- The COVID-19 economic crisis has increased the risk of defaults and restructurings of sovereign bonds, as it has coincided with the closures of mines, a hibernation in the tourism industry, and an oil price war that has decimated the oil markets.
- Holders of sovereign bonds subject to default or restructuring may be able to avail themselves of the international investment protection system, including through its mechanism for the international arbitration of investment disputes.
- International arbitration of sovereign bond disputes has led to sizeable settlements in the past, which can affect the impact of sovereign debt and restructurings both on sovereign states and on foreign investors.
- Governments and bondholders should fully assess how the international investment protection system affects their rights, as well as the implications for any negotiations over sovereign bond defaults or restructurings.
The culmination of the economic effects resulting from COVID-19 has put significant pressure on the debt obligations of countries around the world, many of which were already facing debt struggles before the crisis. As of April 2020, at least eight countries had external financing requirements that exceed their foreign exchange reserves — a sign of macro-economic vulnerability.1 Such economic conditions have previously led to sovereign debt defaults or restructurings, and left dissatisfied creditors in their wake. When creditors perceive that recourse to domestic courts is absent or inadequate, some may potentially resort to international arbitration as part of their efforts to engage with governments over the resolution of both sovereign debt defaults and restructurings.
In recent years, dissatisfied creditors have brought international litigation and, in particular, arbitrations — to great consequence — following sovereign debt defaults or restructurings. Most notably, Argentina defaulted, on its foreign sovereign debt in 2001, and eventually restructured 76% of its defaulted bonds (almost US$62.5 billion worth of debt). Several rounds of restructuring followed, involving deferred payments of interest and haircuts on the face value of the bonds. Holdout creditors owning approximately 7% of the debt brought expensive and drawn out litigation in domestic courts. Meanwhile, other creditors pursued a series of high-value investor-state arbitrations, one of which Argentina reportedly settled for US$1.35 billion. This settlement thus substantially reduced the impact of the restructuring vis-à-vis those creditors.
The protections offered by international investment law may provide creditors means of recourse against a State (i.e., a sovereign state, not a subnational division) following sovereign debt defaults or restructurings — even when they are necessary or unavoidable. International investment protections, when applicable, regulate governmental actions on the basis of certain broad standards. When these protections are allegedly violated, foreign investors may bring international arbitrations against the State to vindicate their rights. Any resulting awards that uphold the investors’ claims are legally enforceable against many of the State’s assets, including assets held outside of the State’s territory.
How to Prepare for Potential Arbitration of Sovereign Bonds Disputes
As the IMF, G7 and G20 work towards providing a degree of debt relief, both foreign investors and sovereign states should prepare themselves for the legal consequences of any impending defaults and restructurings. Where there is a significant risk of sovereign debt default or restructuring, governments and foreign investors should take the following actions to prepare themselves for potential
- Review the terms of the existing debt – The existing debt may impose certain requirements on what can and cannot be achieved in a restructuring by individual bondholders. In particular, collective action clauses may enable a supermajority of bondholders to impose new proposed terms on all bondholders, or may prevent the acceleration of the debt, in the absence of sufficient support from bondholders. Relevantly, an international arbitral tribunal reportedly concluded that a Cypriot bank had waived its claims against Greece through its acceptance of restructuring terms.2
- Consider whether major bondholders are subject to investment protection – The international investment protection system is largely composed of bilateral and multilateral treaties between sovereign states that protect investors from one of the state parties with investments in the territory of the other state party. For example, the Argentine bondholders that were Italian nationals were able to bring international arbitrations against Argentina based on the investment protection treaty in force between Argentina and Italy.3
- Monitor the conduct of the bondholders and the government during negotiations – The actions and behavior of both the bondholders and the government during negotiations will likely affect their positions in any subsequent international arbitration. An arbitral tribunal is more likely to look favorably on those parties who engaged in negotiations reasonably, consistently, and in good faith.
- Assess the legal implications of any proposed restructuring terms – The parties should properly consider the legal implications of the proposed terms regardless of the time and other pressures of the negotiations. The interaction between the proposed terms for restructuring and the protections of the international investment protection system may be complex. For example, a default or restructuring that discriminates against bondholders is more likely to result in liability — as prior arbitral tribunals in finance and banking sector disputes have been particularly intolerant of perceived discrimination against foreign investors.
- Assess the legal implications of potential methods of defaulting or restructuring – The legal consequences of sovereign debt defaults or restructurings in the international investment protection system may depend on whether it is implemented through passive default, through agreement (such as per a collective action clause), or through the unilateral imposition of terms. Arbitral tribunals considering Argentine bond cases gave particular attention to the fact that Argentina unilaterally implemented the restructuring by legislative fiat.4
- Assess the legal implications of the economic emergency – Legal exposure before the international investment protection system may depend on the economic emergency confronting the government. If the government is in a dire economic situation, it is likely to garner more sympathy for defaulting on or restructuring its debt. However, if a government does so when its economy is returning towards normality, an arbitral tribunal is less likely to absolve the state of responsibility.
1) Financial Times.
2) Cypriot bank withdraws multibillion-euro claim against Greece.
3) Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/5, Decision on Jurisdiction and Admissibility, 4 August 2011, ¶ 422.
4) Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/5, Decision on Jurisdiction and Admissibility, 4 August 2011, ¶ 321.