(9) EC. Hahn, supra n. 235, p. 88. This is the exception. The rule is protection of confidential information. Hahn, supra n. 235, p. 88. Co-operation remains thus the central element of the SGP. The deposit will turn into a fine if, in the Council’s judgment, the excess deficit is not corrected within two years (EC, Council Resolution 97/C 236/01 of 17 June 1997 consideration 5). Konow, supra n. 230, p. 165 et seq.

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financial position, Regulation 1467/97 allows certain flexibility in applying those sanctions.243 4.2.2.3. Comparison The IMF Article IV Consultations and the excessive deficit control under the SGP are similar. Both can be characterised as indirect auto-control procedures. While the fact-finding process is in the hands of expert groups, i.e. the Commission, in the case of the EMU, and technical staff in IMF Consultations, the final decisions are taken by political bodies, namely the Council and the Executive Board, respectively. Moreover, these procedures take place at regular annual intervals. However, while the IMF bases its fact-finding process mainly on on-site inspections, the Commission’s recommendations are primarily based on the information submitted by the member states. Further differences arise with regard to the voting procedure. The IMF is consensus oriented. As far as possible, decisions are to be made unanimously. There is no legally binding decision at the end of consultations. Even if the IMF is de jure allowed to make legally binding decisions, as in the case of interpretation issues according to Article XXIX IMF Agreement, it is reluctant to do so. The efficiency of IMF decisions is dependent on voluntary observance by the member states. Binding decisions are thus as worthwhile or worthless as non-binding ones.244 However, if a member state refuses to observe a binding decision, this undermines the Fund’s authority.245 In contrast, excessive deficit procedures may well lead to binding recommendations and sanctions, even against an opposing minority of member states. Binding decisions are possible in the EU, as there is a general consensus among member countries as to their observance.246 On balance, these results demonstrate the different levels of integration between the IMF, with a nearly worldwide membership, and of the EMU, with significantly fewer members from only one region. Discussions concerning a compliance control system will thus have to address the issue of whether

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244 245 246

Hahn, supra n. 235, p. 92 et seq.; Herdegen, supra n. 227, p. 31 notes that, while such discretion deprives the sanction mechanism of its automatism, a certain elasticity within the sanction regime must be accepted as a compromise, as more ambitious projects would have been beyond what could realistically have been achieved. Steinhauer, supra n. 210, p. 50. Ibid., p. 51. Ibid., p. 264.


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an international or a regional solution would provide a better institutional framework for compliance control in financial relations. 4.3. The Institutional Framework for Compliance Control 4.3.1. Compliance Control by an International Body? One might consider transferring the regulatory tasks to the institutions that already deal with the restructuring of state debts at present. These are, above all, the IMF; the Paris Club, where the countries re-negotiate their debt with official creditors; and the London Club, for the re-negotiation of private creditor debts. Thus far, IMF controls have not been able to prevent sovereign debt crises. Some critiques even argue that the IMF’s crisis management system only accelerated the outbreak of such crises.247 The Paris and the London Club, similarly, do not provide viable alternatives. Neither are they formal international institutions, nor do they have any legal status, nor the resources that would be necessary to fulfil the task of an institution responsible for the international surveillance of state finances.248 It may also be doubtful whether countries, in particular debtor countries, would co-operate with these creditor organisations. In the banking context, proposals for the establishment of a new ‘world regulator’, which would be a supra-national institution with competence to control domestic regulatory bodies, have been made.249 By analogy, one could suggest the creation of a new institution for global monitoring of domestic economic and financial policies. Indeed, commentators expect that it is only a matter of time until an international organisation with the task of monitoring observance of international financial standards is established.250 Due to the high level of interests at stake in the international financial market, this trend is becoming more and more apparent. Demands for oversight

247 248 249

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Eichengreen/Portes, supra n. 46, p. 5. Ibid. See the proposal by Kaufman, Henry, The New Financial World: Policy Shortcomings and Remedies, in: Fuhrer, Jeffrey C.; Schuh, Scott, Beyond Shocks: What Causes Business Cycles, FRBB Conference Series No. 42, Boston June 1998, p. 365 et seq. Morais, Herbert V., The Quest for International Standards: Global Governance vs. Sovereignty, (2002) 50 U. Kan. L. Rev., p. 813.

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boards for auditing firms,251 or a closer surveillance of the implementation of international financial standards,252 illustrate this development. The litmus test for such an international ‘super regulator’ would, however, be whether it would be possible to agree on certain standards (4.3.1.1) and whether decisions by this body could be efficiently enforced (4.3.1.2). 4.3.1.1. The Diversity of Standards for Macro-economic Stability The basis of compliance control mechanisms, such as surveillance under Art. IV IMF Agreement and the SGP, is the disclosure of relevant economic and financial data. However, the establishment of common minimum standards for macro-economic soundness could pose significant problems on an international level. Thus, the SGP relies on the ratio of government deficit, or, as the case may be, government debt to GDP in the SGP, while under IMF surveillance inflation is the most relevant factor. The decision as to which factors should be applied in the sovereign context is a difficult one and cannot be taken globally. As Stanley Fischer stated: [. . .] debt criteria taken from Maastricht and the advanced industrial economies are not appropriate for emerging markets countries.253

For example, with regard to the development of Argentina’s government debt/deficit – GDP ratios, both values were well below the critical SGP reference values of 60,254 respectively 3255 percent. Nevertheless, markets lost confidence in Argentina256 while they still believe (and are likely to continue to believe) in economies such as Portugal, which has repeatedly exceeded these ratios.257 Incidentally, the IMF’s inflation criterion was scarcely any better at predicting the Argentine crisis, as Argentina’s insolvency rate since 1995 did not exceed 3.4 percent and then even fell below zero percent.258 251 252

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254 255 256

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BIS, 73rd Annual Report (1 April 2002–31 March 2003), Basel, 30 June 2003, p. 150. G7, Declaration of the G-7 Finance Ministers and Central Bank Governors, 30 October 1998, available at: www.imf.org/external/np/g7/103098dc.htm. Fischer, Stanley, Farewell to the IMF Executive Board, Washington D.C. 30 August 2001. Concerning the ratio of government debt to GDP. Concerning the ratio of the actual or planned government deficit to GDP. For a detailed discussion of the reasons see: Hausmann, Ricardo; Velasco Andrés, Hard Money’s Soft Underbelly – Understanding the Argentine Crisis, Harvard July 2002. Portugal confirmed a deficit of 4.1 percent of GDP in 2001 in its report submitted to the Commission by 1 September 2002 (see: EC, Public Finances in EMU 2003, p. 45). Baer, Werner et al., The Achievements and Failures of Argentina’s Neo-Liberal Economic


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Therefore, an instrument for international compliance control would have to provide for sufficient flexibility. 4.3.1.2. The Enforcement Deficit in International Compliance Control As mentioned previously, international compliance control is a mechanism based on voluntary co-operation. If a party refuses to co-operate, a gap of enforcement results. A technique used by the IMF is conditionality. Conditionality, as explained above, means the granting to a member country of a loan which is contingent upon the country’s agreement to a plan for moving toward a sustainable economic system.259 Whether this solution truly improves compliance is doubtful. Even if less powerful developing countries adopt a raft of IMF-backed measures to secure IMF approval for their next loan tranche, countries will often start to modify or cancel laws adopted under IMF tutelage immediately after they cease to depend on IMF resources.260 There might, therefore, be significant obstacles to efficient enforcement of compliance control at the international level. 4.3.2. A Regional Compliance Control Body Summing up, regional diversity and the possible enforcement deficit speak against global compliance control in international financial relations, as well

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Policies, (2002) 30–1 Oxford Development Studies, p. 65. A drastic example of regionally diverging standards for the assessment of the health of an economy is the requirement for EMU member states to extensively discuss the effects of ageing populations on the domestic budgets (cf. in general: EC, European Economy 2000, p. 54 et seq). In contrast, such requirements almost appear macabre in some African countries, where life expectancy – mainly due to AIDS – is estimated to decline by fourteen years until 2010 (UNAIDS, Statement at the Third Ministerial Conference, www.unaids.org/publications/documents/ health/access/wtostatement.html). Critics argue that the IMF thereby intrudes on state sovereignty, specifically the ability of states to set their own domestic policy (cf. Mendoça, Maisa, A Question of Sovereignty: Brazilian Governors Fight Back Against the IMF, Global Exchange Campaigns, 25 March 1999, available at: www.globalexchange.org/campaigns/ brazil/economy/sovereignty. html). However, IMF standby-agreements are made dependent on a prior letter of intent of the prospective debtor country, which already specifies, which measures shall be taken to conform domestic policy to IMF conditions. According to the principle volenti non fit iniuria an intrusion to national sovereignty thus does not exist (Weigeldt, supra n. 206, p. 193). An example of such developments is Thailand (FT-Europe, 1 August 2003, p. 6).

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as against an international surveillance institution. Alternatives might be to rely either on domestic or on regional compliance control. It is true that each country could certainly, in principle, fulfil the task of compliance control more efficiently than any other institution. Such an arrangement, however, creates a clear conflict of interest.261 Countries would always be tempted to be too optimistic, for both political and economic reasons,262 in particular if the governing parties are subject to the various incentives of political competition in democracies, which in so far could be misleading. Against this backdrop, regional institutions would provide a viable alternative.263 They would have the advantage of providing a middle ground between national and international bodies. Of course, this approach would have to ensure that greater regional integration does not develop at the expense of splitting the world into regional blocks. Nevertheless, regional institutions would be beneficial because they would be able to take advantage of geographical proximity and cultural understanding and would be able to adopt compliance control standards that are suited to regional circumstances.264 Regional organisations can make far better use of peer pressure to overcome the gap of enforceability. In fact, a fast and determined process of decision taking in the IMF is generally thwarted by the impossibility of applying such peer pressure.265 For instance, critics note that statements of the IMF, such as those concerning surveillance advice, are often insufficiently frank and direct266 and rather “resemble debate in the United Nations Security

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Cf. Crow, supra n. 214, p. 18. Ibid. Cf. Asian Development Bank Institute, Regional Arrangements for Strengthening Financial Architecture in Asia, Executive Summaries Series No. 19/00, 2000, available at: www. adbi/org/archive/arch_es.htm.; Bergsten, Fred, Missed Opportunity, (1998) 12–6 International Economy, p. 26 et seq.; Stiglitz, supra n. 221, p. 267; Yokoi-Arai, Mamiko, Regional Financial Institutionalization and the Creation of a Zone of Law: The Context of Financial Stability/Regulation in East Asia, (2001) 35 Int’l Law., p. 1627 et seq. Kong, Quingjang International Regulation of Finance: Is Regionalism a Preferred Option to Multilateralism for East Asia? In: Marauhn, Thilo; Grote, Rainer, The Regulation of International Financial Markets – Perspectives for Reform, Cambridge 2006, p. 105. As in trade, regionalism in finance can be seen as a stepping stone for multilateralism, cf. the letter to the editor by Pradumna B. Rana, Director of the ADB’s Regional Economic Monitoring Unit, FT-Europe, 12 August 2004, p. 10. Bergsten, supra n. 263, p. 26. Crow, supra n. 214, p. 36.


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Council”267 where a nuanced and diplomatic language prevails simply in order not to offend domestic sensitivities.268 However, the use of peer pressure, which could help to overcome those obstacles, would require the existence of a community of states and the identification of the respective country with that organisation.269 Such a community does not exist among the more than 180 IMF member states. In contrast, within smaller, geographically contiguous groups of countries, there exist much stronger forces of self-interest and immediate concern than in an international IMF-style organisation.270 Furthermore, enforcement in regional organisations may, on the one hand, benefit from the superior power of a state in the region while on the other hand enforcement measures can be carried out on terms and conditions that are more acceptable for less powerful states.271 The choice of a regional option is also backed by economic considerations. Thus, although there is a lot of talk about a globalised economy, such an economy does not yet exist. Instead, economists still cluster groups of countries into certain ‘neighbourhoods’ when they have to decide which countries are treated similarly272 and international organisations still assess the economy of emerging markets and advanced economies in different

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FT, 4 March 2003, p. 18. How sensitive governments can react in face of unfavourable reports about their domestic economy is illustrated by Germany, where officials, after a critical assessment of Germany’s credit worthiness by the three biggest privately owned rating agencies Fitch, Moody’s and S & P accused these American companies of a bias against Germany and its companies (see: FT, 18 June 2003, p. 45). Leben, Charles, Les Sanctions privatives de droits ou de qualité dans les organisations internationales spécialisés, Brussels 1979, p. 285. Kong, supra n. 264, p. 106; see also the already above mentioned letter to the editor by Pradumna B. Rana, writing that steps to implement a local currency-denominated bond market in Asia have been initiated “with the ultimate objective of applying peer pressure on each other to bring regional markets up to global standards”, FT-Europe, 12 August 2004, p. 10. The usefulness of regional institutions is thus inter alia acknowledged by Article 53 of the UN Charter in respect of maintenance of international peace and security. In line with this provision, commentators argue for an enhanced co-operation of the UN Security Council and (strengthened) regional organizations such as NATO (Murphy (1994), supra n. 97, p. 282 et seq.). This model is for instance used by investors when one country is in financial difficulties. All other countries in its neighbourhood will then also be affected by a run of the investors on the assets of those countries, Chun, supra n. 142, p. 2668.

