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28 Int'l Fin. L. Rev. 22 (2008-2010)
The Coroner's Inquest

handle is hein.journals/intfinr28 and id is 690 raw text is: ECUADOR'S SOVEREIGN BOND DEFAULT The coroner's inquest Sovereign documentation must strengthen trustee responsibilities and prevent states from buying debt they have defaulted on n late 2008, the Republic of Ecuador defaulted on its international bonds. This was not a novel occurrence. In a study published in 1993 (The Risks of Sovereign Lending: Lessons from History), Salomon Brothers concluded that Ecuador had the worst debt performance record of any of the 70 payment-challenged countries they surveyed. There have been two additional defaults since 1993. But this latest default was different. Two highly concessional debt restructurings (one in 1995 and the second in 2000), together with record oil prices, had left Ecuador in 2008 with an enviably manageable external debt profile. The motivation for this default was domestic politics, not financial necessity. It was the first time in modern history that a sovereign debtor had demanded that its external commercial creditors write off most of their claims (65%, as it turned out), without advancing a plausible argument that financial distress warranted such extraordinary debt relief. The demise of the doctrine of absolute sovereign immunity in the second half of the last century left sovereign debt markets operating on the assumption that the menacing prospect of legal enforcement of debt contracts, coupled with a fear of market exclusion and the prospect of a censorious raised eyebrow from the multilateral financial institutions, would act as an effective brake on casual sovereign defaults. In the Ecuador case, the system designed to protect bondholders against such a default failed. They were left with no option but to knuckle under to a demand that they forgive 65% of their claims against a sovereign debtor that visibly had the resources to continue servicing those obligations. The questions are how could this have happened and what needs to change in order to ensure that the traditional legal balance between sovereign debtors and their commercial creditors is restored? The historical context There has been a steady movement over the last 15 years towards supermajority creditor control of sovereign debt workouts. The textual evidence of this is in the documentation used for the issuance of bonds by emerging market sovereigns. For example: *Acceleration of bonds following an event of default now typically requires a vote of at least 25% of the bondholders (as opposed to the traditional format that permitted each bondholder to accelerate its own bonds following default). • Collective action clauses, first introduced into New York law sovereign bonds in 2003, are now standard in most emerging market deals. These clauses permit the payment terms of the bonds to be amended with the consent of 75% of the bondholders. Prior to this innovation, the payment terms of a New ;That drafter seized the opportunity to strip out the provision that contains the living, beating heart of a trustee's fiduciary dutyP York law-governed sovereign bond could not be altered without the unanimous consent of the bondholders. * An increasing number of these bonds are being issued pursuant to trust indentures in the New York market and trust deeds in the London market (in contrast to the fiscal agency structures used in prior periods). Trustees represent the interests of the bondholders; fiscal agents are agents of the issuer of the bonds and owe no fiduciary duties to the bondholders. ° Most recently, several New York law trust indentures for sovereign bonds have centralised all powers to enforce the bonds in the hands of the trustee. The traditional US practice (an invariable practice in corporate bonds) permits each bondholder to sue for its share of a payment that was not made on a scheduled maturity date. Full centralisation of enforcement powers in the hands of the trustee has long been the norm in English law trust deeds. The principal motivation for these documentary changes was a desire to replicate, in the sovereign context, the supermajority creditor control of debt workouts that exists in most corporate insolvency regimes. If unforeseen circumstances prevent normal servicing of the debts, the proponents of this approach argued, the judgment of the large majority of the creditors should control whether and how to adjust payment terms in response to those circumstances. Individual creditors should not be given an opportunity to disrupt a consensual restructuring or to exploit the concessions granted by the vast number of their fellow lenders. Supermajority creditor control, however, never implied that bondholders would forfeit their rights to enforce their claims through legal proceedings. In particular, the movement toward the use of trust structures for emerging market sovereign bonds was not intended to dilute creditors' legal rights, but merely to centralise those powers in the hands of a trustee that would exercise them for the ratable benefit of all creditors. Naturally, this assumed that the entity appointed to exercise these centralised powers would, if and when necessary, acquit itself of its duty to preserve, protect and defend the interests of the bondholders. These assumptions, and this legal architecture, were tested for the first time in connection with Ecuador's 2008 default on two series of its bonds and the country's subsequent offer to repurchase those bonds at a very deep discount. As things turned 22 IFLP/September 2009 www.iflrcom 22 IFLR/September 2009 www.iflr, com

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