– By : Oonagh Fitzgerald, Steven L. Schwarcz –
In recent years, many countries — including Greece, Argentina and Ukraine — have found themselves indebted beyond their ability to pay. Argentina may now be on the brink of resolving a decade-long dispute with some of its creditors, but its predicament highlights a fundamental problem of sovereign debt.
Unlike individuals and corporations, countries cannot use bankruptcy laws to restructure unsustainable debt. They are forced to try to separately renegotiate each of their debt contracts, which often fails because it requires unanimity. Although attempts have been made to try to bypass this requirement by including so-called collective action clauses in sovereign debt contracts, many contracts still lack them. Furthermore, most collective action clauses only bind a party to the particular contract that includes it. The parties to any given sovereign debt contract, therefore, can act as holdouts in any debt restructuring plan that requires the parties to all of the country’s other debt contracts to agree to it.
Recent judicial decisions interpreting New York law, which governed the relevant Argentine debt contracts, have made sovereign debt restructuring even harder; they allow “vulture funds” to extract ransom money by buying debt claims to block the ability of majority creditors to reach a settlement. These decisions broadly threaten New York’s dominance as the law that governs sovereign debt contracts.
Yet New York has the unique ability not only to preserve its dominance but also to help solve the sovereign debt crisis. Because around half the world’s sovereign debt contracts are governed by New York law, the state could pass a measure to amend the voting requirements under those contracts. For example, contracts that now require unanimity for revisions could be amended to allow changes that are approved by at least a supermajority of similarly situated creditors (even if those creditors’ claims arise under different debt contracts); such a law would overcome the major hurdle to sovereign debt restructuring. That, in turn, would give struggling nations the real prospect of equitably restructuring their debt to sustainable levels, thereby lowering sovereign borrowing costs and increasing creditor confidence by reducing uncertainty.
This is a financially powerful opportunity for New York. Never before has a U.S. state had the power to influence the international community to such an extent. Being that New York City is the world’s financial center and home of the United Nations headquarters, it is fitting that circumstances have endowed the state with this power. Enactment of such a measure would also reinforce New York’s legitimacy as the governing law for future sovereign debt contracts.
The state also would not be treading on a federal treaty prerogative. Absent an actual federal treaty, New York has the absolute right to fill the legal breach. Even though the law could retroactively impair contract rights, any impairment would be a reasonable exercise of the state’s police powers to protect its economy — reducing the likelihood that a country-debt default could trigger a systemic collapse, as occurred in 2008 when mortgage-debt defaults triggered a global economic meltdown. And because any impairment must be voluntarily agreed to by a “supermajority” of creditors, such a law would preserve reasonable contractual expectations based on what creditors then realistically expect to receive as payment.
Circumstances have given New York state the astonishing ability to make history by establishing an orderly sovereign debt resolution procedure under the rule of law. New York would benefit, and the world would benefit. This extraordinary opportunity is too important for the state to ignore.
Copyright 2017 the Center for International Governance Innovation. This article was first published by the Centre for International Governance Innovation and is reproduced here with permission.