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sections, as well as distinguishing between the major regions in these country groups.273 Furthermore, as experience demonstrates, while forced communities, such as the Former Republic of Yugoslavia, are almost doomed to fail, voluntary unions that prove to be successful, like the EU, receive requests for accession even from beyond their (geographic) limits.274 The growth of regional unions into more global unions thus cannot be excluded. However, instead of a ‘big-bang approach’,275 the establishment of regional regulatory institutions would be a gradual and systematic undertaking, which, by first preparing a regional basis, enables a later convergence between the different regional bodies. This approach takes into account the fact that the development of structures that are appropriate for a global regulatory body is an evolutionary and educational process.276 Finally, the regional approach coincides with world-wide political initiatives to strengthen regional co-operation and, consequently, does not have to overcome such significant levels of political resistance when it comes to implementation.277 Apart from the EMU – which is certain to grow over the coming years, either due to the accession of the still outstanding EU members, or due to new EU member countries that qualify for the EMU – there are, for instance, the African monetary unions of the CFA-Franc countries278 or the Mercosur in South America, which is also to be developed further into a monetary union similar to the EMU.279 However, monetary unions are still absent in large parts of the world. An 273 274 275 276 277 278

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Cf. BIS, supra n. 251, Section II/III. See e.g. the vividly discussed case of Turkey. Morais, supra n. 250, p. 819. Cf. Marauhn (2003), supra n. 112, p. 298. Cf. Eichengreen, supra n. 109, p. 93 et seq. Consisting of the UEOMA (Union économique et monétaire ouest-africaine) and the CEMAC (Communauté économique et monétaire de l’Afrique Centrale); cf. in detail: www.izf.net/izf/index.htm. Cf. press notice from 14 January 2003: Duhalde y Lula darán un nuevo impulso al Mercosur, available at: www.calsa.com/br/cweng/noticias/cadnoticia1.asp?tit=Duhalde+y+Lula+da rán+un+nuevo +impulso+al+Mercosur+. Significant steps toward a growing integration of the Mercosur member states are, in particular, the election of Eduardo Duhalde as the first President of the Commission of Permanent Representatives – an institution often compared to the president of the EU Commission – at the 25th summit of the Mercosur in December 2003. Furthermore a permanent Court of Appeal was created (see e.g.: Woischnik, Jan, Mercosur: neuer Präsident, neues Gericht, neues Sekretariat, (2004) 20 KAS-AI, p. 82 et seq.).


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alternative would be to refer the establishment of the compliance control body to regional development banks. Such institutions have been established around the world. They include the African Development Bank (AfDB), the Asian Development Bank (ADB), the Caribbean Development Bank (CDB), the European Bank for Reconstruction and Development (EBRD) and the Inter-American Development Bank (IADB).280 These banks have the expertise and could receive the resources necessary to provide the institutional framework for a compliance control body in international financial relations. On balance, it is suggested that the Model Convention should provide for the establishment of compliance control bodies. These bodies should be located at the level of regional development banks. 4.3.3. The Case for an Advisory Committee The compliance control body could be supported and supplemented by an Advisory Committee of independent experts which, without having a right to make binding decisions, should upon request by a country or its population, pronounce its opinion with respect to IMF decisions in the context of sovereign loans.281 The World Bank Inspection Panel could be taken as a model for such a committee.282 This panel was the first independent mechanism of an international organisation to respond to claims by private citizens who feel that they have been, or could potentially be, harmed by the international institution’s decisions. Upon receipt of a request, the panel investigates the case and submits its finding to the World Bank management, which then will make its final decision.

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There are significant fresh moves to create an “East Asian Community” including initiatives towards a regional bond market with a regional clearing and settlement system, a bond rating system, a trading system and so on. While, when such ideas were first proposed in the 1990’s by Mahatir Mohamad, the then Malaysian leader, and in 1997 by Japan, the US put an effective veto on these plans, Asian nations seem to be less susceptible to Washington’s pressure this time (FT-Europe, 5 August 2004, p. 5); see also Yokoi-Arai, supra n. 263, p. 1668, suggesting the establishment of an Asian Development Fund at the ADB. Kranz, Jerzy, Le droit du Fonds monétaire international et les affaires des pays membres, (1986) 29 GYIL., p. 135. Cf. Shihata, Ibrahim F., The World Bank Inspection Panel: In Practice, 2nd ed., Oxford 2000.

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By analogy, the Advisory Committee could monitor the provision of a minimal standard of living and the respect of elementary human rights for the debtor state’s population in the negotiated reorganisation agreement. It would present its findings to the negotiating parties, as well as to the regional compliance control body. To avoid potential public pressure, the parties could agree to adapt their reorganisation agreement. In this case the Committee’s report would not be made public. The Advisory Committee could also work as a mediator in creditor-debtor negotiations if they otherwise reached at a deadlock.283 This would require a request by one of the negotiating parties. Instead of creating a new committee, an alternative solution could be to refer that task to those panels already established at the regional development banks.284 This solution might be less costly. Furthermore, the ‘panelists’ are already on the spot and they usually have better background knowledge of the overall situation in a particular country in their region. This could be helpful as otherwise, reports would be drafted based solely on the impressions gathered during a ‘short-trip’ to the respective country. The Model Convention should therefore provide for the establishment of an Advisory Committee to complement the regional compliance control body. Both should be installed at the (existing) regional development banks. The framework of compliance control procedures should be modelled on the SGP and Article IV Consultations. Due regard should be paid to the protection of procedural rights during these procedures. It is recommended that an Advisory Committee should monitor the observance of those rights. 4.4. Compliance Control and Lender of Last Resort Function It is proposed that international credit insurance could significantly increase the preventative impact of a compliance control system.285 Specifically, it is argued that, if in a domestic banking context bank-runs can be eliminated

283 284

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Kranz, supra n. 281, p. 135. In fact, all important IFIs, above all the African Development Bank, the Asian Development Bank, and the Inter-American Development Bank have, in the meantime, created panels similar to the World Bank Inspection Panel, but the IMF has not (Morgan-Foster, Jason, The Relationship of IMF Structural Adjustment Programs to Economic, Social, and Cultural Rights: The Argentine Case Revisited, (2003) 24 Mich. J. Int’l L., p. 639 n. 311). Soros, George, The Crisis of Global Capitalism – Open Society Endangered, New York 1998, p. 176 et seq.; idem, FT, 31 December 1997, p. 12.


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by the provision of a safety net, an analogous institution should be created to stop state debt runs.286 The contemporary credit insurance schemes used in the domestic banking sector date back to a proposal by Bagehot, who suggested the creation of a Lender of Last Resort (LLR), i.e. an institution “willing [. . .] to accept a risk unacceptable to other lenders” to guarantee the prompt award of aid prior to securing policy reforms287 where banks are in a liquidity crisis.288 Its international counterpart could be modelled along the lines of the Multilateral Investment Guarantee Agency (MIGA).289 Accordingly, countries would underwrite the cost of insurance by paying a fee when floating loans. In the case of a sovereign in financial distress, the deposit insurance would first of all, on account of its mere existence, reassure creditors that their investments are safe, thereby reducing the likelihood of a run. If a run were nevertheless to takes place, the deposit insurance would provide the funds necessary to compensate the creditors. However, deposit insurance schemes are prone to moral hazard problems.290 Furthermore, an insurance scheme would require that all loans were insured. Hence, severe difficulties arise if loans do not qualify for insurance because they exceed the economically sound level of debt that a country can handle.291 Due to these concerns, in practice there is no sovereign debt insurance fund, but rather the IMF, which has emerged as quasi292 or de facto,293 LLR.294

286 287

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290 291 292

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Ibid. Guttentag, Jack; Herring, Richard, The-Lender-of-Last-Resort Function in an International Context, (1983) 4 Essays in International Finance No. 151, p. 4. The term ‘lender of last resort’ is attributed to Sir Francis Barings, who, in 1797, spoke about the Bank of England as dernier resort from which all banks could receive liquidity in times of crisis. Ironically his heirs lived to see the failure to rescue the Barings Bank in 1995 (see: Lastra, Rosa Maria, Lender of Last Resort: An International Perspective, (1999) 48 International and Comparative Law Quarterly, p. 340). Silard, Stephen A., International Law and the Conditions for Order in International Finance – Lessons from the Debt Crisis, (1989) 23 Int’l Law, p. 974. Garcia, supra n. 157, p. 5. Eichengreen, supra n. 109, p. 86 et seq. Meltzer, Allan, Report of the International Financial Institution Advisory Commission 2000, available at: www.house.gov/jec/imf/ifiac.htm. Lastra, supra n. 288, p. 355. In contrast to a ‘true’ LLR, the IMF lacks the powers of a central bank; it cannot create money and does not have the resources to cover all potential foreign exchange obligations.

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Whether the bail-outs implemented by the IMF are necessary, or on the contrary harmful, is a heavily disputed issue. This is also reflected by the fact that the EMU introduced a strict ‘no bail-out clause’.295 Once again, a comparison of the ratio and effects of both these systems will be insightful. 4.4.1. A Comparison of the (No) Bail-out Policies of the IMF and the EMU In recent years the IMF has adopted assistance programmes for troubled countries on an ad hoc basis. Nevertheless, the consistent outcome has been significant lending and more or less full repayments to foreign creditors.296 IMF bail-outs have been criticised for creating moral hazard, as prospective lenders probably believe that the IMF will similarly provide resources in future cases of national illiquidity, and thus make their lending decisions as if there were an explicit guarantee.297 In this sense, bail-outs may be inequitable. Investors remain free to “make off with their winnings and do not have to pick up the tab for their losses”.298 The risk for bad investments is thus – via the IMF bail-outs – ultimately transmitted to the taxpayers.299 Furthermore, IMF bail-outs usually depend on the financial support of national governments, as IMF resources are minuscule compared to the sheer private capital flows300 and the potential claims that have to be bailed out. Whether a country obtains money from the IMF thus becomes a political decision not necessarily based on economic wisdom.301 Apart from

295 296 297

298 299 300

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Although the IMF has the power to create liquidity in the form of Special Drawing Rights (SDRs) according to Art. XV (1) IMF Agreement, this option is merely theoretical as it would have to be approved by member states, which has not happened to date (cf. Tarullo, supra n. 128, p. 657 particularly n. 151). Art. 103 (1) EC. Tarullo, supra n. 128, p. 620. Rogoff, Kenneth, International Institutions for Reducing Global Financial Instability, NBER Working Paper No. 7265, Cambridge, July 1999; available at: www.nber.org/ papers/w7265, p. 8. Lastra, supra n. 288, p. 360. Ibid. Sharma, Shalendra D., Constructing the New International Financial Architecture – What Role for the IMF?, (2000) 34 (3) J.W.T., p. 60. For example due to pressure from the G7, the IMF provided Argentina with new resources although it persistently refused to fulfil the structural reforms required by the IMF (FT-Europe, 31 July 2003, p. 3).


