Oxford University Comparative Law Forum
Private Ordering in Sovereign Debt Restructuring:
Reforming the London Club
by Christian Kirchner* and David Ehmke**
(2012) Oxford U Comparative L Forum 3 at ouclf.iuscomp.org | How to
cite this article
Table of contents
Sovereign bonds are no longer a safe haven for investors.***
Essentially, sovereign bonds are the sovereign’s promise to pay
out interest on principal lent by the bondholders and to repay the
principal at maturity. Investors’ confidence in sovereign debtors
keeping their promise is declining. Many sovereign debtors are
facing heavy problems financing budget deficits by issuing bonds
on the international capital markets. Financial distress on the
part of private debtors can be dealt with via private contractual
arrangements or bankruptcy procedures, whereas there are no
insolvency procedures for default on sovereign debt. The idea of
developing similar private arrangements (private ordering) or of
creating an international bankruptcy law for sovereign debtors
(public ordering) is very attractive. But attempts to design debt
restructuring mechanisms for sovereign states similar to those for
private debtors have not been successful.1 Private ordering
in sovereign debt restructuring has played a role in the past, and
the so-called London Club has played a prominent role in such
cases (3.1, 3.2). But today, financial markets are much more
complex. Workable solutions for debt restructuring via private
ordering have to reflect that complexity. We propose to reform the
procedures of the London Club to better cope with the problems of
sovereign debt in international financial markets of today. Such
reforms may be needed for debt restructuring within the European
Economic and Monetary Union (Euro Zone). But they should also be
applicable on an international level. Sovereign financial distress
is not a problem confined to the Euro Zone.
2. Methodological Issues
In order to discuss a proposed change of rules – i.e. a normative
endeavour – it is necessary to first engage in a positive analysis
and introduce a set of assumptions. The following considerations
will be based on the methodological approach of New Institutional
This sub-branch of economics focuses on the rules of the game in
the form of institutions3, i.e.
general rules together with the mechanism of enforcing them. Both
the rules and the mechanisms may be formal or informal.4 If
institutions are being changed this should have an impact on the
addressees of the rules. In order to predict their reactions,
institutional economics has to work with a set of assumptions that
partly derive from neo-classical economics: scarcity of resources,
methodological individualism, and self-interested rational
behaviour. But there are modifications: the assumption of full
rationality is replaced by that of bounded rationality5,
which is then complemented by the assumption of opportunistic
Behavioural economics has been criticizing the rationality
assumption and has produced new insights into how actors behave in
different situations and settings,7
further clarifying the scope of ‘bounded rationality’.
Institutional economics particularly stresses that information is
3. Proposal for the Development of the London
3.1 The London Club in its Contemporary
In the second half of the 20th century, commercial bank loans
became increasingly important for sovereign debtors who had
previously financed their budgets with loans provided by other
In reaction to this change, the Bank Advisory Committee – also
known as the ‘London Club’ – was founded as an informal forum for
negotiation. Unlike the Paris Club,10 the London Club has neither a
fixed venue for negotiations nor a permanent office.11
The committee is formed ad hoc12 and the members may differ
from case to case. They can represent a specific region or a
specific set of claims against the debtor.13 Together with
the debtor, the committee works out a restructuring plan, which is
recommended to the creditors, who then decide whether to accept or
reject it.14 The IMF is involved
in the negotiation process as a liaison between the London and
Paris Clubs; it also evaluates the sustainability of the sovereign
debtor’s debt burden.15
3.2 Change of the Creditors Structure
The London Club was frequently used during the Latin American
sovereign debt crisis in the 1980s. The imminent default of some
Latin American sovereign debtors particularly affected the largest
creditor banks in the United States. If the sovereign debtors had
halted interest payments, many creditors would have been forced to
declare insolvency, since the regulatory system of the United
States required a loan to be listed as ‘nonperforming loan’, if
interest was not paid 90 days after the due date.16
Thus the strategy was to gain time. The debtor received fresh
money to pay interest while the creditor banks tried to get rid of
their bad loans.17
Due to the principle of equal treatment the financial regulatory
administration and the largest commercial banks exerted pressure
on non-participating creditor banks.18 In order to
avoid the risk of constantly granting new loans to debtors who
obviously reached an unsustainable debt level, the creditor banks
sold their claims on the secondary market with a discount
reflecting the probability of default.19 The conversion
of bank loans into bonds as a part of the Brady Plan20
accelerated this process.21
This process as well as the attraction of bonds having a higher
marketability because they are relatively easy listed and traded
on stock exchange markets has led to an essentially different
structure of creditors, who are now more diverse and larger in
number. Nowadays, apart from the enormous bond purchases in recent
months by the ECB, the largest share of outstanding claims against
sovereign debtors is in the hands of private creditors.22
These private creditors are smaller and larger commercial banks,
investment funds, hedge funds, pension and vulture funds,
insurance companies, business enterprises, and private persons
doing their business primarily locally or as repeat players on the
international capital markets with different repayment periods and
different interest rates.23 This has led to anonymity and
heterogeneity of information status among the creditors, their
concerns, and their behaviour. Hedge and vulture funds especially
have continuously been blamed by European politicians for having
caused the sovereign debt crisis in Europe and are therefore the
target of regulatory efforts. Hedge funds are legally constructed
to coordinate various investments. By contrast, vulture funds are
specialised on investments in the debt of weak debtors. We
consider the popular blame to be a diversionary manoeuvre –
blaming a scapegoat instead of recognising the alarming signals of
market price decrease of sovereign bonds and escaping the Ponzi
scheme of indebtedness.
