Series of bills could materially impact sovereign debt markets globally.
Overview of new legislation
Legislators in the State of New York (NY), whose law governs many sovereign debt contracts, introduced three general categories of bills related to sovereign debt restructurings. The first is intended to provide support under NY law for international sovereign debt restructuring initiatives by ensuring that recoveries on claims incurred prior to a state’s entry into such an initiative comport with equitable burden sharing under the initiative and that any such recovery is limited to the proportion that would be received by the United States (US) federal government. The second would create a new Article 7 under the NY Banking Law to implement a sovereign debt restructuring. The third would ensure that holders of interests governed by NY law cannot assign those interests and must participate in the restructuring. We describe each initiative below.
Summary of NY bills that support international initiatives
A comprehensive set of international rules for the restructuring of sovereign debt does not presently exist. When a corporation or other business entity defaults on payments or engages in a restructuring, it must follow the domestic laws of its jurisdiction to reorganize or liquidate its business or remaining resources. However, when countries restructure, they may follow a combination of their domestic laws, the laws governing particular debt contracts (commonly New York or English law), and relevant international laws. In addition, norms and practices of the international finance community, including the International Monetary Fund (IMF), G20, Paris Club (an informal group of – mostly OECD – official creditors whose role is to find coordinated and sustainable solutions to payment difficulties) and ad hoc committees of private creditors, shape the negotiations and resolution of unsustainable sovereign debt.
International initiatives like the Heavily Indebted Poor Countries (HIPC) Initiative (created in 1996), the Debt Service Suspension Initiative (DSSI) (created in May 2020) and the G20 Common Framework for Debt Treatments fill any gaps in the law. For example, the IMF and World Bank decide a country’s eligibility for the HIPC initiative and approve loans and grants from a special trust at concessional rates in return for domestic reforms to improve future debt sustainability. In the case of the Covid-19 pandemic, the DSSI suspended USD12.9 billion in debt-service payments for 48 countries from May 2020 to December 2021 to enable countries to redirect spending to fight the pandemic. The G20 Common Framework subsequently built on the DSSI by including China in restructuring negotiations, and was employed in Chad, Ethiopia and Zambia, albeit with mixed results.
New York state legislators propose to support these types of initiatives with bill A2970 (link here) introduced in February 2023 by Assembly-member Patricia Fahy and bill S4747 (link here) proposed just weeks later by NY Senator Brad Hoylman-Sigal. These bills are the equivalent of one another (that is, one submitted in the NY State Assembly and the other submitted in the NY State Senate). These bills purport to increase effectiveness of debt restructuring, to improve perceived equity and legitimacy of international restructuring initiatives and to increase participation of public creditors in debt restructuring programs as a by-product of fair burden-sharing. Whether sovereign debt market participants agree remains to be seen.
Under the proposed bills, claims for borrowed money or guarantees (and domestic or foreign judgements with respect to those claims), if incurred prior to the debtor country’s application to participate in an international initiative, would be recoverable only to the extent that (1) such claims comport with “burden-sharing standards” as defined by the international initiative, (2) holders of such claims meet inter-creditor data sharing and public disclosure standards, and (3) recoveries on such claims are limited to the same proportion to which the US federal government would have been entitled under the initiative if the US federal government were holding the claim. As of the time of this publication, the Assembly version of this bill has made it through the initial Judiciary Committee review and to the Ways and Means Committee but has yet to be voted on by the Assembly as a whole. The Senate bill was sent to the NY Senate Judiciary Committee on February 14, 2023, where it remains. Indeed, other bills proposing similar legislation had been introduced in the past, but were never signed into law.
Summary of NY bills providing a restructuring mechanism
Under Assembly bill A2102A (link here), introduced in March 2023 by Assembly-member Maritza Davila and several co-sponsors including Assembly-member Jonathan Rivera (and similar to a bill introduced by Senator Gustavo Rivera in 2021 (link here) that was not passed), New York's banking law would be amended to add a new Article 7 which would provide a mechanism to restructure unsustainable sovereign and subnational debt. The bills essentially adopt a model law proposed by Steven Schwarcz of Duke Law School (link here) which is intended to reduce the social consequences of debt crises, systemic financial risk, creditor uncertainty, and the need for bailouts.