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that, an essential reason why domestic bail-outs for banks are successful is that banking regulators are allowed to require dismissal of incumbent bank managers. In contrast, the IMF “will likely take pains to avoid comment on the desirability of continuing an incumbent government”.302 It might even be argued that these bail-out policies are contrary to the IMF’s principle of uniform treatment of members. This is definitely the case for initiatives to create further IMF facilities that would be used only by major countries, i.e. those creating systemic risk.303 Finally, given the experiences of recently unsuccessful political bail-outs, one might have good reason for preferring that the IMF stop acting as LLR,304 as is already the case between the EMU and its member countries. With the start of the EMU, the member states lost two tools that previously could have been used to deal with increasing debt. First, member states lost the power to steer the monetary supply by creating new money;305 and second, they lost the power for realignment, i.e. devaluation of their currency. As a result, the risk of an insolvency of the member states increased significantly.306 De facto insolvencies like the one of the Land Berlin307

302 303 304

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306 307

Tarullo, supra n. 128, p. 655 et seq. Cf. the critique by Givanviti, supra n. 108, p. 112. Schwartz, Anna J., Is There a Need for an International Lender of Last Resort, (1999) 19-1 The Cato Journal, p. 1 et seq.; available at: www.cato.org/pubs/journalcj19n1/cj19n1–1.pdf. Even the Independent Evaluation Office (IEO) on the IMF concluded in its “Report on the Evaluation of the Role of the IMF in Argentina, 1991–2001” (available at: www.imf. org/External/NP/ieo/2004/arg.eng/index.htm) that the Fund would have been better off with clear ‘stop-loss’ rules to determine whether its support for a country’s policies is still working. The IMF’s supporting Argentina’s weak policies for too long is seen by the report as one of the main failures in the IMF’s policies towards this country, leading to the final financial breakdown. Of course, this debt reduction by inflation only worked when the debt was in domestic currency. Furthermore, even if countries have the option to ‘service’ their debts by printing more money, they are often reluctant to do so, as this inflation can lead to political instability if accompanied by contractionary fiscal policies. It also reduces the value of government bonds, which can impose significant losses on domestic creditors, notably banks; cf. the corresponding example of Turkey in the 1990s (Scott, supra n. 59, p. 113). Konow, supra n. 230, p. 25. Commentators suggest in this regard that the IMF proposals for state insolvency could be analogously applied to the Länder (cf. Weinzen, Hans Willi, Berlin und seine Schulden, Berlin 2003, p. 162 et seq.). See also Rossi, Matthias; Folke, Gunnar; Notwendigkeiten und Inhalt eines Haushaltsnotstandsgesetzes, (2006) 39, ZRP, p. 8 et seq. Indeed, almost 50 percent of Berlin’s tax revenues have to be spent on interest payments (ibid., p. 9). The

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underline the fact that insolvency and the potential necessity to bail-out are no longer a mere hypothesis for public entities in Western Europe.308 Nevertheless, Art. 103 EC explicitly declares that there will not be any bailout of insolvent member states. 4.4.2. LLR Funds as a Vehicle to Implement Sound Economic Policies? The question thus arises whether there are such differences between the IMF and the EMU, so that there is still a need for the IMF to play a role as LLR. Indeed, for the IMF, the decision to no longer bail-out insolvent states would probably reduce its influence on potential bail-out candidates, since this would exclude the possibility of being able to use the lever of conditionality against these countries. This is even more of a problem, since, generally, the more a country needs IMF support, the more likely it is that it will agree to the reforms demanded.309 However, regional regulatory bodies, as proposed above, could rely on other, probably much more effective tools, such as peer pressure. They would not be dependent on granting last resort loans based on conditionality. It may, however, still be argued that bail-outs reduce costs310 by averting

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reason why Berlin is nevertheless still rated Aa3 by Moody’s and AAA by Fitch, instead of a junk grade, is the strong system of fiscal compensation (Länderfinanzausgleich) and additional federal grants (Bundesergänzungszuweisung) in place in Germany (ibid., p. 41). Both mechanisms guarantee that Berlin will not default on its debts in the foreseeable future, even if it cannot autonomously repay its debts. According to research by Standard & Poor’s, providing for the aged could treble average OECD country debt by 2050. Germany for example would see its public debt grow to more than 300 percent of GDP compared with the 60 percent Maastricht ceiling. Japan faces a debt-to-GDP ratio of over 700 percent. In particular an increase in life expectancy; a low birth rate; and high debt levels are named as the most important factors. According to the research, most of the OECD countries, which are currently all rated investment grade, would risk downgrades to the speculative or junk category in the following 30 years (FT-Europe, 1 April 2004, p. 31). It is true that the research is based on an ‘auto-pilot’ scenario, assuming that the governments will maintain their recent (1999-2003) fiscal stance throughout that period, which appears rather unrealistic. In any case, to avoid a true ‘fiscal Armageddon’, reforms of the social security systems would have to go well beyond most countries’ recent reform initiatives (ibid.). Commentators state that, without conditionality, the effect of IMF surveillance would be severely limited, as for all other member states, even a negative PIN is virtually no sanction, since they can usually prevent the most critical parts in this report due to their influence anyway (Selmayr, supra n. 209, p. 74 et seq.). Kleinert, Jens, Einlagensicherungssysteme nach deutschem und U.S. amerikanischem Recht, Baden-Baden 1999, p. 42.


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much more critical situations.311 Indeed, chaos may result if one country defaults and many others follow. Nevertheless, it is questionable whether a bail-out is in fact the right mechanism to avert this kind of chaos as, in the Asian crisis, Thailand, Indonesia and Korea received rescue packages from the Fund. Nevertheless, the crisis continued to be ‘contagious’. Argentina, in contrast, was not bailed out.312 Other countries were affected,313 but the crisis was no worse than the one in Asia.314 Whether, and to what extent, bail-outs prevent country runs therefore remains an open question. Instead, however, an explicit no-bail-out clause could have a deterrent effect, if it is not suspended on account of the general political situation. Hence, it could prevent the emergence of further crises. 4.4.3. The Need to Increase the Credibility of No-bail-out Clauses Nevertheless, it is noteworthy that commentators express considerable doubts as to the credibility of the European no-bail-out clause. Apart from economic considerations,315 concerns about the credibility of the EU’s no-bail-out clause arise from the current practice under the SGP, pursuant to which the Council is reluctant to sanction member states that do not comply with the SGP. In fact, it is doubted whether the SGP’s sanctions procedure, as discussed above, will ever be used at all.316 Thus, when the European Commission recommended for the first time in January 2002 that an early warning be sent to Germany and Portugal, which had both failed to reach the targets for 2001 and ran the risk of deficits exceeding 3 percent of GDP reference value,317 the Ecofin Council decided not to endorse the Commission’s

311 312

313

314

315 316 317

FT, 27 September 2002, p. 11. International Herald Tribune, 10/11 August 2002, p. 8, writing that the reason Argentina did not receive support while Brazil was granted a record loan in 2002 was due to domestic (U.S.) concerns. U.S. banks had around $25.6bn outstanding in loans to Brazilian borrowers, i.e. much more than their exposure to Argentina. Notably, other Mercosur members, but also countries such as Mexico and Spain, whose banks and companies are heavily involved with the Argentine economy, suffered considerably, cf. SZ, 24 July 2002, p. 23. A possible reason for the limited contagious effects of Argentina’s default is that around 40 percent of the amount that Argentina defaulted on was held domestically (FT-Europe, 13/14 March 2004, p. 2). Sutter, supra n. 164, p. 47 et seq. Lembergen/Wachenfeld, supra n. 231, p. 32. EC, supra n. 233, p. 39.

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recommendation, since Germany and Portugal were considered to have “effectively responded to the concerns expressed in the Commission recommendation.”318 This reaction is understandable in so far as the ministers of finance and economics, who, as members of the Ecofin Council, are responsible for the final decision, are reluctant to do so, because next time it could be their country that misses the target.319 One criticism of this procedure is that the drafters of the SGP are said to have disregarded the evidence that the more similar the interests in a group, the more difficult it is to enforce efficient compliance control.320 However, a first important safeguard to assure that decision-making is not made illusory is that a 2/3 majority voting is sufficient for the imposition of sanctions.321 In addition, the country concerned is not allowed to vote in its own case.322 Finally, in their own interest, states will vote to sanction a fellow state’s insufficient budgetary discipline, where failures of this kind could have a severe adverse impact on their own domestic economy. First experiences with the SGP demonstrate that it is far from ineffective. Thus, the mere threat of sanctions convinced Portugal to cut its deficit to 2.8 percent in relation to GDP in 2003.323 In contrast, Germany eventually managed to obtain at least a temporary suspension of the pact’s sanctions mechanism.324 To avoid the impression that the SGP’s rules can de facto be suspended during economic downturns caused by difficult circumstances, it is crucial to further strengthen the credibility of the SGP and its no-bail-out clause. Commentators argue that, where regional institutions are weak in terms of the diplomatic or economic pressure they can bring to bear on a rule-violator, particularly due to the political difficulties involved in acting against a state which is relatively powerful within the region, a supra-regional or international organisation might better resolve the problem.325 However, where there is no consensus, international institutions do not enforce decisions either. Instead, a factor that would significantly increase the credibility of no-bail-out clauses is the establishment of a procedure that adequately

318 319 320 321 322 323 324 325

Ibid., p. 51. Konow, supra n. 230, p. 34. Ibid. Votes are calculated according to Article 205 (2) EC. Article 104 (13) EC. FT-Europe, 23 February 2004, p. 2. Ibid. Cf. Murphy (1994), supra n. 97, p. 283.


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deals with the reorganisation of sovereign debt in the case of default. Combined with such a system, a no-bail-out clause can be seen as a useful tool against moral hazard. The Model Convention should therefore explicitly rule out the possibility that any bail-out payments could be obtained from the public sector.

Chapter IV Implementation As in all areas of law, a legislative proposal is only good to the extent that it can reasonably be implemented. Commentators have provided a wide range of suggestions, as to how implementation of the RSSD might be achieved. While some argue that the powers under a well-interpreted Article VIII 2 (b) IMF Articles of Agreement granted to the IMF1 would be sufficient (1), others favour an amendment of those articles (2). An alternative route suggests the draft of a model convention or model law (3). In addition, one can consider whether the existence of general principles, as discussed above, can be regarded as sufficient for the implementation of the RSSD (4).

1. Article VIII (2) (b) IMF Agreement A first approach argues that it would not be necessary to implement a new RSSD. Instead, according to this argument, it is sufficient to refer to Article VIII of the IMF Agreement section 2 (b) which reads: Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this agreement, shall be unenforceable in the territories of any member.

The ‘plain meaning’ of this provision, as asserted by some commentators, is “that certain contracts, that are offensive to the exchange control regulations of an IMF member country (other than the one in which the forum is situated) cannot be enforced.”2 On the basis of this broad interpretation,

1 2

Hereinafter IMF Agreement. Allegaert, Theodore, Recalcitrant Creditors Against Debtor Nations, or How to Play Darts, (1997) 6 Minn. J. Global Trade, p. 456.

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it is concluded that, if a debtor state in financial distress imposes restrictions on the payment of foreign currency to external creditors, then parties to a sovereign debt agreement, including the debtor state’s government, are prevented by those very exchange controls from repaying their debts to foreign creditors.3 Indeed, one might consider the (at least theoretically appealing) idea that the contract under which their debt was incurred, was rendered unenforceable by Article VIII (2) (b) IMF Agreement. Accordingly, section 2 (b) would cause effects similar to a standstill and it could even be used as a basis to defend a consensual reorganisation agreement against dissenting creditors.4 However, even the supporters of this view concede that there are evident inadequacies in the legal text,5 leading to uncertainties in its interpretation. The overwhelming majority of courts have interpreted section 2 (b) in a narrow sense. Specifically, the term ‘exchange contract’ poses a significant obstacle to the use of the section as a RSSD substitute. Thus, courts have held that ‘exchange contracts’ means all those contracts that have as their immediate objective the conversion of local currency to foreign currency,6 thereby excluding conventional loans or bonds, whose only means of payment is one single currency.7 The narrow interpretation of Article VIII (2) (b) IMF Agreement arguably disregards the objectives of the provision, as well as those of the IMF.8 Nevertheless, it is so strongly established that the use of section 2 (b) as a defence in sovereign default has ceased almost completely.9 Without a significant overhaul, the provision is therefore not appropriate to address the issues of a RSSD.

3

4 5 6

7

8 9

Power, Philip J., Sovereign Debt: The Rise of the Secondary Market and Its Implications for Future Restructurings, (1996) 64 Fordham L. Rev., p. 2723 et seq. Allegaert, supra n. 2, p. 466. Ibid. Ebke, Werner, Article VIII, Section 2(b), International Monetary Cooperation, and the Courts, (1989) 23 Int’l Law, p. 677 et seq. For a contemporary decision by a German Court denying the applicability of Article VIII (2) (b) IMF Agreement as a defence in sovereign default see e.g. L.G. Frankfurt, Judgment 14 March 2003–2–21 O 509/02, (2003) 58 JZ, p. 1011. Ebke, supra n. 6, p. 682. Euliss, Richard, The Feasibility of the IMF’s Sovereign Debt Restructuring Mechanism: An Alternative Statutory Approach to Mollify American Reservations, (2003) 19 Am. U. Int’l L. Rev., p. 133.

