**2. The conflict of law regime of sovereign debt restructuring**

The international dimension of SDR does not arise primarily from international law as set out in Article 38 of the Statute of the International Court of Justice, but by contractual provisions that incorporate laws other than the legal system of the Debtor State. In general, there are no "top-down" international norms that govern SDR in the form of treaties, custom or principles. Instead, there is a "bottom-up" normative system that arises from the number of debt contracts issued by Debtor States that contain provisions which introduce elements of a foreign legal system to them. While there are international laws that may apply to SDR such as the principle of sovereign immunity or the Hague Convention on the Recognition and Enforcement of Foreign Judgments [11], these international norms are limited to the extent that they do not dictate how SDR is implemented as a whole.

The legal environment where SDR presently operates is a regime of "conflict of laws" or "private international law." Conflict of laws does not principally concern itself with international law. Rather, it is the application of domestic law whenever a particular jurisdiction is "faced with a claim that contains a foreign element" ([12], p. 2). In other words, a conflict of law approach does not depend on the application of international law among States. Instead, it entails the operation of a particular domestic law in cases involving the interaction between at least two legal systems. Thus, "[t]he *raison d'être* of private international law is the existence in the world of a number of separate municipal systems of law—a number of separate legal units that differ…from each other in the rules by which they regulate the various legal relations arising in daily life" ([12], p. 4).

As in the current regime of SDR, the rules that generally govern SDR are strictly not international law, but a State's domestic rules that apply when foreign laws that are incorporated in a debt contracts. The practice of SDR is therefore situated within a conflict of laws regime which recognizes that while a State may enact rules in the treatment of foreign laws, "[a] sovereign is supreme within [its] own territory…[It] can, if [it] chooses, refuse to consider any law but [its] own" ([12], p. 4). As discussed below, while the principle of State sovereignty is conceded in theory, its practical application in SDR is qualified by the set of debt contracts that a State has entered into in accessing capital.

The provisions that are often stipulated to introduce elements of a foreign legal system in debt contracts are (a) dispute settlement clauses that confer jurisdiction to a tribunal other than the domestic courts of the Debtor State; and (b) governing law clauses (see [13]). Incidentally, these contractual provisions mirror the scope of private international law which is "always concerned one or more of three questions, namely," (a) the jurisdiction of the domestic court; (b) recognition and

*Accounting and Finance - New Perspectives on Banking, Financial Statements and Reporting*

made the resolution of sovereign debt crises an international affair. For their protection, creditors often demand that debt contracts contain provisions that introduce elements of foreign legal systems to them—e.g. provisions on governing law and the choice of a tribunal other than the domestic courts of the Debtor State. As in the Argentinian crisis that started in the early 2000s, Argentina had to contend with creditor holdouts carrying injunctions secured from New York courts

Thus, in the case of sovereign debt crises with international dimensions, their resolution involves the interaction between at least two legal systems. The protection given by a foreign legal system has a deterrent effect on unilateral debt restructuring by the concerned State. However, this situation also creates the opportunity for delays and holdout behavior by giving creditors protection contractually drawn from a legal system outside that of the Debtor State. This becomes a collective action problem that ultimately hinders the resolution of a sovereign debt crisis. The International Monetary Fund (IMF) has long acknowledged that "While private creditors as a group may recognize that support for rapid restructuring is in their own interest, they may hesitate to agree to a restructuring out of concern that other creditors may hold out and press for full payment on the original terms after the

Proposals for a collective and multilateral proceeding for the resolution of sovereign debt crises have been fairly widespread in the literature (see [4], p. 87). These proposals usually draw from domestic bankruptcy rules which, among others, support a global stay on debt collection efforts, the application of the automatic acceleration principle, priority rules and variants of creditor equality treatments [4, 5]. However, the resolution of a sovereign debt crisis would not be as simple as, to paraphrase

significant characteristics of sovereign debt restructuring (SDR) that are not found in domestic bankruptcy regimes such as the non-availability of an option to liquidate the Debtor State and the critical role of macroeconomic policy and economic growth in the

Given that the current resolution efforts primarily occur within a conflict of law regime, this paper argues that a minimum level of multilateralization is needed to universalize broad norms that channel collective behavior during a sovereign debt crisis. These norms should consider "inclusive economic growth and sustainable development" within the Debtor State as rational and viable strategy in SDR.

