An Incremental Approach to Sovereign Debt Restructuring: Sovereign Debt Sustainability as a Principle of Public International Law

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An Incremental Approach to Sovereign Debt Restructuring: Sovereign Debt Sustainability as a Principle of Public International Law Juan Pablo Bohoslavsky & Matthias Goldmann* I. INTRODUCTION: LOOKING BEYOND
An Incremental Approach to Sovereign Debt Restructuring: Sovereign Debt Sustainability as a Principle of Public International Law Juan Pablo Bohoslavsky & Matthias Goldmann* I. INTRODUCTION: LOOKING BEYOND STATUTORY AND CONTRACTUAL APPROACHES II. PRINCIPLES IN INTERNATIONAL LAW III. THE EMERGENCE OF SOVEREIGN DEBT SUSTAINABILITY AS PRINCIPLE OF PUBLIC INTERNATIONAL LAW A. Before the End of WWI: The Prevalence of the Private Law Paradigm B. Before the End of Bretton Woods: A Public Law Regime in the Making C. After Bretton Woods: The Emergence of Sovereign Debt Sustainability IV. HOLDOUT LITIGATION: A LITMUS TEST FOR DEBT SUSTAINABILITY A. Holdout Litigation as a Legal Challenge to Debt Sustainability B. Holdout Litigation as a Factual Challenge to Debt Sustainability C. Recent Affirmations of Debt Sustainability V. SAFEGUARDING DEBT SUSTAINABILITY: AN INCREMENTAL APPROACH TO SOVEREIGN DEBT RESTRUCTURING A. Contractual and Other Bilateral Approaches B. The Difficulty with a Treaty Option C. An Incremental Approach Based on Legal Principles VI. CONCLUSION: CHALLENGES AHEAD I. INTRODUCTION: LOOKING BEYOND STATUTORY AND CONTRACTUAL APPROACHES Current sovereign debt restructuring practice does not always provide timely and effective solutions for troubled states. Restructuring is tedious and causes economic hardship; this makes it unattractive for leaders of debtor states with increasingly unsustainable debt burdens to enter the process in time. 1 Once states decide to restructure, overly optimistic growth expectations * Juan Pablo Bohoslavsky, Dr. iur. (Salamanca), LL.M. (Austral University), LL.B. (Comahue), is the Independent Expert of the UN Human Rights Council on the effects of foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights. Matthias Goldmann, Dr. iur. (Heidelberg), LL.M. (NYU) is a Junior Professor at Goethe University Frankfurt and Senior Research Affiliate at the Max Planck Institute for Comparative Public Law and International Law in Heidelberg, Germany. This paper is based on an expert statement submitted for the 2015 UNCTAD Trade and Development Report. For valuable feedback, the authors would like to thank the staff and experts at UNCTAD, participants at DebtCon1 at Georgetown Law School in January 2016, as well as the 2015/2016 editors of the Yale Journal of International Law. 1. From the rich literature: Lee C. Buchheit, et al., Revisiting Sovereign Bankruptcy 14 THE YALE JOURNAL OF INTERNATIONAL LAW ONLINE [Vol. 41: 2 might lead to inadequate restructuring terms. 2 Once the debtor state makes an exchange offer to its bondholders, holdout strategies might lead to further delays. 3 To improve this economically and politically unsatisfactory situation, two types of solutions dominate the discussion: contractual proposals (such as improved aggregated Collective Actions Clauses CACs) 4 and statutory proposals (e.g., a treaty establishing an international bankruptcy court). 5 The relative practical advantages and disadvantages of each set of proposals are the subject of a rich debate. What is less often discussed is whether they satisfy the normative demands towards sovereign debt restructuring that emanate from the international legal order and its practices. The goal of this Article is therefore to reconstruct the normative implications of current sovereign debt restructuring practice and measure contractual and statutory proposals in their light. The normative implications of current sovereign debt restructuring practice find expression in principles of international law (reflecting the main structures of the international legal order), to be distinguished from general principles of law (reflecting overlapping consensus among domestic legal orders). We explain this difference in Section II. In Section III we argue that changes in sovereign debt restructuring practices over the last decades reflect an increasing recognition of sovereign debt sustainability as a principle of public international law. This principle expresses the now widely shared conviction that states need healthy financial conditions for economic development, as well as the provision of welfare. It therefore also implies concern for the protection of human rights in sovereign debt crises, including of internationally guaranteed economic, social and cultural rights. We track down the emergence of this principle in the practice of sovereign debt restructuring. While a private law paradigm prevailed up to the end of the First World War that left the resolution of sovereign debt crises to unregulated, ad-hoc negotiations between debtor states and their creditors, first traces of the recognition of sovereign debt sustainability as a public interest can be found in the aftermath of the First World War. They coincided (Brookings Committee on International Economic Policy and Reform, 2013), available at Christoph Trebesch, Delays in Sovereign Debt Restructurings (working paper, 2010), available at RestructuringDelays.pdf?attredirects=0. 