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2. Amendment of the IMF Agreement Pursuant to Article XXVIII IMF Agreement, the Fund’s Articles can be amended upon the agreement of 3/5ths of its members, constituting 85 percent of the total voting power. The establishment of the RSSD could thus be achieved through an amendment of the IMF Agreement, if these majorities can be obtained.10 However, having the largest quota of all members of the Fund, the U.S. wields just over seventeen percent of the vote, so that it effectively has a veto power.11 The U.S. made use of this factual veto power and rejected the IMF’s SDRM proposal in spring 2003.12 So far, the reasons for the U.S.’ opposition remain unclear. Commentators have speculated that the U.S. might be uncomfortable with the establishment of a court-like entity – or SDDRF in the terms of the IMF proposal – with binding decision-making powers, with regard, for example, to the Forum’s verification of creditors’ claims.13 Based on these considerations, it was suggested that instead of amending the IMF Agreement with a fully-fledged RSSD, only the already discussed Article VIII (2) (b) ought to be amended. According to this proposal, the provision should explicitly state that temporary restrictions on debt repayments imposed with the IMF’s approval are ‘exchange controls’ within the meaning of Article VIII (2) (b) IMF Agreement.14 However, first of all, this

10

11

12 13

14

See e.g. the respective proposal by the IMF, The Design of the Sovereign Debt Restructuring Mechanism – Further Considerations (27 November 2002), available at: www.imf.org/external /np/pdr/ sdrm/2002/112702.pdf. (hereinafter: IMF (2002)), at 275 et seq. In contrast, it is noted that the aggregated amount of votes of the IMF’s ten major debtors, including Argentina, Brazil and Indonesia does not exceed ten percent. Arguably, the SDRM proposal could thus be adopted without the consent of the major debtors (Scott, Hal S., A Bankruptcy Procedure for Sovereign Debtors, (2003) 37 Int’l Law, p. 135). The inadvisability of such a result, though, is apparent, since sovereign debt reorganisation is largely dependent on voluntary co-operation. This can hardly be obtained from a debtor that does not support the underlying objectives of the procedure (in general: Beyerlin, Ulrich; Marauhn, Thilo, Rechtsetzung und Rechtsdurchsetzung im Umweltvölkerrecht nach der Rio-Konferenz, Berlin 1997, p. 40). Euliss, supra n. 9, p. 126. Cf. Power, supra n. 3, p. 2766; Skeel, David A., Why the Class Action Strategy is Worth a Second Look, [September 2003] Int’l Fin. L. Rev., p. 3 guesses that the political obstacles in place could also include “fierce opposition from the U.S. lawyers and bankers who tend to benefit from the present reliance on bailouts.” Euliss, supra n. 9, p. 143 et seq.

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amendment would confront the IMF with a conflict of interests, since the Fund, as the institution approving the exchange control regulation itself remains a creditor, meaning that its decision will not be considered to be objective.15 Furthermore, this limited amendment would necessarily ignore important contemporary difficulties in sovereign debt reorganisation, such as collective representation or collective action problems. Even if one agrees that a ‘RSSD light’ is better than no RSSD, it remains unclear whether such a proposal would gain the consent of the U.S. In particular, the formal role of the IMF would significantly increase, as it would have to decide on whether a debtor state filed in good faith for activation of the reorganisation process and the IMF would have discretion to suspend creditors’ property rights.16 Furthermore, the amendment approach, as all statutory approaches, is likely to be time-consuming. In the IMF’s history, three amendments have been made with an average time of 22 months in each case.17 Taking into account the major changes in IMF procedures that an amendment amounting to a surrogate of a fully-fledged SDRM would require, it is foreseeable that these changes would require significantly more time.18

3. Model Law Another proposal for the implementation of the RSSD is to do so by means of a model law. An internationally recognized institution like UNCTAD would draft a set of rules that deals in detail with questions connected with the RSSD, such as stay, majority voting, etc.19 This approach, however, might prove difficult, as implementation in domestic law could provoke serious problems in terms of conflict of law, at least if it were to be applied retroac-

15

16 17

18 19

Tarullo, Daniel K., Rules, Discretion, and Authority in International Financial Reform, [2001] J. Int. Econ. L., p. 675. Ibid., p. 674. EMTA, Discussion Draft on the IMF’s SDRM proposal (12/6/02) (available at: www.emta. org/ndevelop/ sdrm.pdf ), p. 6. Ibid. Paulus, Christoph G., A Statutory Procedure for Restructuring Debts of Sovereign States, (2003) 49 RIW, p. 403 (hereinafter: Paulus (2003)); Schwarcz, Steven L., Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, (2000) 85 Cornell L. Rev., p. 1011 et seq.

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tively.20 Specifically, creditors that have relied on an a priori chosen law, particularly New York State law, to govern their investments would be surprised by these unexpected changes.21 The implementation of a statutory approach could lead to the result that, whatever terms were agreed upon, they could suddenly be changed by the implementation of the model law as transformed into domestic law.22 Most importantly, the validity of decisions obtained by majority voting and leading to a reduction of principal or interest,23 might be regarded by minority creditors as a form of expropriation, which might possibly require the implementing state to pay compensation.24 20

21 22

23

24

Boeri, Celeste, How to Solve Argentina’s Debt Crisis: Will the IMF’s Plan Work?, (2003) 4 Chi. J. Int’l L., p. 254. A non-retroactive application would, in turn, have to tackle the issue that arises similarly in connection with CACs, namely that there is no relief for troubled debtors as far as pre-existing obligations are concerned. Ibid. Under public international law, legal retroactivity is permitted as long as it is neither discriminatory nor arbitrary (Schwarcz, supra n. 19, p. 1012). Only if retroactivity were to amount to expropriation would a duty to provide compensation arise (ibid.). Expropriation, in turn, requires a taking of property, so that the owner “will not be able to use, enjoy or dispose of the property within a reasonable time after the inception of such interference” (Shaw, Malcolm N., International Law, 5th ed. Cambridge 2003, p. 740). Nonetheless, lawful actions include the subjection of foreign assets to taxation, the imposition of trade restrictions or measures of devaluation (Brownlie, Ian, Principles of Public International Law, 5th ed. Oxford 1998, p. 535). Retroactive application of legal provisions in the field of sovereign debt reorganisation as discussed here would thus not constitute unlawful expropriation under public international law (see also Schwarcz, supra n. 19, p. 1014). Such changes to the payment terms are excluded in bonds issued under New York State law; see supra Part B, Chapter I, 1.2.). To be precise, often some forms of indemnification of creditors of defaulted sovereign debt obligations already exist under current domestic laws. Cf. e.g. Haisch, Martin, Mindern Verluste aus der Veräußerung von argentinischen Anleihen die Steuerlast?, (2002) 34 DB, p. 1736 et seq. analysing tax reduction benefits for holders of defaulted Argentine bonds. In fact, Germany’s then Federal Minister of Finance, Hans Eichel, complained that the reduction in tax revenues due to outstanding interest payments on Argentine bonds was significant (Speech on “G20: Gemeinsam für mehr Wachstum und Wohlstand ”, delivered on 19 February 2004 in Buenos Aires, available at: www.bundesfinanzministerium.de/ BMF-.336.23030/Reden/index.htm). Because of this, however, it is highly improbable that states would agree to pay even more to those creditors in the form of compensation for losses resulting from majority voting; see: Meesen, Karl M., Die insolvenzrechtliche Option in der internationalen Schuldenkrise, (1990) 89 ZVglRWiss, p. 273. Furthermore, Italian creditors of Argentine bonds in particular made the most of a creditor-friendly jurisdiction pursuant to which numerous contracts on Argentine bonds with banks were considered to be void (in detail: Sangiovanni, Valerio, Finanzskandale (Argentinien, Cirio

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Problems of this kind already arose in the U.S. There, a number of states have ‘pre-bankruptcy’ statutes, which create a vehicle for municipalities to readjust their debts with effects comparable to those available in bankruptcy courts, with provisions for a standstill, majority voting and so on.25 One of the leading cases with regard to pre-bankruptcy statutes is the one of New York, which in November 1975 enacted an Emergency Moratorium Act in order to respond to the city’s growing fiscal crisis.26 This act provided inter alia for a three-year moratorium on the enforcement of outstanding short-term notes due in 1975 and 1976 in return for additional interest for those noteholders that agreed to exchange their old notes for new ones.27 It was argued that this legislation was in violation of the contract clause and the New York Court of Appeals in fact held that the debt moratorium was in violation of the State Constitution.28 In contrast, in 1942 the U.S. Supreme Court, in Faitoute Iron & Steel Co. v. City of Asbury Park, had upheld a moratorium law enacted in New Jersey.29 In view of the potential implementation of a model law in the U.S. it is thus worth having a brief look at the differences in both cases. As already mentioned, a sensitive point is the contract clause which provides that “[n]o State [. . .] shall pass 30 any [. . .] law impairing the obligation of contracts.” In other words, the contract clause is the American version of the pacta sunt servanda principle. It is, nevertheless, accepted that this clause may be restricted by a measure that “addresses a legitimate end” and that is accomplished by “reasonable means”.31 In the Asbury Park case, the Supreme Court found that the New

25

26

27

28

29 30 31

und Parmalat) und die Haftung der Anlagevermittler in der neuesten italienischen Rechtsprechung, [2006] BKR, p. 476 et seq.). Freyberg, Daniel J., Municipal Bankruptcy and Express State Authorization to be a Chapter 9 Debtor: Current State Approaches to Municipal Insolvency – And What will States do Now?, (1997) 23 Ohio N. U. L. Rev., p. 1011. New York State Emergency Moratorium Act for the City of New York, 1975 McKinney Session Laws, Chapters 874, 875 (McKinney Supp. 1997). Comment, The Constitutionality of the New York Municipal Wage Freeze and Debt Moratorium: Resurrection of the Contract Clause, (1976) 125 U. Pa. L. Rev., p. 168. Flushing National Bank v. Municipal Assistance Corporation for the City of New York, 358 N.Y. 2d 848 (1976), which basically held that the debt moratorium was in violation of the city’s constitutional obligation to pledge its ‘faith and credit’ for the payment of the principal of any indebtedness for which it contracts. 316 US 502 (1942). See: US Const. Art. I, § 10. Home Building & Loan Association v. Blaisdell, 290 US 814 (1879); in the international

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Jersey legislation had been enacted “to meet the public emergency arising from a default in the payment of municipal obligations.”32 In addition to factual distinctions as to the different financial situations of Asbury Park and New York, these divergent decisions can be explained in particular by the different concepts of debt restructuring that were used in each case. The most important factor is that, rather than mandate an explicit unilateral plan as in New York, the New Jersey legislature authorised the submission of the restructuring plan to the consent of a creditors’ majority of not less than 85 percent and, even with regard to the potential minority creditors, the act granted protection, since an independent judicial review that the plan was also in their interest was required.33 This is important because, although it is true that, generally, the legislator has a broad scope regarding the enactment of rules impairing private creditors,34 it might be misleading to conclude that it should also be possible for a sovereign legislator (be it a municipality or a state) to enact a law which deals with the insolvency of this very public entity. While, in the first case, the government can be regarded as a referee acting in the best interest of the public, this impartiality can hardly be assumed when the legislator has to act in its own interest and to decide upon its own obligations. Here, the potential for the abuse of legislative powers is great.35 Transferring these considerations to the international sovereign context leads to the following: First of all, the inclusion of sufficient creditor control as to the final outcome, or even control by a neutral third instance, would significantly increase the assumption that the legislation is in the best interest of all participating parties, and thus decrease the potential that a violation of the contract clause or an expropriation would occur. The impartiality of the law could be reached by following the suggestion to give an international institution such as UNCITRAL the power to work out the details of the RSSD.36 Under these conditions, the risk of a successful expropriation challenge to the RSSD model law under a national law

32 33 34

35 36

law context, corresponding interpretation of the contract clause might flow from the principle of comity (cf. Meesen, supra n. 24, p. 274 et seq.). Faitoute Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502 (1942), at 504. Comment, supra n. 27, p. 208 et seq. See e.g. Paulus, Christoph G., A Legal Order for Insolvencies of States, available at: www.dse. de/ef/sdrm/paulus.htm, p. 7 noting that it is accepted throughout that a national legislator has the power to enact an insolvency law for its private law entities. Comment, supra n. 27, p. 189. Cf. Paulus (2003), supra n. 19, p. 403.

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appears to be limited.37 Nevertheless, widespread, ideally across-the-board, implementation of the model law could pose considerable obstacles for the model law approach. It has been argued that developing and emerging countries might be forced to implement the model law by means of conditionality.38 However, particularly if those countries are not sufficiently involved in the drafting process, the use of conditionality will certainly elicit assertions of ‘legal imperialism’39 and the emergence of domestic resistance might not seem so far-fetched.40 Even if countries adopt the model law, it usually does not necessarily mean that they will actively co-operate in the implementation and enforcement of that law. This reaction is explained by a lack of identified effect. The identified effect, meaning the effect expected from the model law, based on the effect identified in advanced economies, is reached when the provisions have been fine-tuned in order to reflect local, political and social considerations.41 This fine-tuning is, however, often absent when the IMF, via conditionality, attempts to implement legislation in developing countries.42 In consequence, a lack of identification with the institution, as well as a lack of identified effect with the provisions that should be adopted, arises, leading to a rejection of the unwanted – some critics even say misleading43 rules.

