Academic journal article Business Law International

Uses and Abuses of Collective Action Clauses in Sovereign Bonds

Academic journal article Business Law International

Uses and Abuses of Collective Action Clauses in Sovereign Bonds

Article excerpt

The topic of collective action clauses in sovereign bonds has recently attracted much attention. In particular:

* These clauses were retroactively inserted by a Greek law into existing bonds governed by Greek law in February 2012 as part of the reorganisation of the Greek government debt.

* The members of the eurozone agreed in the revised Treaty establishing the European Stability Mechanism, signed by all 17 euro area Member States, that collective action clauses will be included, as of 1 January 2013, in nearly all new euro area government securities.

* The use of collective action clauses was discussed in the recent judgment of a New York Federal District Court and Court of Appeals about the meaning of the pari passu clause in the much-discussed case of NML v Argentina.

It is therefore worth discussing the implications of these developments for sovereign debt. Important questions are:

* How will collective action clauses affect sovereign workouts and, apart from the eurozone, will these clauses become standard in all sovereign issues?

* How would collective action clauses be used for a rescheduling of sovereign bonds involving a haircut?

* Are there are advantages in using these clauses in a re-profiling of sovereign debt?

* Are there any uses of collective action clauses that are likely to be held invalid by the courts?

* What are the voting majorities and how do aggregation clauses work?

* What impact do collective action clauses have on steering committees and bondholder trustees?

* What should be the governing law of collective action clauses?

The debt-to-GDP ratios of many first world sovereign states are historically very high and some could creep higher. Interest rates could spike.

Whether or not the official sector or the private sector thinks this time is different, participants on both sides need to carry out contingency planning. The role of collective action clauses is a major element in the plan.

What are collective action clauses?

The term 'collective action clauses' is a generic term to cover three types of provision:

1. Provisions for majority voting by bondholders to change the terms of a bond (in particular key terms such as interest, maturity and principal amount) so that dissenting minorities are bound by the change.

2. A no-action clause whereby no bondholder can accelerate or take action against the issuer without the consent of a specified proportion of the bondholders.

3. Provisions appointing a trustee or other bondholder representative on behalf of the bondholders, often including a provision whereby recoveries from a defaulting debtor received by a trustee for the bondholders are shared among the bondholders pro rata.

The most important clause is bondholder voting and it is this set of clauses this article will concentrate on.

Financial democracies and the law

Just as political democracies have spread, so have financial democracies. Examples are shareholder voting, syndicate democracy clauses in syndicated bank credit agreements and creditor voting on plans in relation to corporate bankruptcy reorganisation statutes.

Financial democracies are property democracies. In order to be able to vote, you have to have a property interest in the form of a bond or a share or a claim against a debtor. The point is that you can therefore buy a vote. The use of collective action clauses changes the landscape in working out the potential outcomes.

How did we get here?

International bonds governed by English law have long contained collective action clauses - since the 19th century in the case of corporate bonds.

Many countries in the civil code camp introduced bondholder community statutes conferring powers on bondholders to change the terms of bonds by majority voting, but sometimes limiting the issues they could vote on. There were or are bondholder community statutes in Argentina, Belgium, Brazil, Chile, France, Germany, Italy, Japan, Luxembourg, Mexico, Spain and Switzerland, and many other countries. …

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