The increasing market for credit derivatives has also had an
important impact on creditors’ behaviour. Derivatives’ value and
due date depend on a specific reference object (e.g. a bond).24
The most common derivative in sovereign debt markets is the
so-called credit default swap (CDS).25 Under the
standardized conditions from the International Swaps and
Derivatives Association (ISDA) and their interpretation as adopted
by the courts, CDSs become due if the sovereign debtor defaults or
the creditor is legally bound to a restructuring plan, e.g.
through collective action clauses (CAC) (3.8). A free approval of
an exchange offer by the debtor caused by factual pressure does
not lead to maturity.26 As a result, creditors holding
CDSs have a significant incentive not to participate in a
negotiation. Their incentive is instead to cause or to contribute
to the default of the sovereign debtor. Since the CDS insures the
purchase price, creditors may behave destructively in order to
receive the higher insurance payment in the form of the purchase
3.3 Objective: Win-Win Situation
Our working assumption is that the chances for an effective debt
restructuring of private creditors’ claims will be improved by
reforms of the London Club if a model can be developed that
creates a win-win-situation for both creditors and debtors. The
creditors aim to reach a satisfaction quota as high as possible
and to prevent defaults in future credit arrangements with the
debtor. The debtor aims at reorganising and restructuring his
current debt, maintaining access or re-entering international
capital markets, getting fresh money and paying the lowest
interest rate possible. In this respect, both parties are trying
either to avoid or to minimize transaction costs.
The restructuring mechanism of the London Club itself produces
transaction costs in form of information and negotiation costs.27
These costs are justified if they pay off as an investment in a
club good – a good that is excludable and non-rival to outsiders
but non-excludable and rival to insiders of the club. This would
be the case if the London Club is able to promote creditors’ and
debtors’ interests, reduce transaction costs, and accelerate the
process. The anticipated costs of the restructuring process in the
London Club will be evaluated by the parties in comparison to the
anticipated costs of the current situation. They will be
calculated ex ante.
3.4 Entitlements and Execution
Since the Sovereign Immunities Act of 1976 in the U.S., the
State Immunity Act 1978 in the United Kingdom,28 and the legal
distinction between acta iuri imperii and acta iurii
creditors can secure a title to their claim on the basis of a
private bond or loan contract. There are many legal and factual
obstacles to the execution of this title over domestic or external
and attempts to do so rarely succeed. Creditors therefore
generally try to hamper the reorganisation and restructuring
process and block the debtor’s access to international capital
This behaviour is intended to create incentives for the debtor to
satisfy the free-riding creditors.
3.5 Economic Challenges on Creditors’ Side
The changing nature of creditors and the spread of credit
derivatives have influenced creditors’ information status, their
concerns, and thus their behaviour. Their underlying motivation
remains unchanged: the increase of their individual economic
advantage. If the creditors neither fear an imminent default,
which could force them to file for bankruptcy, nor aspire to
better relationships to the debtor, their interest dictates
pressing for a satisfaction quota as high as possible.32
In order to achieve this goal, it is necessary to overcome some
obstacles: anonymity and heterogeneity cause collective action
problems. It becomes harder for the debtor to estimate the
reaction to his restructuring offer.33 The creditors
have to be identified to coordinate their actions in the
Incomplete information can lead to a rush to the exit, panic
sales, and cancellations.35
Some creditors expect a better position as free riders or
holdouts if they try to enforce their claims in court and execute
against the debtor’s assets,36 to trade their claims on the
secondary market, or to withhold cooperation.37 Especially for
smaller creditors, the holdout tactic may be the only effective
chance to give prominence to their concerns. The fear of the
first-mover disadvantage causes holdout behaviour. Creditors that
tend to cooperate in principle will probably tend not to cooperate
if they calculate that other creditors will benefit from their
concessions later on.38 CDSs create incentives to hold
out, and the result is expensive delay.39 Holdouts and
free riders can block the debtors’ access to international capital
markets, disrupting the negotiations (3.4).40 For the debtor,
it becomes more attractive to satisfy the creditors’ claims to
prevent the costs that are caused by them.41
A moral hazard problem comes into play if creditors can benefit
from a risky investment without carrying the losses in case the
risks are realized.42
Risky investments become more attractive.43 In the
expectation of a bailout, creditors tend to hold out – a behaviour
that is destructive for collective interests. Therefore the
probability of a bailout needs to be reduced.