37

38 39

40 41

42

43

It is certain that a definitive answer could only be given after an appropriate analysis of the domestic law of the implementing state (Meesen, supra n. 24, p. 272 et seq.). Cf. Paulus (2003), supra n. 19, p. 403. Pistor, Katharina, The Standardization of Law and Its Effects on Developing Economies, (2002) 50 Am. J. Comp. L., p. 108. Ibid., p. 99. Yokoi-Arai, Mamiko, Regional Financial Institutionalization and the Creation of a Zone Law: The Context of Financial Stability/Regulation in East Asia, (2001) 35 Int’l Law, p. 1647. An internal report by IMF officials concerning the Fund’s involvement in Indonesia has now explicitly acknowledged that its work was “inadequate in many respects.” (cf. FTEurope, 19 December, 2003, p. 5). Similarly, the Independent Evaluation Office (IEO) of the IMF concluded in its Report on the Evaluation of the Role of the IMF in Argentina from 1991–2001 (available at: www.imf.org/External/NP/ieo/2004/arg/eng/index.htm) that the Fund made several mistakes in the years preceding the Argentine financial crisis. The report particularly complains that the IMF was ‘too lenient’ over Argentina’s deficits and that, in general, oversight was poor. According to critical commentators, surveillance, on whose results the conditions are based, is a process, whose cornerstones are already fixed in the IMF headquarters. According to these commentators, the mission brief, which is usually drafted according to a standard pattern, already contains the most important results and the succeeding mission to the country only serves to check some details (Stiglitz, Joseph, Globalization and Its Discontents, New York 2002, p. 64).

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Furthermore, the model law could lose its signalling effect.44 The danger arises that countries would not reject the model law, but ‘free-ride’ on its reputation, e.g. as far as compliance control standards are concerned. In this case, the country merely submits to the provision to create a façade, for example to present the image of safety for investment, while not necessarily implementing and responding to the core ideas of the law. In this case, the reputation of the model law would also ultimately suffer.45 Furthermore, implementation of the model law by means of conditionality definitely would not work for most of the creditors’ countries. The implementation by creditors’ countries, though, is, at the end of the day, crucial for the efficiency of the model law, because it is the norm rather than the exception that the creditors’ countries’ courts will eventually have to decide on the validity of the restructuring agreement. In fact, most bond contracts are subject to foreign jurisdiction, to prevent the debtor state from later changing its law to the disadvantage of its creditors.46 The situation that a creditor state’s court accepts a decision of a debtor state concerning measures altering obligations under a debt agreement thus far remains the exception.47 Therefore, voluntary implementation in the creditor country itself would be necessary to impose measures such as binding majority voting on the creditors. Yet the implementation of a model law would not necessarily be (politically) easy, or at least easier than an amendment to the IMF Articles of Agreement. Resistance from the U.S. in particular is to be expected, due to the fact that in the meantime and in response to the case law cited above Congress has enacted section 903 of the Bankruptcy Code, which provides that “a state law prescribing a method of composition of indebtedness of [its] municipality may not bind any creditor that does not consent to such composition.”48 This overturned the Supreme Court’s

44 45

46 47

48

Pistor, supra n. 39, p. 125. Yokoi-Arai, supra n. 41, p. 1647, citing the example of the Asian countries which, before the crisis, enthusiastically adopted standards such as the Basel Capital Accord, without truly implementing them. See supra Part A, Chapter II, 2. The famous case in this regard is the Allied decision cited above, in which it was held at first that the actions of Costa Rica had to be recognised in the US courts (Allied Bank International v. Banco Credito Agricola de Cartago, 733 F.2d, at 23 et seq.). As noted, though, this decision was also subsequently reversed (Allied Bank International v. Banco Credito Agricola de Cartago, 757 F.2d, at 520 et seq.). 11 USC. § 903(1) (1994).

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Asbury Park decision.49 The provision was passed to ensure equal treatment of municipal bondholders throughout the nation, which was considered to be insufficient, given that the bonds of almost every municipality are widely held. “Only under a Federal law should a creditor be found to accept such an adjustment without his consent.”50 In other words, only a unanimous implementation of the model law, at least by all creditor countries, is likely to be sufficient to convince the U.S. also to implement the law. Otherwise, i.e. without U.S. consent, the efficiency of the law will be at least limited. In this case, another obstacle to the efficient implementation of the model law approach might be that foreign creditors could attempt to bypass the law by suing the sovereign in a foreign jurisdiction that did not adopt the proposed model law. If creditors were to win such lawsuits, they would proceed to try to attach the sovereign’s foreign assets, thereby disrupting the restructuring negotiations.51

4. Application and Codification of the General Principles of Law The analysis of domestic corporate reorganisation laws demonstrated that these have a number of tendencies in common. Moreover, at least two of the most important features of insolvency laws, namely automatic standstill and majority voting, are accepted by all legal systems assessed in this study and can be regarded as constituting general principles of insolvency law. The basic features of a reorganisation procedure could therefore be simulated in the sovereign context if domestic courts applied those general principles. The more liberally the courts deal with the acknowledgement of general principles, the more features could be simultaneously transferred, in accordance with the example of the ECJ’s use of general principles.

49

50 51

Tung, Frederick, After Orange County: Reforming California’s Municipal Bankruptcy Law, (2002) 53 Hastings L. J., p. 887, n. 16. H.R. Rep. No. 2246, 79th Cong. 2d. Sess. 4 (1946). Schwarcz, Steven L., Global Decentralization and the Subnational Debt Problem, (2002) 51 Duke L.J., p. 1231, who assumes that, due to the scarcity of such assets, the remedy would be meaningless in most cases. Nevertheless, even in those cases, disruption which protracts negotiations and disturbs creditor-debtor confidentiality will be caused.

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Arguably, though, the use of general principles of law suggested is therefore a progressive one. Courts faced with a decision of this kind might be reluctant to follow suit, primarily because there are no known precedents, at least in the area of sovereign debt restructuring. However, the possible range of (dogmatic) objections is basically limited to three positions.52 First of all, it might be argued that there is no common use of specific rules of corporate reorganisation, particularly in developing countries. While this might have been true two decades ago, this study shows that, at the latest since the mid-90s, developing countries have reformed and extended their insolvency laws and have for the most part come closer to the framework of reorganisation laws in industrialised countries. Principles derived from domestic corporate insolvency laws are thus sufficiently ‘general’. Second, one might consider provisions as they are contained in insolvency laws to be too technical to represent a general principle. Principles of law are the essential elements of a legal system, such as basic rights and obligations, and the conditions for the implementation thereof. Consequently, specific regulations, such as the precise timetable for the negotiation process as fixed under certain domestic laws, do not fall within the ambit of general principles.53 In contrast the rule that majority voting may be binding on the minority, for instance, is the most fundamental principle of each democracy, where nobody would seriously assume that a minority should decide on an issue to the disadvantage of the majority.54 Furthermore, the prohibition against enforcing a claim when a debtor is insolvent is based on the principle of equal (creditors’) treatment, since this is a codified standard in all modern constitutions and human rights treaties.55

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53

54

55

See for the following Leyendecker, Ludwig, Auslandsverschuldung und Völkerrecht, Frankfurt a.M. 1988, p. 303 et seq. At least in the context of regulations of the financial system it is a useful mechanism to limit legislation to such fundamental decisions and to leave it with the executive branch (i.e. in the sovereign context the courts) to fill in the technical details, cf. Röber, Volker, The Regulation of Financial Services in the European Union, in: Marauhn, Thilo; Grote, Rainer, The Regulation of International Financial Markets – Perspectives for Reform, Cambridge 2006, p. 83. As to the fundamental importance of this principle for efficient reorganisation procedures see e.g. Häsemeyer, Ludwig, Insolvenzrecht, 3rd ed. Köln 2003, p. 52 et seq. Paulus (2003), supra n. 19, p. 404 writing that “equal treatment is one of the fundamental prerequisites of every insolvency procedure”.

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A denial of a general principle, based on its alleged ‘technicality’, also often results from an understanding of ‘general’ as referring to the meaning of the principle. This, however, is not the case. As illustrated above, ‘general’ in this sense would be synonymous to ‘catch all but mean nothing’, depriving ‘general principles’ of their status as a source of law.56 Instead, a principle is general if it is applied in general.57 As demonstrated, standstill provisions, as well as majority voting are in common use in all of the insolvency laws assessed. The third feature of general principles that is discussed is the lack of a third instance that could adjudicate disputes arising under the RSSD. However, where general principles exist, the judge is directly justified in applying them.58 Domestic courts could therefore enforce the imposition of a standstill or the binding nature of a negotiated agreement achieved by majority vote, as they do in corporate reorganisations. In turn, general principles would not necessarily have to be agreed upon by a broad majority of states, as would be necessary, for example, for an amendment of the IMF Agreement. Instead of a ‘statutory’ insolvency law for sovereigns de lege ferenda, the solution suggested here is a de lege lata approach, which is based upon existing (latent) public international law, thereby also excluding problems of retroactivity. Certainly, the legal phenomenon of a persistent objector might hinder the full efficiency of the general principles approach. However, a safeguard to reduce this risk to the minimum is already provided by the method of deriving these principles, since it acknowledges the particular importance of the legal orders of the parties concerned when revealing them.59 Beyerlin/Marauhn point out that the probability that a state complies with a rule is highest when this rule is

56 57

58

59

See supra Part C, Chapter I, 3.2.2.4. Cf. Koenig, Christian, Commentary to Art. 25, n. 27, in: Starck, Christian (ed.), Das Bonner Grundgesetz – Band 2: Artikel 20 bis 78, 4th ed. München 2000. Bassiouni, M. Cherif, A Functional Approach to ‘General Principles of International Law’, (1990) 11 Michigan J. Int’l L., p. 769; for the German jurisdiction, for instance, Koenig, supra n. 57, at 44 notes that general principles of international law have to be applied by the courts without transformation by the legislator. The use of general principles of international law is a dynamic, not a static process, i.e. new principles are regularly adopted by the courts. Weiß, Wolfgang, Allgemeine Rechtsgrundsätze des Völkerrechts, (2001) 39 AVR, p. 430 et seq.

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based as far as possible on consensus.60 Consensus is the fundament of all general principles in international law. The general acceptance of those principles could further be improved if they were codified. This task should be assigned to the International Law Commission (ILC). The ILC would ideally fit the task as it was established by the General Assembly “with the declared objective of promoting the progressive development of international law and its codification.”61 The Commission has already produced a substantive variety of draft articles on subjects such as jurisdictional immunity or state responsibility. These drafts often form the bases of international treaties, which are binding on those states that signed and ratified them.62 The drafts are furthermore part of state practice, which can lead to the emergence of new rules of international customary law.63 The negotiation and drafting process could be facilitated by first concluding a framework convention, which would later be supplemented by way of protocols.64 The framework convention could fix a timetable for future negotiations. It could further include deadlines by which certain changes to sovereign bond documentation, such as the insertion of CACs, are to be carried out, as well as by which time certain non-binding soft-law instruments, such as an international Code of Good Conduct for sovereign debt reorganisation, are to be established. Arguably, negotiations could first be conducted on a regional level. As discussed above, this would be particularly useful with respect to the establishment of a system of financial compliance control.65 Due to the more homogeneous composition of countries belonging to the same region, implementation of this compliance control mechanism might be easier, and therefore faster, on a regional rather than a worldwide level.66

60 61 62

63 64

65 66

Beyerlin/Marauhn, supra n. 11, p. 92. Shaw, supra n. 22, p. 112. Examples are the International Conventions on the Law of the Sea (1958), Diplomatic Relations (1961) or on the Law of Treaties (1969). Shaw, supra n. 22, p. 113. In more detail on this mechanism, regularly used in international law see: Beyerlin/ Marauhn, supra n. 11, p. 30 et seq. Supra Part C, Chapter III, 4.3.2. Cf. Beyerlin/Marauhn, supra n. 11, p. 15 et seq., 35 et seq.

