Academic journal article Law and Contemporary Problems

When Bad Things Happen to Good Sovereign Debt Contracts: The Case of Ecuador

Academic journal article Law and Contemporary Problems

When Bad Things Happen to Good Sovereign Debt Contracts: The Case of Ecuador

Article excerpt

I

INTRODUCTION

Multinational corporations were meant to be reassured by the protections incorporated into bilateral and regional investment agreements. However, judging from the growing number of claims filed with the International Centre for Settlement of Investment Disputes (ICSID) and other arbitration vehicles-more than three hundred and fifty treaty-based, investor-state disputes as of the end of 2009--it is evident that many corporations have found out the hard way that sovereign states are not always suitably restrained by the international treaties they have signed and ratified. (1)

Likewise, private-sector commercial-bank creditors, bondholders, and suppliers--even official bilateral and multilateral lenders--have come to learn by repeat experience that financial contracts entered into by sovereign borrowers, no matter how airtight and well-intentioned at the time they were crafted and signed, can be perverted or ignored by governments lacking in ability or willingness to pay.

This article illustrates this point by focusing on the case of Ecuador, a country whose governments have defaulted nine times on foreign-currency bonds and numerous times to foreign commercial-bank creditors and others, such that the sovereign has been in default for at least 109 out of the last 184 years--sixty percent of the time from 1826 through 2010. (2) By its own reckoning, the government has been in arrears on interest payments to some foreign creditor or another in each and every year starting in 1987. (3) The lesson from abundant history is that, despite decades of innovations in international-loan and bond contracts involving sovereign financial obligations--courtesy of some of the best minds in New York, London, and beyond--lawyers, bankers, analysts, and investors are best advised to operate under no illusions: sovereigns are indeed sovereign, independent of the laws of other nations. Those who harbored the hope that Argentina's bad behavior as a sovereign debtor was a major exception that would not soon be repeated should be persuaded by the case of Ecuador that, although the absence of sovereign willingness to pay remains rare, it is not rare enough. Notwithstanding the best of legal contracts and the surrender of sovereign immunities under New York, English, or other foreign law, in actual practice, rogue sovereign debtors can be held accountable or effectively restrained only by the forceful actions of other sovereigns. (4) During the nineteenth century, this was sometimes accomplished by the successful exercise of military force and, during the twentieth century, through the application of diplomatic, trade, and financial sanctions or incentives, both unilaterally and through multilateral organizations.

II

THE GOOD INTENTIONS

After repeated refinancings and deferrals of debt-service obligations to foreign commercial banks, and the accumulation of sizeable interest arrears (particularly from 1987 through 1994), the government of Ecuador finally reached a comprehensive debt-forgiveness and restructuring deal in 1995, under the aegis of the Brady Plan. The terms agreed to reflected creditor concessions that were more generous than those granted to any other Latin American government up to that moment; in particular, the discount bond--accepted by creditors willing to give up claims on principal owed--involved a forty-five percent "haircut" rather than the usual thirty-five percent. (5) As in other Brady Plan applications, the various securities issued in exchange for old defaulted loans (in this instance the par, discount, past-due-interest, and interest-equalization bonds) incorporated a number of legal innovations designed to make them virtually inviolable in any future economic emergency. First, they were freely transferrable bonds listed on the Luxembourg Stock Exchange, precisely so their ownership could change over time and so they would not be easily traceable for the purpose of getting them restructured again. …

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