3.6 Economic Challenges on Debtor’s Side
The information relationship between debtor and creditors is
asymmetric. The debtor may withhold disclosure of relevant
information about his economic situation and level of debts
(ex-ante opportunism)44 so he can choose to default
without need, unwilling to pay his debt.45 He can
discriminate between different creditors and offer preferential
satisfaction to creditors that provide fresh money46 or with whom he
intends to strengthen his (economic or political) relationship. He
might exploit the referendum if he can influence it through bonds
under his control, directly or indirectly giving him the voting
power to accept his own restructuring offer.47 Moral hazard is
caused by a sovereign debt restructuring mechanism that is too
On the other hand, a bailout could be used to delay the date fixed
for payment into the next legislative period. Additionally, the
debtor may choose to strategically breach the restructuring
contract to renegotiate better conditions.
3.7 Proposed Structure and Instruments for the
3.7.1 The Release
In private bankruptcies, there are different mechanisms in
domestic bankruptcy laws to restrict the debtors’ opportunities to
dispose of his assets and to forestall creditors’ actions against
the debtor’s assets by means of a stay or moratorium. Sovereign
debt restructuring through the London club does not affect the
sovereignty of the sovereign, so it cannot impose exchange
or a stay.50
Hence, we recommend a release by a vote of a qualified majority to
strengthen the incentive for the debtor to meet his contractual
obligations. This also has the advantage of bringing to light
whether the debt level is unsustainable. The fear that a release
would release information that could damage the debtors’
creditworthiness is unfounded. Such information can easily
circulate without the mechanism we recommend. The mechanism should
be able to be terminated by a qualified majority if it is deemed
to be no longer needed. A release should also be possible upon the
debtor’s request. To prevent a misuse of the mechanism upon an
opportunistic appeal by the debtor, a qualified majority should be
empowered to reject the appeal.51
3.7.2 A Representative Creditor Committee
The principle of representation should be retained in order to
secure an effective negotiation forum.52 Presumably, the
number of representatives will increase. The representative
creditor committee’s task will be to represent and inform the
creditor group constantly about the negotiation progress. Its
mandate would be bound by the instructions of the creditor group
it represents. Finally, the creditors will vote on the plan
proposed by the representative committee.53
3.7.3 Formation of Groups
The complexity of negotiations in the London Club due to the
heterogeneity of interests (3.2, 3.4, 3.5) requires the formation
of creditor groups representing a nearly homogeneous group of
creditors. Criteria may be the regional origin, the basis and
amount of their claims, the type of creditor, or similar factors.
The formation of groups has the advantage of supporting
communication within the group, facilitating representation
through a single representative who exclusively supports the
interests of one nearly homogeneous group of creditors.
Debtors could potentially exploit the group-formation process for
so the creditors themselves should be entrusted with this task. If
the mechanism is activated, they should be asked to organize
themselves in groups. The goal should not be the identity of
interests within the group, but rather relative homogeneity of
interests, so that creditor groups can agree on a common direction
for negotiations in a timely manner. Because the creditors would
have to register their claims to vote,55 the trustee
(2.3.4) will have acquired the information needed to coordinate
and assist the formation of the creditor groups. The number of
representatives should reflect the amount of claims. Whenever the
owner of the claims changes, the Club should be duly informed in
order to guarantee adequate representation, which is particularly
in the new owner’s interest.
To minimise collective action problems stemming from asymmetric
information and unorganized communication among creditors and
between the creditors and the debtor, the bond or loan contract
should mandate the appointment of a trustee.56
He should operate independently from the mechanism, but he could
serve as a neutral mediator in the negotiations. His task should
be to inform all creditors constantly about the economic situation
of the debtor and whether the debtor is meeting its obligations.
He has to be empowered to represent the rights of all creditors in
His mandate would not be focused on creditor concerns, but instead
on the fulfilment of the legal obligations of the debtor towards
the creditors. Other concerns (e.g. to trigger a default for a
pay-out from the CDS) should not be taken into account. We do not
recommend the fiscal agent in New York law nor the creditor
representative in German law as a model for the trustee: the
fiscal agent acts as a paying agent on behalf of the debtor (and
not the creditors), for whom he performs certain payment
obligations. Nor does the fiscal agent act on behalf of creditors’
interests, meaning he cannot be entitled to represent the
creditors in court.58
The creditor representative in German law, who can be entitled to
legally represent the creditor’s concerns, is not subject to
appropriate restrictions concerning the relationship to the
debtor. This is problematic in particular because of the option to
restrict the creditor representative’s liability.59 However, we
consider the trustee60 in New York law and the bond
in English law to be a suitable model for sovereign bonds. Both
have to meet essential prerequisites ensuring their performance on
behalf of the creditor’s concerns and avoid any conflicts of
interests, and both are subject to sanctions like liability
provisions e.g. under the New York Trust Indenture Act or the UK
Although the creditors would be free to appoint a new trustee,
the debtor should be given the first opportunity to nominate one.
To prevent a rush to the courthouse (2.4),62 the right to
accelerate as well as all procedural rights should be concentrated
and delegated to the trustee through an acceleration clause63
and a clause restricting any individual legal enforcement.64
Should the trustee fail to heed the vote of a qualified minority,
the restrictions should be suspended.65 To maintain
these restrictions, a pro rata clause has to be inserted in the
bond or loan contracts. Consequently, if a free rider receives any
payment from the debtor, the trustee will be required to demand
this payment pro rata to the part outstanding debt in proportion
to the amount of the free rider’s claim against the debtor.