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5. A Multiple Track Approach While it is true that the general principles of law approach advocated here implies some significant changes to the current way in which sovereign debt reorganisation is dealt with and the solutions put forward represent what might be regarded as a solution founded essentially upon considerations of efficiency and balance of interests, it should, however, have become apparent in the foregoing analysis that it is not only efficiency and ‘common sense’ that decide on the implementation of a proposal, but also political interests, which vary depending on the countries’ individual self-interest. Taking into account this political reality, it is a truism that negotiation and, even more so, the implementation of an international convention become increasingly difficult the more they are connected with infringements of original sovereign rights and the higher the potential procedural costs are.67 Probably the most promising route to achieve this goal is by means of a multiple track approach. In addition to the drafting of a Convention by the ILC, as suggested above, the insertion of contract clauses and the establishment of a Code of Good Practices in particular may provide an interim solution. The most serious shortcoming of CACs is probably that they do not cover existing debt. The most important aspect of CACs might, in so far, be that the parties to sovereign finance instruments – be it debtor states or their creditors – become more sensitive to the imminent dangers of these transactions. The route towards a fully-fledged RSSD will have to be gradual. To this extent, the general use of CACs is an important step in the right direction. A further supplementary means to fill the legal gap in the field of sovereign debt reorganisation is the establishment of a Code of Good Practice.68 This would establish a standard for dealing with a sovereign in financial distress. So, for instance, creditors should not immediately grab for the debtor’s assets when they learn of the crisis, but attempt instead to find a solution in co-operation with the debtor and the other creditors.69 A similar ‘code’

67 68

69

Ibid., p. 31. Cf. Paulus, Christoph G., Some Thoughts on an Insolvency Procedure for Countries, (2002) 50 Am J. Comp. L., p. 539. There is a growing trend for banks – public as well as private institutions – to agree to adhere to such codes of good practice. For instance, in 2003, several leading international banks, such as Citigroup, agreed to the so-called ‘Equator Principles’. These principles are

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works fairly well in the private banks’ sovereign debt rescheduling process in the London Club.70 The impact of such a good practice code could arguably be increased if it were published by the Basel Committee on Banking Regulations and Supervisory Practices (commonly referred to as the Basel Committee).71 The Basel Committee is a standing committee of the central bank governors of the Group of Ten (G-10) countries,72 which convenes periodically at the Bank for International Settlement (BIS). While the accords, concordats and core principles of this Committee are not legally binding, they have nevertheless become the regulatory standard in virtually all states involved in international banking activities.73 In its endeavours to promote its goals while respecting political and territorial boundaries, the Committee makes use of a technique called ‘soft law’. The term soft law refers to a set of legal provisions or informal duties adopted under formal or informal treaties or multilateral agreements.74 Soft law is most useful when hard law is inefficient, particularly if it cannot surmount deadlocks in international relations, which often result from economic or political differences. Soft law is consequently defined as an international legally non-binding rule created by a group of specific national authorities, and adopted into their national laws or administrative codes.75 Despite the informality of soft law, its implementation is more a ceremonial act than a substantive requirement.76 Several methods have been designed to compel other nations to adopt international standards. First,

70

71 72

73

74

75 76

intended to integrate human rights issues, such as protecting natural habitats and indigenous people, into the banks’ lending policy (FT-Europe, 4 November 2003, p. 4). See: Rahnama-Moghadam, Mashaalah et al., The Clubs of London & Paris: International Dispute Resolution in Financial Markets, (1998) 53 Disp. Resol. J., p. 73 et seq. Basle Committee in most English language literature. These are: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, Switzerland, U.K. and U.S. (G-10 is thus a misnomer, which is due to the number of member states in 1962, when this group originated); Luxembourg also takes part in the Basel Committee rounds. Emmenegger, Susan, The Basel Committee on Banking Supervision – A Secretive Club of Giants?, in: Marauhn, Thilo; Grote, Rainer, The Regulation of International Financial Markets – Perspectives for Reform, Cambridge 2006, p. 138. Lee, Lawrence L., The Basle Accords as Soft Law: Strengthening International Banking Supervision, (39) 1998 Va. J. Int’l L., p. 3. Ibid., p. 4. Tarbert, Heath Price, Are International Capital Adequacy Rules Adequate? The Basle Accord and Beyond, (2000) 148 U. Pa. L. Rev., p. 1789.

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the draft of international standards usually takes place in a comfortable and familiar fraternal setting, like the Basel Committee mentioned above, which creates a certain degree of synergy and might also profit from peer pressure.77 Second, under the procedures for promulgating EU directives,78 the EU itself has often used this legal vehicle to transfer the standards of the Basel Committee into the domestic legislation of EU Member States.79 Lastly, means such as IMF conditionality are used to ‘suggest’ that developing countries adapt their local financial infrastructure and architecture along the lines of the Basel Committee standards.80 It has already been discussed that IMF conditionality will not improve reception by developing countries. Notably as despite several attempts by developing countries to join the Basel ‘Club of Giants’, the Basel Committee has chosen to keep its membership quite limited.81 On the other hand, it is precisely this limited membership that assures an efficient and timely reaction to the rapidly changing challenges in international financial relations.82 Alternatives to this mechanism would nevertheless have to be developed. Moreover, the Code of Good Practice should primarily address the creditors’ institutions, i.e. banks from industrialized countries. Those, in turn, are to a large extent represented in the Basel Committee. Accordingly, one might argue that debtor countries’ interests are only indirectly affected, namely in so far as they do (not) benefit from the provisions of the Code of Good Practice in subsequent reorganisation cases. Another, more daunting, problem might be that individual bondholders are even less likely to agree to adhere to such standards, at least if they are not eventually implemented into binding domestic law. For bondholders there is no commitment to repeat lending and they are not subject to pressure from their peers, their government or central banks.83 At the end

77

78 79

80 81 82 83

Cf. the statement by Jochen Sanio, German governmental representative at the Basle Committee, stressing that the mere threat of a veto at a committee meeting inevitably leads to a problem of credibility; (2002) 55 Kreditwesen, “Kein Mitgliedstaat darf für sein Banksystem ungerechtfertigte Sondervorteile herausholen”, p. 105. Cf. Art. 249 EC. Norton, Joseph, J., Devising International Bank Supervisory Standards, London 1995, p. 258. Ibid., p. 261. Ibid., p. 229. Emmenegger, supra n. 73, p. 146. Scott, supra n. 11, p. 116.

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of the day, the sovereign debt crisis can thus only be satisfactorily solved if there is concerted action on the political level towards reaching a binding reorganisation system for sovereign debt.

Part D Conclusion

Conclusion The international financial architecture, namely the area of sovereign debt reorganisation, is undergoing major changes. The pace of change has accelerated significantly in recent years. The increasing need of states for new external funds and bonds in particular, combined with the increasing use of highly volatile financing instruments, makes markets, especially those at a developing or emerging stage, vulnerable. Legal doctrine and international case law, on the other hand, have developed the ancient doctrine of absolute sovereign immunity towards a more restrictive understanding. Thus, sovereign contracts in the field of sovereign financing are usually considered to be subject to judicial scrutiny. Furthermore, waivers of sovereign immunity in most modern debt agreements enable debtors to attach sovereign property located abroad, thereby to a certain degree subjecting the state to the risk of enforcement. The consequences are unsatisfactory for both creditors and debtor states. Creditors, while de lege lata allowed to enforce their claims, often fail to receive adequate repayment, due to the lack of sufficient funds located outside the debtor countries’ territory. Debtors, on the other hand are faced with a growing threat of law suits when they default on their debt. Default furthermore makes them a pariah on the market, excluding them from fresh funds. Consequently, default is a ‘worst case’ scenario for both creditors and debtors. Nevertheless, there are no international conventions on how to deal with insolvent debtor states or how default by such states could be avoided. A survey of customary international law furthermore illustrates that sovereign debt rescheduling in fora such as, in particular, the Paris Club and the HIPC Initiative may be regarded as some sort of sovereign reorganisation law in statu nascendi. However, there is a lack of intent, in the sense of a settled opinio iuris to be bound to certain forms of debt reorganisation. Similarly, customary international law often does not provide a legal basis for rights to stop repayments. The clausula rebus sic stantibus doctrine falls short, as there are no unexpected changes to the basis of sovereign debt contracts that would make these agreements void. The odious debts doctrine

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is even weaker as a defence, since it is doubtful whether this doctrine has a sufficient legal basis. To a certain degree, a valid defence for stopping repayments might be seen in the state of necessity doctrine. This doctrine, though, will usually be too strict in its conditions – particularly as the state itself must not have contributed to the state of necessity – for it to be of any use to defaulting debtor countries. In view of this legal lacuna, various proposals have been made as to how this gap in the international financial architecture may be bridged. This discussion was enlivened after Anne Krueger suggested the establishment of a Sovereign Debt Restructuring Mechanism (SDRM). In a general sense, the proposals can be divided into a contractual approach and a statutory approach. The first approach focuses primarily on an improvement of standard bond documentation. Thus, collective action clauses are to be inserted in new bond issues to facilitate future restructurings by allowing majority voting on all bond terms, including payment terms. Collective representation clauses are intended, in addition, to improve the representation of the mass of creditors, which are often highly dispersed and heterogeneous, and enable faster and more structured renegotiations. A main flaw in this proposal is that only future issues will be subject to them. Thus, they are an additional aspect of a sustainable solution, but not a solution in themselves. In contrast, the statutory approach would also comprise those bond issues that have already been made, and could have a retroactive effect. Despite this undisputed advantage of a statutory approach, the solution as suggested in the SDRM has not yet received the requisite support on a political level. This significantly hinders any form of implementation on the basis of an amendment to the IMF Articles of Agreement. The proposal discussed here analyses whether general principles of law might provide a resource for the establishment of a Reorganisation System for Sovereign Debt (RSSD). General principles, meaning those ideas that are common to a representative proportion of legal systems, are a traditional source of international public law as recognized by Art. 38 ICJ Statute. Not only are these general principles regularly referred to in international judicial decisions, they also constitute the basis of important treaties, such as the CISG. Some critics, though, oppose the use of general principles, on the basis that they would lead to arbitrary results. This, however, is not a genuine defect of general principles, but rather of the method, or arguably the lack of method, used to derive those principles. As explained, though, there is


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nothing miraculous or arbitrary about the means of deriving general principles of international law. Instead, due regard must be had to the following steps: identification of the problem to be solved in a manner which frees the issue from domestic legal doctrine; selection of the relevant legal systems to be compared; and a comparison of solutions rather than legal wording. This method guarantees a high degree of objectivity as to the results obtained. Based on a comparison of the corporate reorganisation laws in Argentina, England, France, Germany and Indonesia, as well as the U.S., it is concluded above that an automatic suspension of enforcement actions, as well as the draft of a reorganisation plan, which is agreed upon by majority voting, are common to all compared legal systems. This study furthermore illustrates that there are significant similarities in the way that the assessed legal systems deal with the commencement of corporate reorganisation cases, their administration by neutral third parties, the involvement of creditors’ representation organs, and the provision of priority reorganisation financing. One finding of this comparison is that whether or not those similarities already constitute general principles of international law is largely dependent on the desire for political integration. While, for example, a court like the ICJ might be more reluctant to accept the existence of general principles in this area, supranational regional courts such as the ECJ might be much more inclined to assume such principles. The following synthesis is based on the finding that even if not all features found in domestic insolvency laws meet the standard of a general principle of international law, there are striking tendencies in the same direction in domestic law that can provide a valuable guideline for the RSSD. The Convention proposed on the basis of these tendencies can be found in the annex. In the next section, this study addresses the issue of enforcement mechanisms. In the meantime, most legal hurdles preventing the enforcement of creditors’ claims against defaulting states have been eliminated. In particular, neither sovereign immunity, nor the Act of State doctrine or international comity are regarded by domestic courts as providing a protective shield for sovereign debtors against such enforcement actions. However, the most significant difficulty appears to be the practical problem of insufficient assets against which creditors could enforce their claims, due to a lack of assets of sovereign debtors held abroad. As public law sanctions – above all retorsion and reprisal – also fail to provide a useful tool in this regard, the study discusses some new approaches, which are suggested to give creditors more leverage against defaulting states

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unwilling to negotiate a reorganisation in good faith. One model proposed in the literature is the use of funds looted from the debtor country by its (former) governing elite. Examples such as illegal oil smuggling schemes in Iraq illustrate that these funds are of a considerable size and that a freezing of those assets, combined with the threat of not returning them to the country can have an impact on a state’s political decisions. However, unilateral actions between states are prone to diplomatic interference. They are not a suitable means to provide for a consensus-oriented way of dealing with sovereign default. Actions by an international organisation, such as the UN Security Council, would in many cases constitute an overreaction and would entail the major risk of deterring a number of states from ratifying the Convention. Thus, sanctions do not represent a valid alternative. A much more promising avenue is the combination of the proposed RSSD with an international compliance control mechanism. Experience, as gained during the Asian Crisis, highlights that a repressive sanctions-based reactive mechanism will usually come too late, as it is of little use in preventing the emergence of a sovereign financial crisis. As a viable alternative, compliance control mechanisms provide a framework in which the information necessary to assess the economic and financial situation in a country can be gathered, and by means, for example, of early warnings, the emergence of crises can be limited. Finally, a comparison of the IMF’s consultations and the EU’s Stability and Growth Pact emphasises that the efficiency of a compliance control system can be improved the more the countries participating in the system are integrated. Consideration is also given to the extent to which a no-bail-out clause is beneficial to the credibility of such a compliance control mechanism, due to the fact that it reduces moral hazard incentives. Implementation of the system discussed to reorganise the debt of defaulting states should follow a gradual, multiple-track approach. An internationally recognized institution, such as the International Law Commission, should draft a framework convention and set up a timetable to outline the road to a binding and fully-fledged treaty to deal with sovereign debt reorganisation. In that period, the increased insertion into sovereign bond contracts of collective action clauses, as well as the establishment of a code of good conduct, should constitute the first steps in the process of filling the currently gaping hole in the international financial architecture.