2. Olivier Blanchard & Daniel Leigh, Growth Forecast Errors and Fiscal Multipliers (IMF Working Paper WP/13/1, 2013). 3. Julian Schumacher, et al., Sovereign Defaults in Court (SSRN working paper, 2014), available at 4. E.g. International Capital Markets Association, Standard Aggregated Collective Action Clauses ( CACs ) for the Terms and Conditions of Sovereign Notes (2014), available at 5. E.g. ANNE O. KRUEGER, A NEW APPROACH TO SOVEREIGN DEBT RESTRUCTURING (2002); José A. Ocampo, A Brief History of Sovereign Debt Resolution and a Proposal for a Mutilateral Instrument, in TOO LITTLE, TOO LATE: THE QUEST TO RESOLVE SOVEREIGN DEBT CRISES 189 (Martin Guzman, José Antonio Ocampo & Joseph Stiglitz eds., 2016); comprehensive overview in Kenneth Rogoff & Jeromin Zettelmeyer, Bankruptcy Procedures for Sovereigns: A History of Ideas, , 49 IMF STAFF PAPERS 470 (2002). 2016] An Incremental Approach to Sovereign Debt Restructuring 15 with institutional arrangements that were vertical rather than horizontal, reflecting an emerging public law regime, This regime was consolidated after the demise of the Bretton Woods system in the early 1970s and the ensuing debt crises that have afflicted the developing world since then. In the course of this development, sovereign debt sustainability gained recognition as the objective of international debt restructuring efforts. Thus, sovereign debt restructurings are not an issue of concern only for the debtor state and its creditors, but for the entire international community. Subsequently, Section IV explores the challenge to sovereign debt sustainability constituted by the rise in holdout litigation, a development that has serious legal and factual consequences for debt sustainability. Nevertheless, in reaction to this development, a wide array of stakeholders has strongly rejected holdout litigation and taken measures to prevent it, thereby confirming the principle of sovereign debt sustainability. Section V assesses current proposals by this standard. As valuable as contractual proposals are from a practical standpoint, taking them as the sole response to debt crises appears normatively unsatisfactory. Sovereign debt sustainability as a global concern implies that sovereign debt restructurings cannot depend on the mercy of the creditors alone. By contrast, statutory proposals would satisfy this requirement. But for the time being, they seem to be politically unavailable. We therefore propose a third avenue: an incremental approach. It complements current practice, including contractual approaches, with a set of legal principles, both principles of international law and general principles of law, with the principle of sovereign debt sustainability as the normative center. They should help remedy the shortcomings of current practice. Section IV concludes. II. PRINCIPLES IN INTERNATIONAL LAW We understand principles in international law to be abstract, general norms, which express an important structural element of the present international legal order. Broadly speaking, principles in international law can take two forms. First, there are general principles of law, which are original sources of international law derived from domestic law. 6 Although general principles of law play an important role for the incremental build-up of a sovereign debt restructuring mechanism, this Article concentrates instead on the second, less widely known form of principles: principles of public international law. 7 Unlike general principles of law, principles of international law do not have a basis in domestic law. Rather, they reflect the main structures of the international legal order. 8 At first sight, the international legal 6. Cf. Art. 38(1)(c), Statute of the International Court of Justice. 7. For a focus on general principles, see Matthias Goldmann, Putting your Faith in Good Faith: A Principled Strategy against Holdouts in Sovereign Debt Workouts, 41 YALE J. INT L L. ONLINE (2016), in this special issue. 8. WOLFGANG G. FRIEDMANN, THE CHANGING STRUCTURE OF INTERNATIONAL LAW 196 et seq. (1964); RÜDIGER WOLFRUM, General International Law (Principles, Rules, and Standards), in MAX PLANCK ENCYCLOPEDIA OF PUBLIC INTERNATIONAL LAW et seq. (Rüdiger Wolfrum ed., 2010); Matthias Goldmann, Principles in International Law as Rational Reconstructions. A Taxonomy (working paper, 2013), available at 16 THE YALE JOURNAL OF INTERNATIONAL LAW ONLINE [Vol. 41: 2 order is a chaotic, amorphous arrangement consisting of myriad rules and practices with different normative status, ranging from treaty law to soft law, which often appear incomplete and contradictory. 