The Pursuit of Rights to Foreign Sovereign Debt in England: Open Season?
8 August 2011
This article first appeared in a slightly different form in the Financial Times, 8 August 2011.
The fragility of certain Eurozone economies (including in particular those which have been in receipt of bail-out funding), has prompted participants in the sovereign debt markets to consider how and where bondholders can recover their investments, in the event that these classes of debt move from "troubled" to "distressed".
There is an inherent tension between the need for States to raise funds by entering into the debt market and their status as sovereign entities. The concept of "sovereign immunity" protects a State and its assets from litigation in national courts. Sovereign immunity can be given a wide meaning (for example, in Hong Kong, where it is deemed absolute) or can be given a more restricted meaning, as in the UK, which broadly excludes from protection activities of a State which are commercial in nature.
In addition, States can waive their right to immunity by making express agreements to permit litigation in selected courts in the event of the State breaching its obligations. In the case of government bond documentation, it is usual to find agreement that bondholders will be able to bring proceedings against the State in specified courts upon a default. In order to make their debt commercially attractive to investors, States need to pay the price of waiving immunity, but will limit the waiver to selected jurisdictions to manage the risk of litigation.
A recent case, NML Capital Limited v Argentina, gave the Supreme Court – the highest court in the UK – the opportunity to review the English law on sovereign immunity. The case arose out of Argentina's debt crisis in 2001 and its moratorium on its government debt payments. NML, a so-called "vulture fund", had, between 2001 and 2003, acquired Argentinean government bonds at a substantial discount to their face value. NML issued proceedings in the New York courts (the venue agreed in the bond documentation) claiming a default on the bonds and seeking recovery of the face value of the bonds, together with interest. In December 2006, NML obtained judgment in New York for $284,184,632.30. English proceedings were then brought by NML to enforce the judgment against Argentinean government assets held in England. Argentina opposed the English proceedings on the basis of a claim to sovereign immunity.
The Supreme Court found in NML's favour and permitted its enforcement action to continue. This important decision is positive for sovereign debt investors, particularly those holding distressed debt and seeking means to recover its value.
The key element for NML's case was the wording of the bond documentation which related to enforcement of judgments against Argentina. The documentation said: Argentina would be bound by judgments obtained against it and that it would not raise sovereign immunity as a defence in enforcement proceedings. The Supreme Court decided that these provisions were an agreement to waive immunity and a submission to the jurisdiction of the English courts for enforcement proceedings.
The judgments drew attention to the fact that these types of provision are usually carefully negotiated by sophisticated parties and advisers and on this basis, when interpreting the scope of the provision, that sophistication and commercial backdrop should be taken into consideration. But this decision only goes so far: the Supreme Court did not agree that there should be a general exception in England to the principle of sovereign immunity for the purpose of enforcing foreign judgments arising out of government bond issuances. Therefore from the perspective of States at risk of future default, it is clear that it is not "open season" on their assets in England; a bondholder will still have to satisfy an English Court that such enforcement proceedings are exempt from sovereign immunity and that determination will be based on the scope of the wording in the bond documentation.
For States, the risk of narrow wording on jurisdiction will be that investors will be deterred from participating in the bond issue and therefore defeat its commercial marketability. For investors, the increased risk to recoverability of a limited submission to jurisdiction may force up the rate of return they can negotiate from States. Distressed debt may be more deeply discounted to face value in circumstances where there is limited recourse against the State. Therefore the commercial fundamentals of sovereign debt transactions in future may be altered by States' reactions to this case.
Philippa Charles, Dispute Resolution Partner at Mayer Brown International LLP