3.7.5 Permanent Institutions
Permanent institutions promise certain advantages such as the
prevention of delays through a well-prepared release of
and the reduction of transaction costs through the assistance of a
permanent administration.67 To
keep costs to a minimum, it would be advisable to work with
minimal permanent staffing and increase the number of staff ad hoc
in times of crisis. Although creditors and debtors will have an
urgent interest in using the mechanism during a crisis, the
permanent costs have to be defrayed by a basic charge that becomes
due when the bond or loan contract is concluded. For those
creditors and debtors who have not paid the basic charge, the
London Club would invoice an extra charge for using its service in
times of crisis.
A secretariat would maintain contact with the trustees. Once the
mechanism was activated, the secretariat would ask the creditors
to register their claims. The register should show the (juridical)
person of the creditor, the amount of his claim, and his voting
The secretariat’s being responsible for the organisational tasks
would assist the formation of the creditor groups. Following the
vote upon the plan, the secretariat should observe the fulfilment
of the debtor’s obligations and inform the creditors about any
The representative committee’s task would be to inform and
represent the creditor groups, to coordinate with the IMF and the
and to negotiate the plan with the debtor.
Often, an imminent default inhibits the deployment of fresh
Fresh money may be a prerequisite for a high satisfaction quota,
e.g. for infrastructural investment and economic growth.71 A
qualified majority in the representative committee should thus be
empowered to give those creditors who provide fresh money after
the start of the mechanism a preferable status for their claims
based on credits in critical phases.72
3.7.6 The Offer of Jurisdiction by an Arbitral
While the national courts of the debtor have an incentive to
decide patriotically or might at least give rise to the appearance
of doing so, an arbitral tribunal located in the London Club
promises to be independent. If decisions of the tribunal become
legally binding when accepted ex ante in the contractual terms of
the bond or loan,74
this may be the best guarantee of independence. The offer of
jurisdiction is then a service offered in the free market. The
judges would be free of bias, with no incentive to decide in
favour of the debtor or the creditors. Otherwise the debtor will
back off from implying the clauses which empower the tribunal in
his bond or loan contracts because he fears higher credit costs if
the tribunal is known to be too debtor-friendly or because he
fears adverse decisions in conflict if the creditor is too
creditor-friendly. The arbitral tribunal has to adjudicate
conflicts between the creditors and between the creditors and the
debtor concerning the negotiation procedure and the restructuring
Also, the competence of the tribunal determined in the contractual
terms could be to decide upon the claim both as to its existence
and its amount.76
A so-called vis attractiva concursus77
would avoid the legal uncertainty caused by free rider’s forum
in different jurisdictions.
3.7.7 The Restructuring Plan
The restructuring plan is the final outcome of the negotiation
and will be subject to the creditors’ vote. If the plan is
accepted by a qualified majority (e.g. by creditors holding two
thirds or 75 per cent of the outstanding debts, the common voting
levels in English bond contracts), it becomes legally binding. The
Plan includes the creditors’ concessions, e.g. a reduction of the
notional amount of the interest rates, the prolongation of the
or the provision of fresh capital. In addition, the plan includes
obligations of the creditor to secure the reduced amount of debts
such as securities or a reorganisation plan with specific measures
like an austerity or infrastructural program. The creditors win a
relative security that the reduced debts will be serviced, and the
debtor profits from his ability to maintain access to or to
re-enter the international capital markets and relatively low
188.8.131.52 Renewal of Original Claims
If the debtor does not meet his obligations as set out in the
plan, sanctions would follow to create an incentive to comply. In
this case, original claims would be renewed at the original
The renewal of claims is connected with high costs for the debtor
and the creditors (e.g. costs of a delay and renegotiation, rising
credit costs). Accordingly, both parties have an interest in
reaching an agreement on a plan with a sufficient reduction of the
debt burden. The restitution of the original claim could be
ascertained by the tribunal upon request of a qualified majority.
If 75 per cent is the qualified majority to vote on the plan,
giving it a legally binding status, it is logical to empower the
qualified minority of 25 per cent to call for renewal should the
debtors breach the contract, as this minority is able to obstruct
184.108.40.206 Equal Treatment of Creditors
The principle of equal treatment (par conditio creditorum)
aims at avoiding discrimination against particular creditors.
There have been proposals to suspend this principle in sovereign
debt restructuring, e.g. not to restructure the debt of private
We also promote a suspension of the principle par conditio
creditorum in sovereign debt restructuring for the following
reasons: to achieve a win-win situation, transaction costs of
negotiation have to be minimized to avoid a costly delay. One may
object that a suspension of the equal treatment principle could
prevent those creditors who feel discriminated against from
consenting or providing further loans. But we have to consider
expectations beyond just purely contractual obligations and the
satisfaction quota as gainful relationships which can be improved
through additional concessions and which can be realized as an
economic gain only by some creditors.83 Other creditors
may accept a higher reduction of their claim for political
reasons. Yet other creditors – especially smaller ones – insist on
a higher satisfaction quota and hold out because this seems to be
their only opportunity to uphold their interests.84 We do not
promote the possibility of different satisfaction quotas in the
normative approach to treating like cases alike and different
cases differently, and are not arguing that only some creditors
are worthy of protection. The suspension of the principle of equal
treatment offers the chance to disentangle the complex situation
of diverse creditor types with heterogeneous and partly divergent
interests that often leads to an impasse. To offer some creditors
a higher satisfaction quota can facilitate the negotiation
process, shorten a delay, and reduce transaction costs,85
so even those creditors with a lower satisfaction quota can profit
from a relatively better outcome.
