Wait a minute, Doc. Ah… Are you telling me that you built a time machine… out of a sovereign bond contract?
Imagine the next place to come under the new era of enforcing sovereign debt
isn’t Argentina, or in the Caribbean, or even a future eurozone crisis. Imagine something…older. Much older.
isn’t Argentina, or in the Caribbean, or even a future eurozone crisis. Imagine something…older. Much older.
For when historians come to study the Great Calamity of 2014 in international relations between the United States and China, they shall surely whisper one name, in trembling tones.
And they shall doubtless point an equally trembling finger at such ornate and frilly bond contracts as this one.
That’s a 4½ per cent gold loan issued by the Imperial Chinese government in 1898 — the year the Hundred Days’ Reform failed and the Empress Dowager led a coup against her nephew, the Guangxu Emperor.
issued by the Imperial Chinese government in 1898 — the year the Hundred Days’ Reform failed and the Empress Dowager led a coup against her nephew, the Guangxu Emperor.
And yes, this is related to Argentina’s pari passu saga, particularly now that it’s turned into a huge headache for third-party creditors. We’ve also been thinking about what the case implies about the practicality of courts granting injunctions against bad sovereign debtors, when the only realistic place to enforce is on third parties.
Even if the following does sound completely insane, do please at least consider the argument…
Concerning these old Chinese bonds. They have an interesting history. Backed by internal tariffs introduced during the Taiping rebellion — the likin tax, a symbol of the fiscal disintegration of the Qing dynasty — they paid out their coupons until September 1940. Not bad going, considering events between 1898 and then. But they have not paid according to their terms since. Such mouldering paper vestiges of a dead empire as they are, you can often find the bonds on Ebay for a few quid.
until September 1940. Not bad going, considering events between 1898 and then. But they have not paid according to their terms since. Such mouldering paper vestiges of a dead empire as they are, you can often find the bonds on Ebay for a few quid.
The Imperial bond might seem a long way away from even the weirder sovereign debt curios of the 2010s — like Argentina’s defaulted debts, or for that matter, the handful of bonds which the modern People’s Republic of China has issued under New York law.
Holders of the PRC’s October 2014 bond, for instance, have happily collected payments on it for almost ten years now, without threat of interruption by third parties. Holders of Argentina’s restructured debt haven’t been quite so confident lately. That’s the power of ratable payment for you — especially when ordered as equitable relief by a US federal court. Pay all together, or pay all nothing.
Although that is where Horatio D. Gadfly comes in.
FT Alphaville recently came across an astonishing letter penned by Mr Gadfly to John Kerry, regarding ownership of these very Imperial bonds…
In it, the US Secretary of State is alerted to something in the bonds which isn’t quite a pari passu clause. But it would arguably be even more slam-dunk as basis for an injunction of ratable payment, enforceable on third-party bondholders.
That is, if Mr Gadfly was to sue the current Chinese government for relief.
It’s a provision for ‘priority… over all future loans‘:
Whereas pari passu is ‘just’ a promise of equal treatment.
Imperialist bond clauses
Funnily enough… late-nineteenth-century contracts (like the 4½ per cent Imperial Chinese issue) could well be the primeval soup from which the sovereign version of pari passu emerged, along with its close cousin, negative pledge. No wonder studying them has been called “legal paleontology”. How these clauses became genuine boilerplate in the twentieth century — crammed into increasingly unsecuredsovereign debt contracts everywhere — is a story for another time.
They probably made some kind of sense in an era where it was still acceptable for governments to dedicate a specific stream of tax revenue to specific bonds, but where they could increasingly sell ever more pieces of debt (using the same collateral) to ever more gullible distant investors. The latter would therefore increasingly demand equality of treatment (or maybe just direct priority).
An era when the first age of globalisation rubbed shoulders with financial imperialism, basically. It is no accident that a bond which handed over railway rights to foreignershelped start China’s 1911 revolution.
So, you might regard the grant of absolute priority to one bond as among the last decadent insanities of a decrepit dynasty. No modern government would fetishise even general debt service so ludicrously. (Would they?)
A sovereign bond Delorean?
But we are getting lost from Mr Gadfly. Here’s his take on the absolutely priority clause’s relevance in 2013, as relayed to (a doubtless alarmed) John Kerry:
In other words, the Chinese Government solemnly promised that until the bonds were paid in full, amounts due under these instruments would enjoy a priority over any other Chinese Government debts contracted after the issue date of these bonds. My research has confirmed that the current Chinese Government has indeed issued new debt securities to investors in the United States, and that those instruments are being paid currently. Specifically, the PRC issued a New York-law governed bond (Euro 1 billion; 4.5%) in 2009. All coupons on that bond have been punctually paid in full; the final payment is due on October 28, 2014. It is obvious that each such payment on those subsequently-issued Chinese bonds violates the Absolute Priority Covenant…
In which you may detect a rather familiar modus operandi.
But before we note how familiar, there are two big objections to note first, all to do with the procedure of suing a sovereign, before the substance of whether it’s been a bad debtor.
1) China could argue that it doesn’t have any responsibility for bonds contracted by the Qing empire. It might even insist that these debts areodious. In fact the Chinese government argued some 30 years ago, in an aide-memoire to one of these bondholder cases (yes, Horatio wouldn’t be the first), that it “recognizes no external debts incurred by the defunct Chinese Governments and has no obligation to repay them”.
