Evaluating Venezuela’s Guidelines for Debt Restructuring

Mark Weidemaier & Mitu Gulati

As reported in the Financial Times, Reuters, and elsewhere, Juan Guaido’s economic and legal team has released a report setting out guidelines for a restructuring of Venezuelan debt. The report, attached here, describes a process that can only happen if/when Maduro loses power and the U.S. government lifts the current sanctions regime, which effectively forbids most transactions in Venezuelan debt. The report is a brief three pages, but it offers intriguing clues about what a restructuring might look like.

Proposals to restructure the Venezuelan debt must accommodate certain basic realities:

- The country is experiencing a dire humanitarian crisis, which demands immediate attention.

- The debt stock is utterly, needlessly complex. Venezuela has somewhere in the range of $200 billion in external liabilities. Virtually all creditors are unsecured, and every creditor’s repayment prospects are tied directly to the government’s ability to monetize one asset: oil. For all practical purposes, every creditor is in the same position. Yet the debt is spread across multiple obligors (the government, PDVSA, etc.) and a bewildering array of obligations (bonds, promissory notes, trade credits, arbitration awards, and who knows what else).

- The government therefore needs time—time to focus on humanitarian needs, time to rehabilitate the oil sector, time to stabilize the political situation, time to determine the full scope of its debts, time for a new government to come up with a credible economic plan for recovery, time to persuade key foreign companies that they won’t be expropriated again if they come back and help in the recovery, and time to come to terms with its creditors. But…

- It may not have much time. Many creditors have been patient. But a few have already reduced claims to judgment and initiated attachment proceedings against crucial government assets, including U.S. oil operations. It is surprising that the litigation floodgates have not opened, but that could happen any day now.

- The next government is going to be highly vulnerable to creditor lawsuits, and particularly so in the United States. It cannot right its economy without selling oil abroad (and sales in the U.S. are typically the cheapest, given refineries and distances). But these sales generate assets in foreign jurisdictions, where creditors will try to seize them. This vulnerability, paired with the complexity of its debt stock, makes Venezuela more akin to Iraq than to more recent crises.

- Finally, the U.S. government may prove a fickle ally. The most effective way to buy time for a Venezuelan restructuring would be for the U.S. and other key jurisdictions to block creditors from attaching Venezuelan assets while the government was engaged in good faith restructuring negotiations. This is what happened for Iraq, but will the Trump administration be able to collaborate with other key nations (China, Russia) to produce a solution similar to that designed for Iraq?  We don’t know.

These facts make for a very messy debt restructuring scenario. But that doesn’t mean the restructuring plan must be complicated. To the contrary, the proposal released by Mr. Guaido’s team attempts to simplify. (Note that the plan does not address debts owed to other nations, presumably including state-owned companies):

Timing and credibility: As noted, Venezuela needs time to address pressing humanitarian needs and, more broadly, to get its house in order. It also needs to persuade its creditors that it has accurately estimated its liabilities and repayment capacity. But the byzantine debt stock created by the Maduro regime, combined with the government’s long-standing refusal to engage with the IMF, means that creditors have little reason to accept the government’s estimates. Not surprisingly, then, the proposal envisions that the IMF will both provide emergency humanitarian assistance but play its usual role in assessing the country’s growth and repayment prospects.

Equal creditor treatment: This is the aspect of the proposal that has gotten the most attention in the financial press. If a creditor has an unsecured foreign-currency claim, it will get the same treatment as any other holder of such a claim, regardless of the obligor’s identity or the nature of the obligation. Thus, the plan, quite sensibly, draws no distinction between holders of unsecured PDVSA bonds and holders of Venezuelan government bonds or between types of Venezuelan bonds (some of the sovereign’s bonds have different contractual rights than others). Nor will the government offer different terms to creditors who have reduced their claims to judgment.

