Collective Action Clauses: The Way Forward
Koch, Elmar B., Georgetown Journal of International Law
Collective action clauses (CACs) are a new element in the international financial architecture intended to ensure the orderly and timely resolution of sovereign default. Before the Working Group of the Group of Ten (G10) was set up in the summer of 2002, (1) no explicit guidelines or framework existed for the formulation of these clauses. (2) The Working Group's proposed guidelines gained wide currency with their endorsement by the G10 Finance Ministers and Governors in September 2002. (3) At the same time, U.S. private sector trade associations (the Gang of Seven) also developed their own proposals for CACs. (4) The International Monetary Fund (IMF) supported the efforts of both the G10 and the Gang of Seven.
In February 2003, such clauses were included for the first time in a sovereign bond issue under New York law by a large major borrower, Mexico. (5) Several other sovereign borrowers followed suit. By the beginning of 2004, it became clear that key elements of CACs, in particular majority action clauses, were routinely included in this new bond documentation on the New York financial market. This feature is expected to contribute to the more orderly resolution of sovereign debt crises by preventing unwarranted creditor holdouts.
Section I of this Essay provides background on CACs in sovereign bond markets. Sections II and III review recent developments in adopting CACs in sovereign bond issues and the continued international support for adopting these clauses. Section IV provides a preliminary legal assessment of these newly adopted CACs. Finally, Section V reviews some key open issues.
CACs are an integral part of the bond contract between a sovereign borrower and a private sector lender. These clauses become effective if and when a sovereign borrower defaults on a bond. In the international context, a sovereign borrower may default on its bonded debt for a variety of reasons. From a legal perspective, it is easy to claim pacta sunt servanda (contracts have to be honoured), but from a humanitarian, economic, or political perspective, a sovereign state may assess debt payments quite differently. CACs have no influence on whether or not sovereign debt is sustainable. CACs are merely a tool in the restructuring of sovereign bonded debt.
From an international perspective, it is desirable to have a fair, orderly, and timely mechanism for resolving debt restructuring issues. It should be noted that CACs do not affect the substance of the debt negotiation process itself. Rather, they are primarily concerned with the process through which litigation can be settled within the legal system. (6) Thus, though agreement or settlement procedures concluded outside the courts--such as negotiation, mediation, or arbitration--may be satisfactory, they will not necessarily be covered by CACs. (7) Contractual CACs are intended to address two emerging issues: (1) the distribution of a large number of retail bondholders worldwide on the heels of a large credit appetite by some sovereigns, starting with the 1991-1992 boom periods; and (2) the associated issue that some creditors will attempt to manipulate the process for their own benefit. More recently, in-fighting among creditors themselves in order to reach the assets of sovereign states has emerged as a serious threat to orderly and timely restructuring.
Traditionally, CACs were included in sovereign bonds governed by English, Japanese, and Luxembourgian law. Sovereign bonds issued under U.S., German, Italian, or Swiss law did not include such clauses. The largest market for sovereign bonds is in New York State. The adoption of CACs on the New York market was key to providing an internationally acceptable level playing field. (8) While Italy adopted CACs in 2003, under New York law, sovereign bonds issued under German and Swiss law in the last year did not contain CACs.
The role of the official sector is to establish a more transparent and level playing field for debtors and creditors in all major domestic legal systems. …