APPENDIX

Model Convention on Sovereign Debt Reorganisation Chapter I Article 1 Scope and Rationale of the Convention This Convention applies to the reorganisation of sovereign debt. It shall facilitate the reorganisation process, increase transparency, and improve the balance of powers between the parties to the reorganisation process. Article 2 Definitions For purposes of this Convention, the use of the following terms shall be defined: “Contracting State” means a sovereign state for which this Convention is in force; “Creditor” means a person – natural or judicial, and private or public – that has a claim for payment against a Contracting State; “Debtor-State” means a Contracting State that has initiated reorganisation procedures under this Convention; “Majority of Creditors” means a combined two-thirds majority per capita as well as in capital; “Neutral Authority” means the geographically responsible regional development bank.

Chapter II Article 3 Initiation of the Procedure A Contracting State may initiate the reorganisation procedure by filing a voluntary petition with the Neutral Authority. Immediately after that petition, the provisions of this Convention shall apply to the relationship between the Debtor State and its Creditors.

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Article 4 Transparency To increase transparency of the procedure, all participating parties are obliged to provide all information necessary in a timely manner. Article 5 Registration and Verification of Claims A Creditor is permitted to participate in the reorganisation process only after registration and verification of its claims by the Neutral Authority. Article 6 Suspension on Enforcement Initiation of the reorganisation procedure automatically suspends the enforcement of all lawsuits and claims against the Debtor State, as well as any other actions to obtain possession of the Debtor State’s property. The suspension is limited to a period of [six] months. It can be renewed for another [six] months upon request by the Debtor State and subsequent approval by a majority of Creditors. Article 7 Creditors’ Committees After activation of the procedure, creditors committees that are representative of the different kinds of claims to be represented shall be appointed. Article 8 Reorganisation Plan The Debtor State and the Creditors’ Committees shall negotiate a debt reorganisation plan. The plan shall provide equal treatment for all Creditors, unless the holder of a claim explicitly agrees to a less favourable treatment. The plan shall provide for the future economic programme of the Debtor State, as well as a future projection of the development of the state’s budget and spending. The plan shall become effective and binding after approval by the Debtor State and a majority of Creditors.

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Chapter III Article 9 Compliance Control [This Chapter could follow the model of the E.U. Stability and Growth Pact, so that states would have to agree to the establishment of regional compliance control bodies].

Chapter IV Article 10 Adjudication of Disputes Any disputes arising under the Convention shall be adjudicated by the Neutral Authority. [Details of dispute adjudication should follow the model of the ICSID Convention].

Chapter V Article 11 Implementation This Convention shall enter into force upon ratification by [twenty] sovereign States. On and before ratifying this Convention, each Contracting State shall undertake efforts to improve the process of sovereign debt restructuring by way of the insertion of Collective Action Clauses into new bond agreements. States shall support the establishment of Codes of Good Conduct in the area of sovereign debt reorganisation.

Chapter VI Article 12 Interpretation Interpretation of and amendments to this Convention shall be made with reference to the general principles of law.

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Idem, Bond Investors Watch for Argentine Tax Figures, Financial Times Europe, 6 January 2004, p. 4. Idem, Kirchner Snubs Creditors on Argentine Bond Restructuring, Financial Times Europe, 12 January 2004, p. 4. Idem, Argentina on the Edge: What are the Consequences of another Default? Financial Times Europe, 8 March 2004, p. 11. Idem, Argentine Bond Default Hits Its Pensioners Hardest, Financial Times Europe, 13/14 March 2004, p. 2. Idem, Argentine Data Expected to Confirm Rapid Recovery, Financial Times Europe, 20 April 2004, p. 4. Turner, Mark, US and UK Ask UN to Freeze Iraq Entities’ Assets, Financial Times Europe, 19 March 2004, p. 7. Webb-Vidal, Andy; Päivi, Munter, Buyers Ignore Chávez Fears, Financial Times Europe, 9 January 2004, p. 31. Wiggins, Jenny, Dominican Republic Might Default, Financial Times Europe, 12 February 2004, p. 31. Williams, Frances, Poorest Countries Missing Out On Trade Benefits, Financial Times Europe, 7 April 2004, p. 6. Wise, Peter, Lisbon Meets EU Budget Demands, Financial Times Europe, 23 February 2004, p. 2. Wolf, Martin, The Fund is not Equal to the Job it was Meant to Do, Financial Times Europe, 10 March 2004, p. 13. No author, Who Went under in the World’s Sea of Cash, New York Times, 15 February 1999, p. A1. No author, Double or Nothing, The Economist – U.S. Edition, 15 December 2001, p. 35. No author, Argentinien wird für die Banken zum Milliardengrab, Die Welt, 26 April 2002, p. 18. No author, Hungern im Land der Rekordernten, Süddeutsche Zeitung, 30 November/ 1 December 2002, p. 9. No author, An IMF Downgrade for the Economy – Another Pre-budget Headache for Gordon Brown, Financial Times, 4 March 2003, p. 18. No author, Argentinien verspricht Gleichbehandlung, Frankfurter Allgemeine Zeitung, 20 June 2003, p. 21. No author, Argentinien geht auf Anleger zu, Frankfurter Allgemeine Zeitung, 2 August 2003, p. 12. No author, Bribery has Long been Used to Land International Contracts: New Laws will Make that Tougher, Financial Times, 8 May 2003, p. 19. No author, Argentinien präzisiert Umschuldungsangebot, Frankfurter Allgemeine Zeitung, 23 October 2003, p. 21 et seq. No author, Argentinien fordert Schuldenerlaß, Frankfurter Allgemeine Zeitung, 3 November 2003, p. 13. No author, Argentina’s Bounce, Financial Times Europe, 22 December 2003, p. 10. No author, Argentinien sortiert Gläubiger, Frankfurter Allgemeine Zeitung, 30 December 2003, p. 19.

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Website Information Calsa, Duhalde y Lula darán un nuevo impulso al Mercosur, Press notice, 14 January 2003, available at: www.calsa.com/br/cweng/noticias/cadnoticia1.asp?tit=Duhalde+y+Lula+ darán+un+nuevo +impulso+al+Mercosur+. Citigroup, Impact of the Recent Legal Decisions, Economic and Market Analysis: Country Analysis and Commentary Argentina, 16 September 2003, available at: www.emta.org/ keyper/keyindustry0916.pdf. Credit Suisse/First Boston, Argentina’s Dubai Proposal: Worse than already Lowered Expectations, Emerging Markets Sovereign Strategy Daily (23 September 2003) Available at: www.emta.org/keyper/Argentina0923.pdf. Dherse, Jean-Loup, A Solution to the Debt Problem, The Banker, 19 May 1999, available at: www.odiousdebts.org/odiousdebts/index.cfm?DSP=content&ContentID=65. Eichel, Hans, Speech on “G20: Gemeinsam für mehr Wachstum und Wohlstand”, delivered on 19 February 2004 in Buenos Aires, available at: www.bundesfinanzministerium. de/BMF-336.23030/Reden/index.htm. Investments Magazine, Argentina Sued for $ 172 Mln by NML over Bond Default, Investments Magazine, 21 November 2003, available at: www.investmentsmagazine.com/ ManageArticle.asp?c=60&a=5342. IMF, Debt Relief under the Heavily Indebted Poor Countries (HIPC) Initiative – A Factsheet, September 2003, available at: www.imf.org/external/np/exr/facts/hipc.htm. Idem, IMF Approves Stand-by Credit for Thailand, 20 August 1997, available at: www.imf. org/external/np/sec/pr/1997/pr9737.htm. Idem, IMF Approves Stand-by Credit for Indonesia, 5 November 1997, available at: www. imf.org/external/np/sec/pr/1997/pr9750.htm. Idem, IMF Approves SDR 15,5 Billion Stand-by Credit for Korea, 4 December 1997, available at: www.imf.org/external/np/sec/pr/1997/pr9755.htm. Idem, What is the International Monetary Fund?, available at: www.imf.org/external/pubs/ft/ exrp/what.htm. Idem, IMF Surveillance – A Factsheet, available at: www.imf.org/external/np/exr/facts/surv. htm. Raffer, Kunibert, Solving Sovereign Debt Overhang by Internationalizing Chapter 9 Procedures, available at: www.studien-von-zeitfragen.net/weltfinanz/Raffer_1. Renner, Michael, Die Rechtsstellung des Gläubigers, insbesondere bei notleidenden Anleihen, available at: www.uni-leipzig.de/bank/institut/dokumente/2000–02–03–02.pdf.

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Outline of Structure Part A Introduction Chapter I. The Early Days of Sovereign Insolvency ....................... 1. Sovereign Insolvencies as a Non-Legal Issue ............................. 1.1. Choice of Law Clauses in Sovereign Bond and Loan Contracts ......................................................... 1.2. Sovereign Immunity ........................................................ 1.2.1. Absolute Sovereign Immunity ............................... 1.2.2. Relative Sovereign Immunity ................................ 2. Unsustainability of the Doctrine of Sovereign Insolvency as a Non-Legal Issue .................................................................

5 6 6 7 7 7 8

Chapter II. Early Proposals for a Legal Framework for Sovereign Debt Reorganisation .................................................................. 11 1. Contract Autonomy .................................................................. 11 2. Choice of Law and Legal Venue Selection Clauses .................. 12 Chapter III. Scope of this Work

.................................................... 15 Part B

Principal Reform Proposals Chapter I. The Contractual Approach .......................................... 1. The Use of Collective Action Clauses and Exit Consents ....... 1.1. Collective Action Clauses ................................................ 1.1.1. Collective Representation ...................................... 1.1.2. Collective Action ................................................... 1.2. Exit Consents .................................................................. 2. CACs and Exit Consents in the Sovereign Context ................

19 20 20 21 22 24 26

304

Outline of Structure

2.1. CACs in Sovereign Bonds ................................................ 2.2. Exit Consents in Sovereign Bonds ................................... 3. Proposals to Extend the Contractual Approach ........................ 3.1. Engagement Clauses ......................................................... 3.2. Initiation Clauses .............................................................. 3.3. Aggregation Clauses .......................................................... 3.4. Class Actions .................................................................... 4. Conclusion ................................................................................ 4.1. Exit Amendments ............................................................. 4.2. Collective Action Clauses ................................................. Chapter II. The Proposal for a Statutory Sovereign Debt Restructuring Mechanism ......................................................... 1. The U.S. Bankruptcy Code – A Model for International Sovereign Debt Reorganisations? .............................................. 1.1. Initiation of Proceedings .................................................. 1.2. Stay ................................................................................... 1.3. Priority Financing ................................................................ 1.4. Debtor-in-Possession ............................................................ 1.5. Creditors’ Committee........................................................... 1.6. Majority Voting ................................................................... 1.7. Cramdown ........................................................................... 2. Conclusion ...............................................................................

26 28 28 29 29 30 30 32 32 33

37 39 39 40 40 41 42 42 43 44

Part C The International Law Perspective Chapter I. The RSSD’s Normative Basis under Public International Law ....................................................................... 1. International Conventions ......................................................... 2. Customary International Law .................................................... 2.1. A Right to Stop Repayment of Sovereign Debt? .............. 2.1.1. Clausula rebus sic stantibus ................................... 2.1.1.1. Change of Currency or Interest Rates ..... 2.1.1.2. Change of Policy ..................................... 2.1.1.3. Violation of WTO Rules ........................ 2.1.2. Odious Debts ........................................................

49 49 50 50 51 52 53 58 59


2.1.2.1. Definition .............................................. 2.1.2.2. Types of Odious Debts ......................... 2.1.2.3. Odious Debts in International Law ...... 2.1.3. State of Necessity ................................................. 2.1.3.1. Essential Interest ................................... 2.1.3.2. Grave and Imminent Peril .................... 2.1.3.3. “Only Means” ....................................... 2.1.3.4. The Balancing Requirement .................. 2.1.3.5. Exceptions to the Application of Necessity .......................................... 2.1.4. Conclusion ........................................................... 2.2. A Right to Debt Restructuring under Customary International Law? .......................................................... 2.2.1. Paris Club Proceedings ........................................ 2.2.2. Proceedings under the Enhanced HIPC Initiative .......................................................................... 3. General Principles of International Law .................................. 3.1. General Principles as a Source of International Law ...... 3.2. The Definition of “General Principles” .......................... 3.2.1. General Principles and Judicial Discretion .......... 3.2.2. The Method of Identifying General Principles .... 3.2.2.1. A Quantitative or Qualitative Standard ... 3.2.2.2. Selection of the Relevant Legal Systems ... 3.2.2.3. Determination of the Problem .............. 3.2.2.4. Extension and Limitation: Reception of General Principles of Law and Determination of Specific Realities in International Financial Markets ............ 3.2.2.5. The Model of the ECJ .......................... 3.2.2.6. The Telos-Oriented Approach of the ECJ and the International Context ...... 3.3. Conclusion ..................................................................... Chapter II. An Insolvency System for Sovereigns Derived from General Principles of International Law .................................... 1. Comparability of Domestic Insolvency Regimes .................... 2. Selection of the Relevant Legal Systems ................................. 2.1. Historical Influences .......................................................

