Has the Second Circuit (Unwittingly) Breathed Life into the Nostrils of Imperial Chinese Government Bonds?

Abstract

The attached letter from one Horatio D. Gadfly will form the basis of the term project for my class at the Duke Law School in the spring semester of 2014. The course is entitled “International Debt Transactions”.

Holders of long-defaulted bonds issued by the Chinese Imperial Government and Tsarist Russian Government have faced two insurmountable obstacles to the enforcement of those instruments in U.S. courts:

(i) Federal courts had previously ruled that the “absolute” theory of sovereign immunity which prevailed in the United States until 1952 applied to debt obligations issued by foreign governments prior to that time. (Under the absolute theory of sovereign immunity, foreign states could not be sued in U.S. courts without their consent.)

(ii) The statute of limitations (six years for contract cases in New York) will have long since expired on those old bonds.

A Supreme Court case decided in 2004 (Austria v. Altmann) reversed the old rule about applying absolute sovereign immunity to claims arising prior to 1952. Under the Supreme Court’s new approach, a federal judge should apply the U.S. sovereign immunity rules prevailing at the time an action is commenced, not the rules that existed when the debt was issued.

As for the statute of limitations, the Second Circuit Court of Appeals ruled in 2012 that a debt instrument containing a financial covenant (in that case, a promise to maintain the equal ranking of bonds) is breached each time the issuer makes a payment to other creditors in violation of the covenant. The decision may imply that the statute of limitations is commenced afresh for the enforcement (by specific performance or injunction) of the financial covenant in the old bonds each time a payment under new instruments is made in violation of the covenant. See NML v. Argentina.

Taken together, these two decisions could possibly, just possibly, breathe life into the nostrils of some sovereign bonds that have for 60 years been esteemed principally for their aesthetic, as opposed to their financial, characteristics. At the very least, magnifying glasses will be trained on framed sovereign bonds hanging in foyers, physician waiting rooms and bathrooms around the country.

Keywords: sovereign debt

JEL Classification: F3