9 Like in any legal order, 10 principles give structure to this amorphous arrangement, ensuring consistency and providing orientation to those applying the law. It is the foremost task of legal practice and scholarship to make sense of this chaos and create a fairly consistent order by identifying and, where possible, codifying principles. 11 Of course, the existence of principles of public international law presupposes that one understands international law as an order, albeit a fragmented one that does not emanate from one centralized power, rather than as inherently chaotic and incomplete. Today, one cannot presume that public international law is not an order. 12 Its development since the Second World War has given rise to the presumption that the rules of international law do not contradict each other 13 and form a legal order that is by and large coherent. 14 Principles are the backbone of that order. They ensure consistency in the application of specific international legal rules and serve the interpretation and further development of the law. 15 Moreover, as any seasoned lawyer can attest, even legal orders that emanate from one central power are often no less chaotic and fragmented than international law as they result from political compromises made by different people at different times. 16 The formation of principles of public international law thus requires a constructive, interpretative effort. They emerge as abstractions from the rules and practice of international law. One may establish a principle by showing that practice follows a fairly consistent normative pattern in a certain field of international law, which is consistent with other rules and principles of international law. This implies that practice will hardly ever follow a principle to the fullest extent. Rather, establishing a principle implies almost by definition that there are certain specific rules that deviate from the principle, as long as the principle prevails. Principles might also reflect a trend or a 9. Id. 10. Seminal: RONALD DWORKIN, TAKING RIGHTS SERIOUSLY 22 (1977); JÜRGEN HABERMAS, BETWEEN FACTS AND NORMS ch and (Repr. ed. 2008). 11. This has been called doctrinal constructivism. See Armin von Bogdandy, The Past and Promise of Doctrinal Constructivism: A Strategy for Responding to the Challenges Facing Constitutional Scholarship in Europe, 7 INT L J. CONST. L. 364 (2009). 12. Cf, by contrast, the Case of the S.S. Lotus (France v. Turkey), 1927 P.C.I.J. (ser. A/B) No. 9, at 16-7 (Sept. 7), which puts principles of international law on a par with contractual or customary obligations. 13. Right of Passage over Indian Territory (Portugal v. India), 1957 I.C.J. 142 (Nov. 26). 14. A first-rate example for this approach is the understanding of jurisdiction in Prosecutor v. Tadic, Case No. IT-94-1-I, Decision on Defence Motion for Interlocutory Appeal on Jurisdiction (Int l Crim. Trib. For the Former Yugoslavia Oct. 2, 1995). 15. Koskenniemi calls them descriptive principles. See Martti Koskenniemi, General Principles: Reflexions on Constructivist thinking in International Law, in SOURCES OF INTERNATIONAL LAW (Martti Koskenniemi ed. 2000). Herdegen prefers calling them values, see Matthias Herdegen, Interpretation in International Law, in MAX PLANCK ENCYCLOPEDIA OF PUBLIC INTERNATIONAL LAW 64 (Rüdiger Wolfrum ed. 2010). See also Samantha Besson, General Principles in International Law Whose Principles?, in PRINCIPLES IN EUROPEAN LAW (Samantha Besson & Pascal Pichonnaz eds., 2011). 16. Cf. supra note 10 both Dworkin and Habermas developed their theories with respect to domestic law. 2016] An Incremental Approach to Sovereign Debt Restructuring 17 tendency in practice that is not yet fully prevailing. In that case, one might speak of an emerging principle. 17 III. THE EMERGENCE OF SOVEREIGN DEBT SUSTAINABILITY AS PRINCIPLE OF PUBLIC INTERNATIONAL LAW This Section tracks the emergence of debt sustainability as a principle in international law. While international legal practice had long turned a blind eye to issues of debt sustainability, the period from the end of the First World War to the end of the Bretton Woods system marks signs of a paradigm change. But it was only after the end of the Cold War that sovereign debt sustainability came to be broadly recognized in the practice of international law. As will be explained in the following, the concept of sovereign debt sustainability implicates a concern for economic development as well as for human rights. A. Before the End of WWI: The Prevalence of the Private Law Paradigm Since the formation of statehood in Europe during early modernity, states have assumed domestic and external debt 18 in order to finance their activities. Before 1800, this led to occasional and sometimes even serial sovereign defaults. 19 But it was only in the 19th century that the volume of sovereign debt and the number of defaults skyrocketed. 20 This period marked the beginning of the development of international sovereign bond markets. 