The formation of creditor classes, which may be different from
the creditor groups outlined above, could be a solution with
benefits for all creditors. Unequal treatment and the formation of
creditor classes solely based on the decision of the sovereign
debtor would be worst because it would give way to uncontrolled
opportunistic behaviour, and consequently to substantial negative
external effects. The formation of creditor classes should thus be
based on a vote of the creditors. The double qualified majority
rule would apply, requiring approval by creditors holding 75 per
cent of the outstanding debts and by the creditors holding 50 per
cent of outstanding debts within the specific creditor classes.
The arbitral tribunal may be empowered to oversee the formation
and to decide upon the question of whether the formation of groups
has sufficient basis in fact. To restrict the incentives for
project-jeopardizing arbitrage, the trading of bonds and loans on
the secondary market from one creditor class to another to profit
from difference in price, the creditors should fix a date from
which assignment operates retroactively.
3.8 Collective Action Clauses
3.8.1 CAC in Sovereign Bonds / Loan Contracts
Collective action clauses (CAC) are an essential prerequisite
for successful negotiations in order to prestructure the
negotiation process. CACs, unlike unanimous action clauses (UAC),
allow for a qualified vote upon payment terms and provide the
contracting parties with the legal power to bind non-cooperating
CACs are commonly included in bonds issued under English law and
approved by that jurisdiction. By contrast, CACs were not implied
into bonds issued in New York due to the market practice of
private bond emissions. The Trust Indenture Act (TIA) of 1939
prohibits majority amendment clauses for payment terms. Therefore,
an amendment of the payment terms requires the consent of each
bondholder under New York law. The TIA was enacted in reaction to
concerns that equity owners of corporations could obtain the
majority voting power by purchasing the bonds issued by that
corporation and afterwards reduce or even suspend the debt for all
creditors. Although the TIA does not affect sovereign bonds, it
influenced market practice in the New York sovereign bond market.
This practice is changing: since 2003, CACs are the common
standard in sovereign bonds newly issued under New York law as
they have long been under English law.87
3.8.2 Incorporation of CACs
The most convincing argument for CACs is their economic value as
the reduction of transaction costs become evident. The currently
pressing question is how to imply CACs into preexisting bond,
particularly in the present Euro crisis. We have to assume many
creditors would reject an exchange offer because they believe they
would be in a better position with UACs if the majority of
creditors accept the exchange offer. This may lead to a prisoner’s
dilemma. To escape this dilemma there seem to be two solutions:
The first solution is a unilateral incorporation by the
sovereign. It may have the legal power to make a unilateral change
to the bond/loan terms if it chooses his national law as the law
to apply. The normative argument against this solution is that the
sovereign who chose a peer level of contract should not be allowed
to then subordinate the creditor to its coercive power.
Additionally, this approval has some substantial economic
disadvantages. It opens the door to ex post-opportunistic
behaviour of the sovereign who would be able to change the terms
in its favour. If it succeeds in a unilateral change of the credit
terms, there will not be a foreseeable limit. There is no valid
argument why the sovereign would not be able to reduce or even
suspend its debts in the same manner. Furthermore, this would have
dramatic consequences for credit costs. There is every reason to
believe that foreign courts would declare a breach of contract.
The second solution is ‘exit consent’. In negotiations with the
debtor the cooperating majority of creditors vote upon those
clauses that are free to change due to the unanimous action
clauses to the detriment of non-cooperating creditors, so their
claims decrease in value.88 This solution is ugly, but it
is a private ordering solution without coercive subordination by
the sovereign and a promising way to restrict ex post
opportunistic behaviour by the debtor and to prevent a hold up
3.8.3 Model Clauses
(1) Majority amendment clause: As it would run counter to a
party’s own economic interest to refuse any cooperation if the
debtor’s debt burden is unsustainable and no institution is
willing to bail out the debtor, an agreement is possible. We have
seen that for a minority of creditors there might be a
significantly higher profit if they free ride or hold out. Thus a
majority amendment clause has to be provided which empowers a
(double) qualified majority to vote upon a plan and legally binds
the dissenting creditors. The voting power of claims that are
directly or indirectly controlled by the debtor has to be
suspended to avert misuse.89
(2) Aggregation clause: If groups of creditors each holding
different bonds or loans fear a first mover disadvantage, this
causes a standoff. To prevent this happening, the different
bond/loan contracts have to be connected by an aggregation clause
so that all creditors vote upon the plan together and
(3) Acceleration, legal enforcement, and pro-rata clause: to
prevent a rush to the courthouse, only the trustee should be
empowered to accelerate and legally enforce creditor rights,
although if he fails to act on behalf of the vote of a qualified
minority, these restrictions should be suspended. A pro rata
clause would establish a right of the trustee on behalf of the
creditors to reclaim any payment a free rider receives pro rata.