Under the proposed legislation, a sovereign nation or sub-sovereign government (other than one eligible for relief under chapter 9 of the US Bankruptcy Code) (a State) would invoke the law voluntarily by filing a petition with the state of NY. The petition would be reviewed by an individual appointed by the NY governor and acceptable to the State and the debt holders (the Independent Monitor), who could, through an as yet undetermined process, dismiss for lack good faith. The Independent Monitor would also prepare a list of creditors and verify the claims to supervise voting.1
The petitioning State must agree to the proposed law’s restructuring procedures and affirm that it has not previously restructured under Article 7 (or under the law of any other jurisdiction which has in effect substantially the same legislation) within the prior 10 years. Once the petition has been filed with the NY (the specific department or location for filing is not currently specified), Article 7 would bind all creditors whose claims are governed by NY law or the law of any other jurisdiction having enacted the same legislation—to the extent that multilateral institutions have NY law governed debt agreements with the State, such debt would be governed by the provisions of this bill notwithstanding their customary preferred creditor status.
In addition, creditors under foreign law instruments can opt to have their claims governed by this law. By its terms, the legislation would have retroactive application to contracts executed prior to its enactment. This retroactive effect is premised on the use of police powers to prevent the spread of financial instability. Indeed, retroactive application against the interests of other creditors could instigate a legal attack by any such adversely affected creditors. It should also be noted that, unlike the federal Bankruptcy Code in the United States, there is no stay under Article 7 on the commencement or continuation of litigation or enforcement of security, whether under New York law or otherwise. This may reduce litigation challenging the legitimacy of the process and the retroactive application of Article 7.
The State must notify its creditors that it has filed within thirty days of filing the petition and, later, if it intends to incur priming debt to fund its restructuring. The procedure for incurring priming refinancing debt is not specified in the current version of the bill. It appears that, upon an announcement being made by the sovereign that it intends to incur such debt, all creditors, whether their claims are governed by New York law or otherwise, have thirty days to contact the Independent Monitor and register their consent or objection. Approval of the financing requires the consent of two-thirds of the responding creditors. Repayment of both New York and foreign law debt is subordinated to the repayment of the priming refinancing debt under the restructuring plan.
The State, and no one else, may submit a restructuring plan to its creditors at any time. The plan must separate creditors into classes, each of which will contain claims that are equal in priority. Multilateral institutions would be classified separately from private creditors. The restructuring plan is approved by each class upon the vote of two-thirds of the class by value; there is no provision for cram-down of a dissenting class. The sovereign must also “certify that, if the plan becomes effective and binding on the state and its creditors under subdivision four of this section, the state's debt will become sustainable.” The term “sustainable” is not defined, nor is it clear whether the supervisory authority or creditors would have the power to challenge the certification.
Disputes under the bill are to be resolved by “a court of competent jurisdiction,” which is empowered to appoint a referee or special master. In practice, disputes are likely to be resolved in New York federal courts, as jurisdiction over a foreign sovereign is a matter of federal law. Claims under laws of other jurisdictions or treaty-based claims will presumably remain subject to their respective dispute resolution processes. In respect of international organizations like the IMF, there may be no court of competent jurisdiction if they are immune from suit under the International Organizations Immunities Act.2
Summary of NY bills addressing assignment of claims
In March 2023, Assembly bill A5290 (link here) and Senate bill S5623 (link here) were proposed to amend the judiciary law by ensuring that holders of instruments governed by NY law cannot assign those interests and must participate in the restructuring of such instruments. Specifically, the bills provide that instruments governed by New York law calling for payment of a monetary obligation by a foreign state impose a duty on the holder to participate in good faith in a modification of the terms of some or all of the unsecured debt deemed unsustainable by the IMF within the last twelve months. To be subject to this legislation, the modification must have been accepted by the holders of at least two-thirds in amount and over one-half in number of the affected debt instruments. If enacted, this particular provision would reduce trading, adversely affect the liquidity in the distressed sovereign debt market, and negatively affect holders of distressed sovereign debt obligations that may need to liquidate their holdings in order to raise cash for other purposes.
Footnotes
1. Note that this version of the bill differs from the 2021 version in which the petition was made subject to supervision by an independent body (the Supervisory Authority) established by the chair of the New York state senate that would have had substantially the same role as the Independent Monitor, but also had to appoint an independent auditor to conduct a “comprehensive audit” which is to consist of “a supervisory action taken to examine and evaluate the public debt contracting, refinancing, or negotiation process, in order to determine the lawfulness, transparency, quality, efficacy, efficiency, and sustainability thereof.” This auditing requirement no longer exists.
2. See 22 USC § 288a (providing immunity from suit and judicial proceedings for international organizations with which the United States participates pursuant to any treaty, absent an express waiver from the organization).