21 Newly independent states particularly those in Latin America and later Japan, Central European, and North African states took out loans from banks located in the United States, Great Britain, and a few other Western European countries like Switzerland. 22 This fueled several cycles of credit expansion and sovereign default in various countries. Sometimes this resulted from unstable political development and wars of independence, and sometimes in reaction to economic development that turned out to be slower than the providers of highly mobile capital had wished. 23 Throughout that period, the international legal order was dominated by 17. On the formation and taxonomy of principles, see Matthias Goldmann, On the Comparative Foundations of Principles in International Law: The Move Towards Rules and Transparency in Fiscal Policy as Examples, in SOVEREIGN FINANCING AND INTERNATIONAL LAW 113 (Carlos Esposito et al. eds., 2013). 18. The terms domestic and external debt refer to the legal regime governing the debt instrument. See Ugo Panizza, Domestic and External Debt in Developing Countries (UNCTAD Working Paper, 2008). 19. CARMEN M. REINHART & KENNETH S. ROGOFF, THIS TIME IS DIFFERENT. EIGHT CENTURIES OF FINANCIAL FOLLY 87 (2009). 20. Id., at Barry Eichengreen & Richard Portes, Debt and default in the 1930s: Causes and consequences 30 EUROPEAN ECONOMIC REVIEW 599, (1986); HORST FELDMANN, INTERNATIONALE UMSCHULDUNGEN IM 19. UND 20. JAHRHUNDERT. EINE ANALYSE IHRER URSACHEN, TECHNIKEN UND GRUNDPRINZIPIEN 20 et seq. (1991). 22. Id. 23. The Baring crisis of 1890 provides a textbook example of such crises. See Kris James Mitchener & Marc D. Weidenmier, The Baring Crisis and the Great Latin American Meltdown of the 1890s, 68 JOURNAL OF ECONOMIC HISTORY 462 (2008). 18 THE YALE JOURNAL OF INTERNATIONAL LAW ONLINE [Vol. 41: 2 the idea of sovereign equality. 24 Hence, debt restructurings were a matter to be dealt between the debtor and the creditor only. 25 This is what we call the private law paradigm. It rests on the idea of a relative equality of arms. On the one hand, states could repudiate their debt and remain protected against foreign law enforcement authorities by their sovereign immunities. On the other hand, creditors could capitalize on the desire of debtor states to regain access to credit markets. Even if the debt had been issued in the debtor state s currency, currency devaluation was not an option since debt instruments frequently included gold clauses, obliging the debtor state to make payments in gold or the equivalent thereof. 26 This delicate balance was often threatened in the one or the other way, triggering government action to reinstate it. On the one hand, creditors for a long time lacked organizations for their effective coordination. 27 This led to the formation of the British Corporation of Foreign Bondholders and later the Foreign Bondholders Protective Council. 28 Even though the American and British governments had midwifed these entities, they did so only to establish an equality of arms, not to actively enforce claims of their nationals. 29 On the other hand, in a few cases, governments of creditors exercised gunboat diplomacy in order to corroborate the claims of their nationals. 30 This gave rise to the Drago-Porter Convention of 1907, which established the universal principle that states may not use force in order to collect claims arising from sovereign debt of the attacked state held by their nationals. 31 As these developments demonstrate, crisis resolution was not always swift and smooth. But reform proposals aimed to reinstate an equality of arms between the parties, in accordance with the private law paradigm. 32 Debt restructurings were hardly seen as problems requiring the intervention of international institutions representing some form of common global interest. B. Before the End of Bretton Woods: A Public Law Regime in the Making The situation changed slightly after the First World War. Sovereign debt issues acquired a new dynamic, as Europe s war-ridden economies, as well as China and other states, required funds for reconstruction and development, 24. S.S. Lotus case (France v. Turkey), 1927 PCIJ (Ser. A) No Feldmann, supra note 21, 200 et seq., 368 et seq. 26. Feldmann, supra note 21, 20 et seq. 27. Eichengreen & Portes, supra note 22, Feldmann, supra note 21, 261 et seq.; Michael R. Adamson, The Failure of the Foreign Bondholders Protective Council Experiment, , 76 BUSINESS HISTORY REVIEW 479 (2002). 29. Eichengreen & Portes, supra note 22, 619; Feldmann, supra note 21, 30-1, A prominent example is the blockade of Venezuelan ports in 1902 by Great Britain, Germany and Italy. British occupation of Egypt in 1882 had the objective to control the Suez channel. See Wolfgang Benedek, Drago-Porter Convention, in MAX PLANCK ENCYCLOPEDIA OF PUBLIC INTERNATIONAL LAW (Rüdiger Wolfrum ed. 2007). 31. Convention Respecting the Limitation of the Employment of Force for the Recovery of Contract Debts, 18 October 1907, 36 Stat This includes Meili s remarkable proposal for an international bankruptcy co
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