Claims reconciliation process (i.e., no-so equal creditor treatment): The guidelines call for a claims reconciliation process to determine the validity and amount of creditor claims; only reconciled claims will be eligible to participate in a restructuring. In this process, the government will likely seek to reduce the face value of many of its obligations, including many billions in debt issued with significant original issue discount (OID) (These are obligations issued at substantially inflated face values -- for more on OID, see here.) In a bankruptcy, the court would likely disallow the portion of a claim representing OID; the claims reconciliation process will attempt to replicate that result. If a creditor participates in the claims reconciliation process but doesn’t like the result and later tries to sue, courts will probably defer to the reconciliation agent’s conclusions. Indeed, even if a creditor does not want to participate, there is a chance it could be made to do so as a condition of filing suit.

Unpaid interest: The proposal says that creditors will be paid according to the terms of their original contracts and that no special treatment will be given to those who have obtained judgments. But judgments, especially those obtained in federal court, accrue interest at a different rate than claims without judgments (the latter, in this case, will be significantly higher). So, how will those with judgements be treated relative to those who didn’t go through the expense of hiring lawyers to obtain a judgment?

The obvious question left by the proposal is this: What is to stop litigious creditors from disrupting the government’s attempts to conduct an orderly restructuring? The proposal itself plays it coy:

“The Authorities acknowledge and appreciate the forbearance from exercising legal remedies shown by most private creditors … Moreover, as noted above, no preferential treatment will be accorded in the debt renegotiation to claims that have been reduced to a court judgment. The Authorities therefore request all claimants to refrain from pursuing legal remedies (and suspend, without prejudice, any actions that have already been commenced) …”

It’s a nice sentiment, but will it sway creditors with strong legal rights? We are skeptical. Argentina did ultimately pay very different amounts to a subset of creditors who had had the most aggressive and effective litigation strategies. And it had very much intended not to do so. Venezuela will likely be a lot more vulnerable to these kinds of litigation strategies.

Indeed, the ultimate audience for the proposal may wind up being courts in the U.S. and elsewhere. Recall that the U.S. government seems unwilling to block creditor attachment efforts in the U.S. Without such affirmative support, Venezuela has few tools available to prevent creditor lawsuits and attachment efforts from going forward.

One intriguing possibility, which we noted in an earlier post, is that U.S. courts might stay creditor lawsuits out of comity—i.e., respect for, and deference to, proceedings in a foreign country. In the specific context of that post—which involved a request for a stay due to the fact that Mr. Guaido could not effectively exercise power right now—we expressed doubt that U.S. courts would accept the comity argument. However, in the context of a credible, good-faith restructuring plan, perhaps courts would be more willing to entertain the idea. Indeed, if we were to design a restructuring plan that might merit deference from a U.S. court, it would look a lot like the one put forth by Mr. Guaido’s team. U.S. courts (including in the Second Circuit) do sometimes grant stays in “exceptional circumstances” in deference to parallel proceedings in foreign jurisdictions. Arguably, the claims reconciliation process is such a proceeding. And if any situation constituted “exceptional circumstances,” it is this one, where a successful restructuring—not to mention a solution to the humanitarian crisis—requires an orderly process.

We’re left wondering, then, whether Mr. Guaido’s team is already looking forward to the coming battles over whether creditors can obtain judgments and commence attachment proceedings. We suspect they are, and that one purpose of the proposed restructuring guidelines is to create a process that will merit deference by U.S. courts. If so, and if U.S. courts are in fact willing to stay creditor lawsuits in deference to the restructuring process, that will be an extraordinary accomplishment.

There are sure to be interesting developments on the creditor side as a result of this report. The big institutional investors have, from what we hear, stuck around a lot longer in this distressed situation than is normal for them. If that is correct, that is good news for the next government because these investors are generally more cooperative than the litigation hawks like Elliott and Aurelius. But prices will likely keep dropping the longer that Maduro sticks around and sanctions are in operation and that will attract more of the litigation hawks. We already hear that sales by U.S. institutions to European distressed debt investors have been rising as of late.