(4) Coordination and information clauses: In absence of exchange
controls, the obligation of the debtor to provide information
about his transactions and his economic situation are the most
effective protection for the creditors and a prerequisite to
valuation of a restructuring offer91
and detection of opportunistic actions.92 To secure
compliance with these information duties, the debtor has to be
sanctioned if he fails to meet his obligations. Contractual
penalties, the right to accelerate the loan or bond and – if the
debtor does not correct and complete the required information
before the vote upon the plan – the renewal of the original claims
would be proper sanctions. It would be the trustee’s and
secretariat’s task to distribute the information.
(5) Arbitration clause: The competencies of the arbitral tribunal
and the binding force of its verdict have to be determined in the
(6) Choice of law clause: The material and procedural law to
apply (to the arbitral tribunal) has also to be determined ex ante
in the CAC. Precise rules confer legal certainty,93
though more abstract rules may be recommended to ensure the
required flexibility to react. The application of a sophisticated
financial law like New York or English law will be rewarded
through low credit costs. This can be explained with the
presumption that emerging-market countries especially would tend
to change their local law to the detriment of the creditors, not
taking into consideration the future increase in borrowing costs.94
Although the majority of sovereign bonds are issued under both New
York and English law, we see significant advantages in English law
practise over New York law practice. As already mentioned, the TIA
is not applicable to sovereign bonds. English law still provides
far more flexibility concerning the creation of bond terms for
corporate bonds, enabling the creditor’s majority to bind a
non-cooperative minority95 – a
prerequisite for successful debt restructurings in private
ordering procedures. This is an advantage that primarily affects
the chances of success for corporate debt restructuring in private
ordering procedures. Long-established market practice and
experience in the drafting of bond terms for bonds issued by
private debtors – particularly in reaction to the latest
developments in the financial markets – also contributes to the
image of ‘London CACs’ as a prototype for CACs in sovereign bonds.
(7) Obligation to incorporate specific CACs in future bond/loan
contracts: At the time of the conclusion of contract, the
creditors cannot foresee whether the debtor will incorporate CACs
into future loan/bond contracts. This causes calculation
uncertainties. For that reason, the debtor should sign a
self-commitment to incorporate specific CACs in further loan/bond
contracts. If he violates his obligation, the interest rate should
rise automatically. Disputes could be determined by the arbitral
Our proposal for reforming the London Club in order to better
manage private ordering restructuring of sovereign debts could be
helpful for restructuring the debts of Member States of the
Eurozone as well. What may be different here are problems of moral
hazard. Creditors of sovereign debtors in the Eurozone may charge
high interest rates because of existing sovereign risk. They may
also expect a bailout of their debtors by the European Union, the
European Central Bank, and/or the International Monetary Fond. It
had been the goal of Art 125 TFEU (non-bailout provision) to
prevent this type of moral hazard, but experience from the
financial crisis of peripheral Eurozone members in 2011 and 2012
has demonstrated that moral hazard prevailed. Different types of
quasi-bailout have been invented and brought into action,
protecting Eurozone members as well as their creditors. The price
for these quasi-bailouts is tremendous. It has to be paid by
taxpayers of Eurozone Member States, especially by those of net
contributors. This price reflects the perils of delayed default.
Our proposal for a workable private ordering debt restructuring
mechanism for sovereign debtors may be regarded as an exit option
from the ongoing costly bailout spiral.
Prof. Dr. iur. Dr. rer. pol. Dr. h.c. Christian Kirchner, LLM
(Harvard), Humboldt University of Berlin, School of Law and School
of Business and Economics (firstname.lastname@example.org).
David Christoph Ehmke, Research Assistant to Professor Kirchner
We are very grateful to Professor Gerhard Dannemann and Christoph
Schuller for their helpful comments and advice.
A good overview is provided by K Rogoff and J Zettelmeyer,
‘Bankruptcy Procedures for Sovereigns: A History of Ideas
1976–2001’ (2002) 49 (3) IMF Staff Papers <http://www.imf.org/external/pubs/ft/staffp/2002/03/rogoff.htm>
accessed 30 October 2012.
R Coase, ‘The New Institutional Economics’ (1984) 140 JITE 229; M
Erlei, M Leschke, and D Sauerland, Neue
Institutionenoekonomik (2nd edn, Schaefer & Poeschel
2007); E Furubotn, and R Richter, Institutions and Economic
Theory The Contribution of the New Institutional Economics
(2nd edn, University of Michigan Press 2005); Christian Kirchner,
‘Public Choice and New Institutional Economics. A Comparative
Analysis in Search of Co-operation Potentials’ in P Baake and
R Borck (eds), Public Economics and Public Choice,
Contributions in Honor of Charles B. Blankart (Springer
2007) 19; D North, Institutions, Institutional Change and
Economic Performance (Cambridge University Press 1990); R
Richter and E Furubotn, Neue Institutionenoekonomik (4th
edn, Mohr Siebeck 2010); S Voigt, Institutionenoekonomik
(2nd edn, UTB 2009); O Williamson, The Economic Institutions
of Capitalism (Free Press 1985).
