Judgments > CACs!!!!

There is a subtext to my recent exchange with Mitu (here, here, and here) about whether a judgment-holder is bound by a subsequent vote to modify a bond’s payment terms, and it is of course Venezuela. U.S. sanctions prevent a restructuring of Venezuelan debt, and this long delay creates a window in which many creditors might obtain judgments. (It hasn’t happened but, you know, it’s a thing that could happen.) Mitu’s disarmingly “simple-minded” query in his most recent post is (of course) quite sophisticated. Might we view the CAC as an inter-creditor undertaking, such that, for example, after a successful restructuring vote participating bondholders could sue judgment-holders for a pro-rata share of any recovery the judgment-holder had managed to extract?

Before I go into a more detailed reply, a general comment. If one thinks that inter-creditor rivalry is a problem in sovereign debt restructuring—and a decision to litigate early is a form of inter-creditor rivalry, in the sense that a litigating creditor hopes to (i) avoid the effect of a restructuring and (ii) potentially earn a priority claim to the proceeds of any sale of attached sovereign assets—then one will want to find ways to limit inter-creditor rivalry. Perhaps the most elegant solution is to posit the existence of inter-creditor duties. I’m not entirely sure what Mitu has in mind when he posits a duty to “accept a supermajority [restructuring] decision.” (He’s raising this as a question, not necessarily insisting that the duty exists, but I’ll treat it as his proposal—hopefully that’s not too unfair.) Would the breach of that duty give rise to a cause of action for damages—measured, say, by any delay in resumption of payment caused by the lawsuit?* Would it require the judgment-holder to share with restructuring participants the proceeds of any recovery on the judgment, to the extent the recovery exceeded the NPV of the restructured bonds? I suspect this latter option is what Mitu has in mind, because it would eliminate incentives to litigate (or “rush-in,” as Steven Bodzin puts it). It would also be consistent with clever transaction structures that Mitu and Lee Buchheit have proposed elsewhere, which are designed to force holdouts to share any recovery with restructuring participants.

But here’s the thing. It might be a great idea to de-fang holdouts (or, in this context, rush-ins) like this. It would also be a great idea for every reader of this blog to send me $100. Alas, the modification provisions in sovereign bonds require neither thing.

I don’t have much to add to my prior post on the meaning of your typical modification clause. I’ll just repeat here that it is very hard to find any language in the clause that would impose inter-creditor duties. The provision sets out guidelines for bond modification. To the extent a judgment-holder still has and asserts rights under the bond, it is bound by the modification. (More on this later.) But the judgment is an entirely different thing, and every lawyer knows this, and the modification clause doesn’t say a thing about it.

We can assume that the duty of good faith and fair dealing—though very weak in this context—imposes some constraints on self-interested behavior by bondholders. But to do the work Mitu’s proposal would need it to do, an inter-creditor duty would have to apply to most cases in which a bondholder files suit prior to a restructuring. And that strikes me as implausible. Let’s take Venezuela as an example, since that country is the motivation for this discussion. I suspect most observers of the Venezuelan debt crisis will agree that most of the country’s creditors have been…. rather patient? I mean, it’s been over two years since default, and there are no meaningful signs that a restructuring will happen any time soon. Can we seriously argue that a bondholder is acting inappropriately by filing suit in this context?

What does it even mean to say that a judgment creditor is bound to accept the decision of the supermajority (perhaps years after it made the decision to file suit)? Let’s assume the creditor has managed to recover the full amount of its judgment—which would likely take many more years and require millions more in legal fees, given the difficulty of finding attachable sovereign assets. Does it get to keep enough “extra” to compensate it for all of the money it spent on lawyers (perhaps in the good faith belief that there might never be a restructuring), or does it just eat all of those fees (perhaps as its penance for violating a duty to other bondholders)? What if its lawsuit is the very reason why the sovereign and the other creditors got off their collective butts and agreed on restructuring terms? (This might not be the issue in Venezuela given the sanctions, but the duty wouldn't be Venezuela-specific...)

If your standard modification clause meant to impose an inter-creditor duty of the sort Mitu has in mind, I would expect it to address some of these fairly obvious questions. And finally, keep in mind that there are well-known contract terms that would accomplish the same result. They are called sharing clauses. How plausible is it to think that an issuer would intend the bond’s modification provisions to impose an inter-creditor duty like this when it declined to adopt a well-understood alternative that accomplishes that result more directly? And wouldn’t we expect the issuer to disclose in the prospectus that a creditor who chooses to file a lawsuit might violate a duty owed to other creditors? (They don’t).

Anyway, I’m being a bit histrionic here. In truth, I’m a big fan of the core of this idea. Sovereign bonds might do well to carefully specify some inter-creditor duties ex ante. Bonds issued under a trust indenture go a step in this direction by centralizing enforcement power in the trustee, who brings suit for the benefit of all holders. I just don’t think one can manufacture meaningful inter-creditor duties from your standard modification clause.

Lastly, Mitu rightly points to the district court decisions in Ex-Im Bank and NML, describing them as holding that a bond “continues to have legal vitality even after the awarding of a judgment” and asking whether these holdings support the argument that a modification binds a judgment-holder. I don’t think they do, for the reasons I gave in the last post. But let me explain a bit more about why I think these cases are entirely irrelevant.

The law often uses metaphors—here, the old metaphor was that a plaintiff’s claims under a contract “merge” into a judgment—to describe much more specific concepts. The merger doctrine was always a pretty crappy metaphor, and the cases Mitu mentions correctly note that it has fallen out of favor. So let’s focus on specific legal questions rather than metaphors. The specific legal question in both Ex-Im and NML was whether a plaintiff that had already sued and gotten a judgment for money damages could file a second lawsuit asserting a claim for violation of the pari passu clause. As I said in my last post, this question implicates the doctrine of claim preclusion, and the judges gave defensible answers. Basically, if a claim wasn’t available to you at the time you brought your lawsuit, you are allowed to bring that claim in a new one.

The topic we are discussing here has nothing to do with that specific question. Our specific question is this: Does a successful restructuring vote under a bond’s modification provisions bind someone who has already received a judgment? It’s a non-sequitur—or at least, only a very partial answer—to say that a bond “continues to have legal vitality even after the awarding of the judgment.” I mean, the statement is correct. Certainly it’s true when the judgment-holder still owns the bond and insists on enforcing some of its provisions (as happened in the two cases above). It’s probably true in other cases as well. For example, if a bond had a sharing clause, an investor who successfully recovered on a money judgment would have to share the proceeds whether or not it still owned the bond. But that’s not because the bond didn’t “merge” into the judgment. It’s because the bond, y’know, had a sharing clause. These don’t. Nor do they have anything that even hints that a modification vote would somehow negate the effect of a court judgment.

*I assume not, because the damages would probably be zero given the difficulty of proving that the lawsuit caused any delay in the restructuring.