305

59 61 63 67 69 71 73 74 75 81 82 82 86 89 89 91 92 94 94 97 99

100 102 105 106

109 110 112 112

306


2.1.1. Laws Mainly Influenced by National Developments ..................................................... 2.1.2. Laws Mainly Influenced by Foreign Traditions .... 2.1.3. Laws Mainly Influenced by a Convergence of Traditions ............................................................ 2.2. Influences of the Philosophical Foundations of Corporate Insolvency Law ............................................................... 2.2.1. Creditor Wealth Maximisation and the Creditor’s Bargain ................................................................ 2.2.2. Debtor Protection ............................................... 2.2.3. Balance of Interest .............................................. 2.3. Economic and Socio-Cultural Influences ....................... 3. Domestic Insolvency Orders .................................................. 3.1. Argentina ........................................................................ 3.1.1. Overview ............................................................. 3.1.2. Description of the Rehabilitation Procedure ....... 3.2. England .......................................................................... 3.2.1. Overview ............................................................. 3.2.2. Description of the Rehabilitation Procedures ..... 3.2.2.1. Administrative Receivership .................. 3.2.2.2. Administration ...................................... 3.3. France ............................................................................. 3.3.1. Overview ............................................................. 3.3.2. Description of the Rehabilitation Procedures ..... 3.3.2.1. The Judicial Rehabilitation Proceedings ........................................... 3.3.2.2. The Amicable Settlement Procedure ....... 3.4. Germany ......................................................................... 3.4.1. Overview .............................................................. 3.4.2. Description of the Rehabilitation Procedure ....... 3.4.2.1. The Rehabilitation Procedure ............... 3.4.2.2. Out-of-Court Settlement ...................... 3.5. Indonesia ........................................................................ 3.5.1. Overview.................................................................. 3.5.2. Description of the Rehabilitation Procedure ....... 3.5.2.1. Insolvency Proceedings under the Insolvency Code ................................... 3.5.2.2. The Jakarta Initiative ............................

113 114 115 116 116 117 118 119 121 121 121 122 127 127 128 128 130 135 135 137 137 140 141 141 143 143 148 149 149 151 151 153


307

4. Comparative Analysis .............................................................. 4.1. Commencement of the Procedure .................................. 4.1.1. Who may File ...................................................... 4.1.2. Commencement Criterion ................................... 4.2. Administration of the Procedure .................................... 4.3. Standstill ......................................................................... 4.4. Creditors’ Committee ..................................................... 4.5. Priority Reorganisation Financing .................................. 4.6. Approval of a Reorganisation Plan ................................. 4.7. Conclusion ..................................................................... 5. Synthesis ................................................................................. 5.1. Rationale of the RSSD ................................................... 5.1.1. Why is there a Need for an RSSD? ..................... 5.1.2. The Pro-Creditor Approach ................................. 5.1.3. The Pro-Debtor Approach ................................... 5.1.4. The RSSD as a Means to Enhance Co-operation ... 5.2. Core Features of the RSSD ............................................ 5.2.1. Commencement .................................................. 5.2.1.1. Who May File? ..................................... 5.2.1.2. Commencement Criterion .................... 5.2.2. Administration ..................................................... 5.2.2.1. Debtor-in-Possession ............................ 5.2.2.2. The Neutral Authority .......................... 5.2.3. Standstill .............................................................. 5.2.4. Creditors’ Committee .......................................... 5.2.5. Priority Financing ................................................ 5.2.6. Approval of a Reorganisation Plan ...................... 5.2.6.1. Majority Voting .................................... 5.2.6.2. Creditor Classes ..................................... 5.2.6.3. Cramdown ............................................

155 157 157 158 159 160 161 161 162 163 163 165 165 167 168 169 170 170 170 171 174 174 176 183 187 189 191 192 192 194

Chapter III. Enforcement Measures ............................................. 1. Domestic Private Law Sanctions ............................................. 1.1. Legal Obstacles ............................................................... 1.1.1. Sovereign Immunity ............................................ 1.1.2. The Act of State Doctrine ................................... 1.1.3. International Comity .......................................... 1.2. Practical Problems ........................................................ 2. Public International Law Sanctions .......................................

195 197 197 197 199 200 201 203

308


2.1. Reprisals ......................................................................... 2.2. Retorsion ....................................................................... 3. New Approaches .................................................................... 3.1. The Use of Looted Funds ............................................. 3.2. Is There a Duty to Return Looted Funds? ................... 3.3. Sovereign Defaults as ‘Threats to the Peace’ ................. 4. The Limits of Traditional Sanctions – The Case for a Compliance Control Mechanism in International Financial Relations ................................................................................ 4.1. The Asian Crisis and the Lack of Sufficient Compliance Control ......................................................................... 4.1.1. The Asian Financial Crisis .................................. 4.1.1.1. Genesis of the Crisis ............................ 4.1.1.2. Domestic Failures that Led to the Crisis ................................................... 4.1.1.3. The Global Transferability of These Factors ................................................. 4.1.2. Lack of Creditor Confidence and Unregulated Budgetary Spending as Origins of the Debt Crises ................................................................... 4.1.2.1. The Emergence of Runs and the Importance of Confidence in the Markets ................................................ 4.1.2.2. Unregulated Budgetary Spending ........ 4.2. The Procedural Framework for a Compliance Control Mechanism .................................................................... 4.2.1. The Procedural Framework of Compliance Control in International Law ............................ 4.2.1.1. Information Gathering ........................ 4.2.1.2. National Sovereignty v. Objectivity of Information – Procedural Principles in International Compliance Control ...... 4.2.2. Compliance Control in International Financial Relations ............................................................ 4.2.2.1. IMF Surveillance under Article IV IMF Agreement ........................................... 4.2.2.2. Compliance Control under the SGP ... 4.2.2.3. Comparison ......................................... 4.3. The Institutional Framework for Compliance Control ... 4.3.1. Compliance Control by an International Body? ...

203 204 205 205 207 208

213 213 214 216 216 217

218

219 220 222 222 223

225 224 227 230 232 233 233


4.3.1.1. The Diversity of Standards for Macro-economic Stability .................... 4.3.1.2. The Enforcement Deficit in International Compliance Control ...... 4.3.2. A Regional Compliance Control Body ............. 4.3.3. The Case for an Advisory Committee ............... 4.4. Compliance Control and Lender of Last Resort Function ......................................................................... 4.4.1. A Comparison of the (No) Bail-out Policies of the IMF and the EMU ..................................... 4.4.2. LLR Funds as a Vehicle to Implement Sound Economic Policies? ............................................ 4.4.3. The Need to Increase the Credibility of No-bail-out Clauses ........................................... Chapter IV. Implementation ....................................................... 1. Article VIII (2) (b) IMF Agreement ....................................... 2. Amendment of the IMF Agreement ....................................... 3. Model Law .............................................................................. 4. Application and Codification of the General Principles of Law ..................................................................................... 5. A Multiple Track Approach ...................................................

309

234 235 235 239 240 242 244 245 249 249 251 252 258 262

Part D Conclusion Conclusion ..................................................................................... 269 Appendix ........................................................................................ Model Convention on Sovereign Debt Reorganisation ............. Chapter I ..................................................................................... Article 1 Scope and Rationale of the Convention ................... Article 2 Definitions ................................................................ Chapter II .................................................................................... Article 3 Initiation of the Procedure ........................................ Article 4 Transparency ............................................................. Article 5 Registration and Verification of Claims .................... Article 6 Suspension on Enforcement ...................................... Article 7 Creditors’ Committees ..............................................

273 275 275 275 275 275 275 276 276 276 276

310


Article 8 Reorganisation Plan .................................................. Chapter III ................................................................................... Article 9 Compliance Control ................................................. Chapter IV ................................................................................... Article 10 Adjudication of Disputes ........................................ Chapter V .................................................................................... Article 11 Implementation ....................................................... Chapter VI ................................................................................... Article 12 Interpretation ..........................................................

276 277 277 277 277 277 277 277 277

Bibliography ................................................................................. Cases ........................................................................................ Books ....................................................................................... Extracts .................................................................................... Articles ..................................................................................... Working Papers and Related Publications ............................... Newspaper and Journal Articles ............................................... Website Information ................................................................

279 279 280 284 286 294 297 300

Index Act of State Doctrine 199 Administrative Receivership 128 Advisory Committee 239 Aggregation clause 30 Agreed minutes 84 Allied Bank case 199 Amendment of the IMF Agreement 252 Approval of a reorganisation plan 162, 191 Arbitration clause 34 Argentina 121 Article VIII (2) (b) IMF Agreement 249 Asbury Park case 254 Automatic standstill 27 Automatic stay 40 Bail-out 242 Balancing requirement 74 Bananas Conflict 58 Basel Committee 263 Brady bond 35 Calvo clause 9 Change of currency rates 52 interest rates 52 policy 53 Chapter 11 approach 37 Choice of law clauses 12 Class Action 30 Claw-back rule 186 Clausula rebus sic stantibus 51 Code of Good Conduct 261 Collective action clause 22, 33, 262 Collective representation clause 21, 33 Comity 200 Commencement Criterion 158, 171 Comparability of Domestic Insolvency Regimes 110 Compliance Control Mechanism 213 Conditionality 84, 227, 235, 244 Contagion 216 Contract autonomy, doctrine of 10 Cramdown 43, 194 Crawling peg system 218 Creditor Classes 192

Creditor’s bargain 116 Creditors’ committee 42, 161, 187 Customary international law 50 De-acceleration clause 24 Debtor-in-possession 41, 174 Default, imminent 83 Dictator debts 62 Drago-Porter Convention 5 Due process 179 Eliot case 202 Engagement clause 28 England 127 Enterprise Bill 127 Equal treatment, principle of 224 Equator principles 262 Equitable burden sharing, principle of 84 Essential interest 69 Evaluative approach 103 Exit consent 19 Exit amendments 20, 32 Expropriation 253 Floating charge 129 France 135 Fresh start 40 Functional approach 99 Gabčíkovo Nagymaros Project 54, 68 GATT 55 General principles of law 89, 258 General principles of EC law 102 Germany 141 Global Committee of Argentina Bondholders 188 HIPC-Initiative 82 Enhanced HIPC-Initiative 86 Hold-outs 43, 167 Hostile debt 61 Hotchpot-rule 186 Identified effect 256 IMF surveillance system 227

312

Index

Implementation of the RSSD 249 Implementation review mechanism 223 Indonesia 149 Initiation clause 28 Insolvenzordnung 141 International Law Commission 65 ICSID 77 Iran-US Claims Tribunal 98, 206 Iraq Compensation Commission 211 Jakarta Initiative 153 Lender of last resort 240 Ley de concursos y quiebras 121 London Club 82, 233 Looted funds 205 Majority action clauses 22, 27, 33 Majority voting 42, 192 Model Covenants for Sovereign Debt Issues 29 Model law approach 252 Multilateral Investment Guarantee Agency 241 Necessity, state of 67 Neutral Authority 176 Non-compliance procedures 223 Odious debts doctrine 59 On-site inspections 225 Opinio iuris 51 Pacta sunt servanda, doctrine of 50, 59 Pari passu clause 27 Paris Club 82, 233 Peril, grave and imminent 71 Priority financing 27, 40, 161, 189 Prisoners’ dilemma 166 Pro-creditor approach 167 Pro-debtor approach 168 Procedural co-operation, principle of 225 Proportionality, principle of 226 Protection of confidential information, Principle of 226

Rationale of the RSSD 165 Reprisals 203 Reorganisation plan 42 Retorsion 204 Right to be heard 225 Sanctions 195 Domestic private law 197 Public international law 203 Selection of the relevant legal systems 112 Historical influences 112 Sharing clause 24 Soft law 263 Sovereign Debt Dispute Resolution Forum 181 Sovereign Debt Restructuring Mechanism 13, 26 Sovereign immunity 7, 197 absolute sovereign immunity 7 relative sovereign immunity 7 Special consultations 228 Stability and Growth Pact 230 Standstill 160, 183 State practice 50 Statutory approach 37 Steering committee 188 Tate letter 7 Tequila crisis 217 Tinoco arbitration 63 Vienna Convention on the Succession of States 64 Vote buying 178 War debts 61 World Bank Insolvency Initiative 111 Inspection Panel 239 World regulator 233 Yankee bond 34

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