On the other hand, US law on state succession isn’t so clear, and that’s the forum where Mr Gadfly’s proposing to bring his case. In particular, “odious debt” has few judicial fans.
” has few judicial fans.
2) Similarly, the People’s Republic has long maintained that it still adheres to the ‘absolute’ theory of sovereign immunity. Much of the rest of the world moved on to ‘restrictive’ immunity after the Second World War. If states are engaged in the same kind of activity as anyone else — like commercial transactions — they could be sued in the courts of other states over that activity. China has always objected, in international law, to this shift. Which might sound like a dead end for Mr Gadfly.
. If states are engaged in the same kind of activity as anyone else — like commercial transactions — they could be sued in the courts of other states over that activity. China has always objected, in international law, to this shift. Which might sound like a dead end for Mr Gadfly.
But the US gradually codified restrictive immunity in its own law from 1952 to 1976, the date of the Foreign Sovereign Immunities Act. Probably just as well, because modern sovereign bond litigation could never have got off the ground without it (or itsUK equivalent). In any case, Gadfly has argued that the only relevant law for his suit is US law.
(Holders of the PRC’s modern New York law bonds, meanwhile, were warned on buying that “China has not waived its sovereign immunity in connection with any action arising out of or based on United States federal or state securities laws…”)
Now, in US law as of 2004, the courts are supposed to apply the regime of sovereign immunity that applied when a case was brought, not when a debt was first issued. The FSIA is retroactive.
was first issued. The FSIA is retroactive.
Assuming that opens the door to Mr Gadfly’s pre-1952 bonds, they still have a problem. New York contract cases limit claims that are older than six years.
But that (finally) is where NML Capital v Argentina might come in. It could have provided some guidance to old Chinese bondholders on two other key bits of bringing an injunction against the PRC. As Mr Gadfly puts it himself:
Statute of Limitations. I recognize that it may be too late now to obtain a judgment for the unpaid principal and interest on the bonds because they went into default so long ago. See Morris v. People’s Republic of China, 478 F.Supp.2d 561, 571-73 (2007). However, the expiry of the statute of limitations does not extinguish the vitality or validity of a debtRights Against Third Parties. Quite apart from my claim against the PRC, I am also advised that one implication of the Second Circuit’s decision in NML v. Argentina is that I may have a right to require the holders of all new Chinese bonds — once I inform them of the existence of the Absolute Priority Undertaking — to disgorge to me any payment that they may receive under those new bonds. See Coast Bank v. Minderhout, 392 P.2d 265 (Cal. 1964) (Traynor, J.).The Uniquely Recalcitrant Debtor. The Second Circuit Court of Appeals has demonstrated that the federal judiciary will stretch to give the aggrieved creditors of “uniquely recalcitrant” sovereign debtors an equitable remedy to redress their grievances. See NML v. Argentina, 2013 WL 4487563 at n.13. Surely, the actions of the Chinese Government in explicitly disavowing predecessor government debts and paying only more recent creditors put it into the uniquely recalcitrant category…
Ingenious crazy isn’t it?
The focus on payments to other bondholders isn’t just to breathe life into the redress of a seven decade-old default. It might also allow suing them directly. Argentina’s restructured holders might end up volunteering to disgorge some payments in order to get holdouts to settle — so maybe the logic isn’t so crazy.
to disgorge some payments in order to get holdouts to settle — so maybe the logic isn’t so crazy.
But also interesting, because you’d hardly expect the People’s Republic of China, rising global power and guardian of absolute sovereignty, to take being enjoined by US courts lightly. Third parties would have to be the route to getting the PRC itself to comply. It would probably see holdouts not as vultures but as annoying gnats (or, well, gadflies). So it would be like testing out the state of play post-Argentina in extremis.
After all, the mechanism the Second Circuit has used to try and control the consequences of the pari passu ruling is to say that Argentina has been not just recalcitrant to holdouts but “uniquely” recalcitrant. This is interesting in itself: the remedy to be derived from a contract is not just about contractual terms but bad behaviour of one of the counterparties. And sure, it’s been very bad. But then look at the PRC: it’s directly repudiated Gadfly’s bonds. How recalcitrant is that?
passu ruling is to say that Argentina has been not just recalcitrant to holdouts but “uniquely” recalcitrant. This is interesting in itself: the remedy to be derived from a contract is not just about contractual terms but bad behaviour of one of the counterparties. And sure, it’s been very bad. But then look at the PRC: it’s directly repudiated Gadfly’s bonds. How recalcitrant is that?
And actually, looking further afield — what about those Tsarist bonds that modern Russia has never fully repaid? Old-style pari passu clauses were put in this debt too before the Bolsheviks repudiated it.
passu clauses were put in this debt too before the Bolsheviks repudiated it.
So we might be getting a host of Gadflies.
Or perhaps (more seriously) we should be asking whether holes in the law on injunctions and sovereign immunity — and not holes in pari passu clauses — have been the problem all along…
passu clauses — have been the problem all along…
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*NB — Horatio Gadfly is not actually real. He’s a figment of the imagination of Mitu Gulati of Duke Law School. Mitu prepared Gadfly’s arguments to test on students of his “International Debt Transactions” course next year. But those Imperial Chinese bonds are real. People do sue over them. No one’s used the paripassu template or teased out its full implications… yet.
Transactions” course next year. But those Imperial Chinese bonds are real. People do sue over them. No one’s used the paripassu template or teased out its full implications… yet.
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