Funds that speculate in sovereign debt, so-called “vulture funds,” are often roundly criticized. They purchase distressed debt on the secondary market at reduced prices and then seek payment in court at face value plus interest, penalties, and fees.[1] Although their actions are legally justified, such funds can have a negative impact on sovereign debtors and their people.

In a recent article, I argue for U.S. regulation of sovereign debt speculation.[2] Although two bills to bar such speculation and profiteering in the defaulted debt of certain poor countries were introduced more than a decade ago in the U.S. House of Representatives,[3] no legislation has yet been passed. A bill introduced in the New York State Legislature last legislative session could have significantly reduced speculation by modifying the champerty rule but was also not passed.[4] Yet, legislation is necessary to create a balance between the rights of creditors and the proper functioning of debtor nations, while also preserving a secondary market for sovereign debt.

The Pros and Cons

Though some vulture funds have won lawsuits seeking to enforce nations’ contractual obligations to repay sovereign debt, concerns have been raised about the morality of such proceedings. Speculative funds are often criticized for harming human rights by depriving heavily indebted states of valuable resources. In addition, the broader consequences of speculative activities can complicate access to funding and thus jeopardize states’ operations. Critics have also focused on the profit that speculators attempt to make from sovereign debt relief granted by other creditors. Moreover,vulture funds can block debt restructuring. Nonetheless, sovereign debt speculation can be beneficial. It helps create liquidity and reduces funding costs. Speculative funds can also perform a monitoring mission. In light of these pros and cons, regulating speculation in sovereign debt calls for caution and a balanced approach.

The Relevance

Since nations facing financial problems cannot benefit from bankruptcy protection, speculative funds that have acquired debt instruments on the secondary market have sued to enforce the contracts that require nations to repay their debts. Though sovereign immunity once protected nations from these lawsuits, the U.S. Supreme Court ruled in Republic of Argentina v. Weltover that when a foreign government acts not as a regulator of a market but as a private participant in it, its actions are commercial within the meaning of the FSIA.[5] Thus, in cases brought by vulture funds, states lose the immunity privilege associated with sovereign debt.

A few years ago, the U.N. Human Rights Council Advisory Committee highlighted the growing consensus on the importance of limiting the activities of vulture funds.[6] In its final report on the activities of these funds and their impact on human rights, the committee stated that, at the national level, “[s]tates should undertake concrete steps aimed at regulating the disruptive litigation of vulture funds concerning sovereign debt.” It recommended that member states adopt legislation to curtail the predatory activities of such funds within their jurisdictions.[7] Adopting such legislation in the United States is all the more justified given the importance of New York law and courts. Indeed, as the U.N. Conference on Trade and Development once stressed, enacting national legislation is peculiarly needed in jurisdictions that govern international bonds.[8]

The Rationale

Given the complexity of the phenomenon, courts that handle claims of vulture funds might benefit from guidance through measured regulation.[9] It is important to limit purchasing debt on the secondary market at a price below its nominal value and then claiming full payment in court when such speculation hinders a state’s responsibility to guarantee the fundamental rights of its people.[10] Nevertheless, any regulation should not undermine the secondary market for sovereign debt and its ability to help create liquidity of capital and reduce funding costs. However, profiteering in sovereign debt is unacceptable if it undermines the human rights of the populations of debtor states.

While any infringement of creditors’ rights may erode principles of contract, Manigault v. Springs helps justify the limitation of speculative activities. In that case, the U.S. Supreme Court decided that “the interdiction of statutes impairing the obligation of contracts does not prevent the state from exercising such powers as are vested in it for the promotion of the common weal, or are necessary for the general good of the public, though contracts previously entered into between individuals may thereby be affected.” The Supreme Court added that “[t]his power, which, in its various ramifications, is known as the police power, is an exercise of the sovereign right of the government to protect the lives, health, morals, comfort, and general welfare of the people, and is paramount to any rights under contracts between individuals.”[11] The primary justification for calling contractual obligations into question stems from the sustainability of sovereign debt. As a result, when the financial difficulties of a state lead it to no longer provide certain essential services to its population so that it remains able to meet its obligations to its creditors, a protective mechanism is fully justified.[12]

Debt sustainability is thus the critical argument justifying the regulation of speculative activities and the only benchmark. Sustainability is one of the basic principles of sovereign debt restructuring listed in the U.N. General Assembly’s 2015 resolution.[13] Its eighth principle provides that  “[s]ustainability implies that sovereign debt restructuring workouts are completed in a timely and efficient manner and lead to a stable debt situation in the debtor state, preserving at the outset creditors’ rights while promoting sustained and inclusive economic growth and sustainable development, minimizing economic and social costs, warranting the stability of the international financial system and respecting human rights.” When sovereign debt is unsustainable, and only if it is, some limitations must be imposed on its service. According to the U.N. Human Rights Council, excessive or disproportionate debt servicing that takes away financial resources meant for the realization of human rights should be adjusted or modified accordingly to reflect the preeminence of these fundamental rights.[14]

