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Sovereign Debt Restructuring and the Best Interest of Creditors


William W. Bratton


Institute for Law and Economics, University of Pennsylvania Law School; European Corporate Governance Institute (ECGI)

G. Mitu Gulati


Duke University - School of Law

August 13, 2010

Vanderbilt Law Review, Vol. 57, Pg. 1, 2004
GWU Law School, Public Law Research Paper No. 59
Georgetown Law and Economics Research Paper No. 387880

Abstract:     
In April 2002 the International Monetary Fund introduced a sovereign bankruptcy proposal only to be rebuffed by the United States Treasury. Where the IMF wanted a mandatory bankruptcy regime, the Treasury wanted to solve distress problems with contractual devices. Sovereign bondholders and sovereign issuers themselves flatly rejected both proposals, even though they were nominally the beneficiaries of both proponents. This Article addresses and explains this bondholder reaction. In so doing, it takes a highly skeptical view of the IMF's proposal even as it shows that the incentive structure surrounding sovereign lending renders untenable the Treasury's contractarian proposal. The Article's analysis follows from a review and restatement of the economic learning on sovereign debt relationships.

The IMF and the Treasury share the objective facilitating restructuring by substituting a regime of collective action for the prevailing practice of requiring unanimous bondholder consent to significant amendments of bond contracts. In so doing they follow a conventional wisdom respecting bond contracts under which standard unanimity provisions are inefficient and irrational. The Article shows that this dismissal of the unanimity requirement comes too quickly. Under our analysis of the problem the debtor distress, bondholders rationally may prefer to make compositions harder to conclude. There is no first best equilibrium bond contract; instead bondholders select from a menu of second best forms, making trade offs between unanimous action and collective action provisions in an imperfect world.

One factor leading lenders to favor unanimous action is the need to self protect. In a world without a good faith backstop, creditors motivated by side deals can take advantage of majority rule to impose suboptimal compositions. Holding out is the only weapon available to the minority creditor. The Article argues that, given such side deals, a stable majoritarian regime cannot be achieved as a matter of free contract. Mandate will be necessary. It follows that the Treasury's contractarian approach is implausible absent a backstop regime of intercreditor good faith duties. The Article draws on the history of corporate reorganization prior to the enactment of the section 77B of the Bankruptcy Act of 1934 to show that courts have grappled with these questions before, intervening aggressively on equitable principles.

Number of Pages in PDF File: 79

JEL Classification: F34, G33, H63, K33

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Date posted: March 14, 2003 ; Last revised: August 14, 2010

Suggested Citation

Bratton, William W. and Gulati, G. Mitu, Sovereign Debt Restructuring and the Best Interest of Creditors (August 13, 2010). Vanderbilt Law Review, Vol. 57, Pg. 1, 2004; GWU Law School, Public Law Research Paper No. 59; Georgetown Law and Economics Research Paper No. 387880. Available at SSRN: http://ssrn.com/abstract=387880 or http://dx.doi.org/10.2139/ssrn.387880

Contact Information

William Wilson Bratton (Contact Author)
Institute for Law and Economics, University of Pennsylvania Law School ( email )
3501 Sansom Street
Philadelphia, PA 19104
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050
Brussels
Belgium
HOME PAGE: http://www.ecgi.org
Gaurang Mitu Gulati
Duke University - School of Law ( email )
Box 90360
Duke School of Law
Durham, NC 27708
United States
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