More concretely, this paper proposes that efforts should be exerted so that the principles of sovereignty, good faith, transparency, impartiality, equitable treatment, sovereign immunity, legitimacy, majority structuring and sustainability under the United Nations (UN) General Assembly Resolution 69/319 a dopted on 10 September 2015 ("Basic Principles on Sovereign Debt Restructuring Processes") may be broadly codified into a treaty. Such codification may include changes in the articulation of these principles to accommodate the positions of States such as those in the European Union (EU) (see [8]). Significantly, the principle of sustainability should emphasize the concept of "inclusive growth and sustainable development" within the Debtor State as part of the SDR framework. This proposal is being made in the context of the lack of support from countries which have the "major financial

centers from which most of the sovereign debt has been issued" ([9], p. 47).

While certainly not an easy feat, the foregoing follows the so-called Incremental Approach that "complement, rather than replace, existing mechanisms, including contractual approaches and the activities of the International Financial Institutions

In criticizing John Austin's Command Theory of law, H.L.A. Hart described it as a "gunman situation

[6, 7]. There are

the legal positivist H.L.A. Hart, a "bankruptcy regime writ large."1

(see generally [2]).

restructuring process.

agreement has been reached" ([3], p. 12).

**124**

writ large."

1

enforcement of foreign judgments; and (c) the choice of law ([12], p. 7). Governing law clauses in a debt instrument may include the specific choice of law provision designating, for instance, New York or English or Japanese Law; or a provision that references an international norm such as a particular treaty or the principle of State sovereignty. Moreover, the adjudicatory body constituted by the debt instrument applies the choice of law or the referenced international norm pursuant to the contract.

During a sovereign debt crisis, the Debtor State may unilaterally restructure its debts pursuant to its sovereign right to set its own macroeconomic policy. In this context, foreign creditors demand that such clauses be contained in debt instruments to effectively act as restraints against unilateral restructuring by a Debtor State. These clauses therefore imply a waiver of the Debtor State's sovereignty. By introducing elements of foreign laws in debt instruments, these clauses "internationalize" what would otherwise be purely domestic contracts that may be amended by the Debtor State. It has been said that "[m]any countries do not regard foreign creditors with great sympathy, especially when the country is bankrupt and the citizens are throwing stones in the street" ([13], p. 4). Thus, for instance, New York or English Law "continue to dominate sovereign and quasi-sovereign lending in large parts of the world[,] including many emerging markets" [14]. New York and English Law are often the choices of law in debt instruments because of their "insulating effect" against "legislative changes in the borrower's country" ([13], p. 4). It is also a factor that the United States and the United Kingdom are often the home States of creditors who hold sovereign bonds. On the other hand, Debtor States normally agree to these clauses in order to access capital from foreign creditors.

The present regime of SDR has also been described as "contractual" given that debt contracts are the primary sources of rights and obligations with respect to sovereign debt. In the case of purely domestic indebtedness, a State has wide leeway in dealing with its debts using its own legal system. However, when a State borrows capital from foreign markets, debt contracts trigger the interaction between two legal systems and, to a more limited extent, between the Debtor State's legal system and international law. This precisely characterizes a conflict of law regime which is principally concerned with the "existence in the world of a number of separate municipal systems of law" ([12], p. 4). As a consequence, without an overarching framework, SDR is necessarily based on the Debtor State's *ad hoc* negotiations with its creditors based on those contracts. The *ad hoc* nature of these negotiations is reinforced by the fact that the distressed Debtor State has to deal with a diverse set of creditors including hedge funds and institutional investors.

Thus, the myriad of sovereign debt contracts is the core operational legal framework in the resolution of a sovereign debt crisis. The application of the international principle of State sovereignty is, to a large extent, determined through the State's express and implied waivers of such principle contained in the debt contracts. In most cases, international law is applied in SDR if it is incorporated in these contracts. While sovereign debt contracts may be covered by an investment treaty as in *Abaclat v. Argentina* [15], this has not evolved into a consistent international norm in SDR. In the first place, whether debt contracts are considered protected under an investment treaty would depend on the specific definition of "investment" under such treaty. Second, such expansive interpretation of "investment" has been criticized as a departure from the common understanding of "investment" as long-term commitment of capital that contributes to the economic development of the host State (see [16], pp. 515–517). In any event, there are currently more than 3000 investment treaties in the world with varying definitions of investment [17]. This situation in international investment law is hardly one that reflects a consistent international norm in SDR.