If sustainability can justify the suspension or reduction of sovereign debt servicing, it can, a fortiori, support an argument for limiting speculative activities. Indeed, because the activities of vulture funds undermine the finances of distressed states, sustainability justifies moderating the actions of these funds. As speculative funds are not parties to the original debt instruments they seek to enforce, it is reasonable to limit their claim to what is at stake for them. Recouping the amount paid to purchase a debt instrument on the secondary market, and only this amount, is legitimately expected when payment at face value would run counter to debt sustainability. Nevertheless, it is necessary to permit a profit from the investment in the form of a legally quantified interest, so that incentives to invest in this market are maintained.

States have a responsibility to mitigate the negative effect of speculation on populations. This duty derives from, among other places, section 2(1) of the International Covenant on Economic, Social, and Cultural Rights and section 2(2) of the International Covenant on Civil and Political Rights. As the United States is a party to these instruments, it must address the activities of vulture funds that violate the rights enshrined in them. This responsibility can be discharged by enacting a law ensuring these rights are respected.

ENDNOTES

[1] The famous case involving this phenomenon is Republic of Argentina v. NML Capital, Ltd. heard by numerous U.S. courts.

[2] The United Kingdom, Belgium, and France have passed legislation directly addressing speculative activities in sovereign debt (see the British Debt Relief (Developing Countries) Act 2010, the 2015 Belgian law combating the activities of vulture funds, and section 60 of the French law n° 2016-1691, known as “the Sapin II law”).

[3] Bill 110 H.R. 6796 and Bill 111 H.R. 2932.

[4] Bill A5290 and Bill S5623 relating to the purchase of claims by corporations and collection agencies. A “Sovereign Debt Stability Bill” is currently in the New York State Legislature (see Bill A2970A and Bill S5542A). This bill does not directly address vulture funds but would affect speculation by interfering in the restructuring of sovereign debt.

[5] U.S. Supreme Court, Republic of Arg. v. Weltover, Inc., 112 S. Ct. 2160, 2166 (June 12, 1992).

[6] U.N. Human Rights Council, Activities of vulture funds and their impact on human rights, 12 (A/HRC/41/51, May 7, 2019). The relevance of regulation was expressed and repeated by other bodies of the United Nations and the International Monetary Fund. Kristalina Georgieva, the managing director of the IMF, stated in a press briefing in 2022 that « [w]e also are pressing for some of the changes, legal changes that need to happen in [New?] York, in London, to close loopholes for vulture funds » (www.imf.org/en/News/Articles/2022/04/21/tr220421-transcript-of-the-imfc-press-briefing (April 21, 2022)).

[7] U.N. Human Rights Council, Activities of vulture funds and their impact on human rights, 18 and 20 (A/HRC/41/51, May 7, 2019).

[8] U.N. Conference on Trade and Development, Sovereign debt restructurings: Lessons learned from legislative steps taken by certain countries and other appropriate action to reduce the vulnerability of sovereigns to holdout creditors, 21(www.un.org/en/ga/second/71/se2610bn.pdf, October 26, 2016).

[9] Martin Guzman points out the issues stemming from the fact that “domestic judges of major lending jurisdictions such as New York, who do not understand the nature of sovereign debt restructuring processes, are still the ones in charge of deciding what the ultimate goals of a restructuring should be, and what remedies should be implemented to achieve those goals” (Martin Guzman, An analysis of Argentina’s 2001 default resolution, 110 CIGI Papers, 15 (2016)).

[10] See Julieta Rossi, Sovereign Debt Restructuring, National Development and Human Rights, 23 SUR – International Journal on Human Rights 185, 191 (2016).

[11] U.S. Supreme Court, Manigault v. Springs, 26 S. Ct. 127, 130 (December 4, 1905).

^[12] Corentin De Jonghe, Vers un encadrement européen de l’activité des fonds vautours?, Droit du Financement de l’Economie 8, 11 (2019).

[13] U.N. General Assembly, Basic principles on sovereign debt restructuring processes (A/RES/69/319, September 10, 2015).

[14] U.N. Human Rights Council, Report of the independent expert on the effects of foreign debt and other related international financial obligations of states on the full enjoyment of all human rights, particularly economic, social and cultural rights – Guiding principles on foreign debt and human rights, principle 49 (A/HRC/20/23, April 10, 2012).

This post comes from Justin Vanderschuren at the University of Louvain and the University of Michigan. It is based on his recent article, “Sovereign Debt Speculation: A Necessary Limitation Justified by a Concern for Debt Sustainability,” forthcoming in the Journal of International Business & Law and available here.