Furubotn and Richter (n 2) 6–7; Richter and Furubotn (n 2) 7;
Voigt (n 2) 26–27.
Furubotn and Richter (n 2) 7; Richter and Furubotn (n 2) 7; for
different types of institutions see Voigt (n 2) 25–33.
Voigt (n 2) 22–23.
Voigt (n 2) 88–89; Furubotn and Richter (n 2) 5.
C Jolls, C Sunstein and R Thaler, ‘A Behavioral Approach to Law
and Economics’ in C Sunstein (ed), Behavioral Law &
Economics (Cambridge University Press 2000) 13; D
Kahnemann, ‘New Challenges to the Rationality Assumption’ (1994)
150 JITE 18; D Kahnemann and A Tversky, ‘Prospect Theory, An
Analysis of Decision under Risk’ (1979) 47 Econometrica 263; C
Kirchner, ‘New Challenges to the Rationality Assumption, Comment
on Kahnemann’ (1994) 150 JITE 37.
Voigt (n 2) 237–238.
L Rieffel, Restructuring Sovereign Debt – The Case for Ad Hoc
Machinery (Brookings Institution Press 2003) 96; G Vitale
‘Multilateral sovereign debt restructuring: The Paris Club and the
London Club’ in B Eichengreen and R Portes (eds), Crisis?
What Crisis? Orderly Workouts for Sovereign Debtors (Center
for Economic Policy Research 1995) 102, 127.
Deutsche Bundesbank, ‘Weltweite Organisationen und Gremien im
Bereich von Währung und Wirtschaft’ (2003)
accessed 15 August 2012, 227 ff; Vitale (n 9) 121 ff.
Eichengreen and Portes, Crisis?, What Crisis? Orderly
Workouts for Sovereign Debtors (Center for Economic Policy
Research 1995) 26; Rieffel (n 9) 103; Vitale (n 9) 127.
Rieffel (n 9) 108 f.
Eichengreen and Portes (n 11) 26; P Power, ‘Sovereign Debt: The
Rise of the Secondary Market and its Implications for Future
Restructurings’ (1996) 64 (6) Fordham Law Review 2701, 2712;
Rieffel (n 9) 103 and 116 f; Vitale (n 9) 127.
Rieffel (n 9) 117 ff.
Eichengreen and Portes (n 11) 26; Rieffel (n 9) 117; Vitale (n 9)
J Fisch and C Gentile, ‘Vultures or Vanguards?, The Role of
Litigation In Sovereign Debt Restructuring’ (2004) 54 (1043) Emory
Law Journal 1047, 1061 f.
Fisch and Gentile (n 16) 1061 f; Power (n 13) 2710 f.
Eichengreen and Portes (n 9) 26; Fisch and Gentile (n 16) 1064 f;
Power (n 13) 2713.
Fisch and Gentile (n 16) 1068 f; Power (n 13) 2715 f; P-H Verdier,
‘Credit Derivatives and the Sovereign Debt Restructuring Process’
(LLM Paper Harvard Law School 2004) 6 accessed 18 November 2013.
Ian Vásquez, ‘The Brady Plan and marked-based solutions to
debt crises’ (1996) 16 (2) CATO Journal 16 <http://www.cato.org/pubs/journal/cj16n2-4.html>
accessed 11 October 2012.
John Clark, ‘Debt Reduction and Market Reentry under the Brady
Plan, Federal Reserve Bank of New York – Quarterly Review Winter
(1993) 41 ff <http://www.newyorkfed.org/research/quarterly_review/1993v18/v18n4article3.pdf>
accessed 15 August 2012,; Power (n 13) 2720 f.
R Brown and T Bulman, ‘The evolving roles of the clubs in the
evolving of international debt’ (2006) 33 (1) International
Journal of Social Economics 11, 21 and 23 f; Fisch and Gentile (n
16) 1072 f; Timothy Geithner and Francois Gianviti, ‘The Design of
the Sovereign Debt Restructuring Mechanism – Further
Considerations’ (International Monetary Fund, November 2002) 5 accessed 15 August 2012; Group of Ten, ‘Report of
the G-10 Working Group in Contractual Clauses’ (26 September
2002) 1 accessed 7
August 2012; J Kämmerer, ‘Der Staatsbankrott aus
völkerrechtlicher Sicht’ ZaöRV 2005, 651, 664; A
Krueger, ‘A New Approach To Sovereign Debt Restructuring,
Statement by the First Deputy Managing Director of the IMF
Anne O. Krueger’ (IMF, April 2002) 1 f
accessed 15 August 2012.
Fisch and Gentile (n 16) 1074 ff.
P Buck-Heeb, Kapitalmarktrecht, (4th edn, CF Mueller
2010) 30 para 87.
B Rudolph and K Schäfer, Derivative
Finanzmarktinstrumente (2nd edn, Springer 2010) 176.
A Gelpern, ‘Domestic Bonds, Credit Derivatives and the Next
Transformation of Sovereign Debt’ (2008) 83 (1) Chicago Kent
Review 170 ff; Verdier (n 19) 60.