**127**

*Sustainability in Indebtedness: A Proposal for a Treaty-Based Framework in Sovereign Debt…*

As discussed below, one way to bridge these opposing views is to formalize norms that are broad enough to allow parties the flexibility to adopt certain measures in the resolution of sovereign debt crises. At the same time, the formalization of these norms should be effective enough to influence collective behavior in SDR. The next part will discuss this proposal through a treaty-based codification of

When UN General Assembly Resolution 69/319 ("B asic Principles on Sovereign Debt Restructuring Processes") was adopted 10 September 2015, 136 States voted in favor, six States voted against, and 41 States abstained ([18], p. 4; [10], p. 37). Among those which opposed the resolution were the US and the UK, "the two major jurisdictions for sovereign debt issuances by emerging economies, as well as

UN General Assembly Resolution 69/319 ar ticulates nine principles in SDR:

macroeconomic policy, including restructuring its sovereign debt…"

3. *Transparency* which is "accountability of the actors concerned…"

1. The *principle of State sovereignty* which is the Debtor State's right "to design its

2. *Good faith* which is the "engagement in a constructive sovereign debt restruc-

4. *Impartiality* which means "independence" and the prevention of "undue influ-

5. *Equitable treatment* which is a State duty to refrain from arbitrary discrimina-

6. *Sovereign immunity* of States from jurisdiction and execution which includes courts' obligation to "restrictively interpret" it in favor of State immunity.

7. *Legitimacy* entails "inclusiveness and the rule of law" in SDR "at all levels."

According to Guzman and Stiglitz, the contractual regime of SDR is essentially a "*non-system*…characterized by bargaining based on decentralized and non-binding market-based instruments centered on collective action clauses and competing codes of conduct" ([18], p. 3). There is widespread literature which strongly criticizes this contractual regime as "disorderly, inefficient, and overly costly" especially with respect to creditor collective action problems, in particular debt runs, holdouts and litigation (Citations omitted. [14], p. 88). Thus, there have been calls for a "hard law" approach or a multilateral legal framework to address these problems (for an overview, see [14], pp. 87–96). On the other hand, there are those skeptical of these proposals because of fears of rigidity of rules and "regulatory overkill" ([14], p. 88). Thus, an *ex ante* SDR framework consisting of mandatory rules carries the risk of stifling the flexibility that is present in *ex post* negotiations. Thus, "[i]nstead of creating a statutory framework 'top-down,' it could suffice to alter the documentation of bond and loan contracts to regulate the restructuring process in a more efficient way" ([14], p. 88). This would be the contractual regime of SDR where the prevailing norms of conduct are based on the terms and condi-

*DOI: http://dx.doi.org/10.5772/intechopen.82470*

tions stipulated in contracts entered into by the parties.

the norms contained in UN General Assembly Resolution 69/319.

**3. Establishing a treaty-based normative framework**

Canada, Germany, Israel and Japan" ([18], p. 4).

ence" and "conflicts of interest."

tion among its creditors.

turing workout negotiations and other stages…"

*Sustainability in Indebtedness: A Proposal for a Treaty-Based Framework in Sovereign Debt… DOI: http://dx.doi.org/10.5772/intechopen.82470*

According to Guzman and Stiglitz, the contractual regime of SDR is essentially a "*non-system*…characterized by bargaining based on decentralized and non-binding market-based instruments centered on collective action clauses and competing codes of conduct" ([18], p. 3). There is widespread literature which strongly criticizes this contractual regime as "disorderly, inefficient, and overly costly" especially with respect to creditor collective action problems, in particular debt runs, holdouts and litigation (Citations omitted. [14], p. 88). Thus, there have been calls for a "hard law" approach or a multilateral legal framework to address these problems (for an overview, see [14], pp. 87–96). On the other hand, there are those skeptical of these proposals because of fears of rigidity of rules and "regulatory overkill" ([14], p. 88). Thus, an *ex ante* SDR framework consisting of mandatory rules carries the risk of stifling the flexibility that is present in *ex post* negotiations. Thus, "[i]nstead of creating a statutory framework 'top-down,' it could suffice to alter the documentation of bond and loan contracts to regulate the restructuring process in a more efficient way" ([14], p. 88). This would be the contractual regime of SDR where the prevailing norms of conduct are based on the terms and conditions stipulated in contracts entered into by the parties.

As discussed below, one way to bridge these opposing views is to formalize norms that are broad enough to allow parties the flexibility to adopt certain measures in the resolution of sovereign debt crises. At the same time, the formalization of these norms should be effective enough to influence collective behavior in SDR. The next part will discuss this proposal through a treaty-based codification of the norms contained in UN General Assembly Resolution 69/319.
