Max Planck Lecture Series: Mr. Philip Wood delivered a lecture on “Proposals for Reform of Sovereign Debt Restructuring: The Contractual Approach”

30 November 2016
On 30 November 2016, Mr. Philip Wood (Allen & Overy) and Prof. Christoph Paulus (Humboldt University of Berlin) discussed the contractual approach to sovereign debt restructuring within the framework of the Max Planck Lecture Series on Sovereign Debt.

Mr. Wood started his presentation by drawing a comparison between corporate and sovereign bankruptcy and the legal regime governing them. Although sovereign bankruptcy has a long history that dates back to several centuries, no statutory regime has been established. The key focus of Mr. Wood’s lecture was whether contractually-based options could fill this legal vacuum. The contractual approach is characterized by the inclusion of contractual devices such as collective action clauses (CACs) in sovereign bonds. Proponents of this approach contend that the sovereign debt restructuring problem can be resolved by the extensive use of contractual clauses without the need for a multilateral sovereign bankruptcy law.

Mr. Wood emphasized that law can play a crucial role in addressing the sovereign debt restructuring problem. However, attempts to introduce a multilateral sovereign bankruptcy instrument are yet to bear any fruit. In the absence of this kind of tools, sovereign bankruptcy is currently governed by the terms of sovereign bond contracts. He pointed out that sovereign debt restructuring frequently happens under the contractual regime. Creditors usually agree with sovereign debt restructuring proposals. Mr. Wood argued that the case of Argentina is rather unusual because of the rare waiver of immunity and the tough stance taken by Judge Griesa in NML v. the Republic of Argentina (the so-called pari passu case).

Noting the fact that the present contractual regime has worked reasonably well, Mr. Wood devoted the final part of his presentation to the question: why do we need a sovereign bankruptcy regime? One important function of sovereign bankruptcy law would be determining the priority of payment in the event of sovereign bankruptcy. There is no formal and general rule that determines the insolvency ladder of priorities under the existing system. Such a priority ladder could be stipulated in sovereign bond contracts, but doing so is not straightforward. Mr. Wood further raised the holdout problem and the issue of ‘financial democracy’. CACs tend to benefit the sovereign debtor and majority bondholders at the expense of the minority bondholders whose bargaining power against the sovereign debtor is weakened. He concluded his presentation suggesting that implementing a complementary statutory regime could be useful.

Prof. Christoph Paulus agreed with most views expressed by Mr. Wood and provided an overall assessment of proposals for reforming existing sovereign debt restructuring mechanism. He noted that the global financial architecture has changed significantly in the last few years. The role of the IMF as the lender of last resort is now shared by regional financial arrangements such as the European Stability Mechanism (ESM). The proliferation of sovereign debt and default, according to Prof. Paulus, enhances the case for a regulated sovereign debt restructuring. Prof. Paulus then laid out the three key challenges facing attempts to reforming sovereign debt restructuring: the stigma of insolvency; the commitment problem; and the holdout problem. Prof. Paulus concluded his presentation by noting that overcoming these three key challenges is of paramount importance in order to create an effective statutory regime for sovereign bankruptcy. His own proposal of a “re-solvency” procedural mechanism was intended to address those questions.

For a picture gallery of the lecture, please click here.