K Richter, Die Wirkungsgeschichte des deutschen Kartellrechts
vor 1914 (Mohr Siebeck 2005) 16; R Richter, Geldtheorie
(2nd edn, Springer 1990) 72 f.
K Hailbronner, ‘Der Staat und der Einzelne als
Völkerrechtssubjekt’ in W Graf Vitzthum (ed), Völkerrecht
(4nd edn, De Gruyter 2007) 191.
F Cranshaw, ‘Insolvenz- und finanzrechtliche Perspektiven der
Insolvenz von juristischen Personen des öffentlichen Rechts,
insbesondere Kommunen (Band 7)’ in S Smid, M Zeuner, and M Schmidt
(eds) Schriften zum deutschen, europäischen und
internationalen Insolvenzrecht (De Gruyter 2007) 68;
Hailbronner (n 28) 191.
For example: Case 2 BvM 9/03 BVerfG (6.12.2006) paras 32
ff; C Mayer, ‘Staateninsolvenz nach Argentinien-Beschluss des
Bundesverfassungsgerichts, Eine Chance für den Finanzplatz
Deutschland?’ WM 2008, 425, 429; A Schwenk,
‘Vollstreckungsrechtliche Aspekte zu Klagen geschädigter
Gläubiger von Argentinien-Anleihen – Anmerkungen zum Urteil
des OLG Frankfurt 8. Zivilsenat vom 29.04.2008 – 8 U 149/07’
jurisPR-BKR 4/2008 Anm. 3 = jurisPR extra 2008, 199, 200.
R Pitchford and M Wright, ‘Holdouts in Sovereign Debt
Restructuring: A Theory of Negotiation in a Weak Contractual
Environment’ (2010) NBER Working Paper No. 16632 <http://www.nber.org/papers/w16632>
accessed 15 August 2012; Mayer (n 30) 425, 429 ff; F Sturzenegger
and J Zettelmeyer, ‘Has the Legal Threat to Sovereign Debt
Restructuring Become Real?’ (2006) Business School Working Papers
Universidad Torcuato Di Tella 04/2006, 27–32.
Geithner and Gianviti (n 22) 5; Krueger (n 22) 7.
C Kirchner, ‘Sovereign Bankruptcy in the EU in the Comparative
Perspective – Comment on Leszek Balcerowicz’s paper’ in P Behrens,
T Eger and H-B Schaefer (eds), Ökonomische Analyse des
Europarechts (Mohr Siebeck 2011) 317, 327.
A Makipaa, Bankruptcy Procedures for Sovereign Debtors
(University of Heidelberg 2003) 6 <http://archiv.ub.uni-heidelberg.de/volltextserver/volltexte/2003/3432/pdf/Bankruptcy_Procedures_for_Sovereign_Debtors.pdf>
accessed 15 August 2012.
S Müller-Eicker, Strategien zur Restrukturierung von
Staatsverschuldungen in Schwellenländern (PhD-thesis,
TU Berlin 2011) 80 <http://opus.kobv.de/tuberlin/volltexte/2011/2956/pdf/muellereicker_stephan.pdf>
accessed 15 August 2012.
S Häseler, ‘Collective Action Clauses in International
Sovereign Bond Contracts – Whence the Opposition?’ (2007) German
Working Papers in Law and Economics – Paper 5, 2 f <http://www.bepress.com/cgi/viewcontent.cgi?article=1199&context=gwp>
accessed 15 August 2012.
M White, ‘Sovereigns in Distress: Do They Need Bankruptcy?’ (2002)
Brookings Paper on Economic Activity 17 <http://weber.ucsd.edu/~miwhite/BPEA_White.pdf>
accessed 15 August 2012.
Makipaa (n 34) 21 f; Power (n 13) 2764.
M Wright, ‘Restructuring Sovereign Debt with Private Sector
Creditors: Theory and Practice’ (2010) Working Paper 4 f and 17
accessed 30 October 2012.
Mayer (n 30) 429 ff; Makipaa (n 34) 18 f.
Mayer (n 30) 430.
B Eichengreen, ‘Sovereign Debt Restructuring’ (2003) 17 (4)
Journal of Economic Perspectives 75, 79 f
accessed 15 August 2012; Kirchner (n 33) 324 f; Makipaa (n 34)29
S Schlemmer-Schulte, ‘Souveränität und Konkurs – Zur
Institutenökonomie der Suspendierung staatlicher Schulden im
Internationalen Recht (Rezension)’ ZaöRV 2006, 236,
Kirchner (n 33) 326.
Kirchner (n 33) 326; Müller-Eicker (n 35) 81.
Kirchner (n 33) 326.
Group of Ten (n 22) 5 and 17.
Rogoff and Zettelmeyer (n 1) 30 f.
H Scott, ‘A Bankruptcy Procedere for Sovereign Debts?’ (April
2003) Mimeo 54 accessed 15 August 2012; S-J
Wei and Z Zhang, ‘Collateral Damage: Exchange Controls and
International Trade’ (2007) IMF Working Paper 4 ff accessed 15 August 2012.
Geithner and Gianviti (n 22) 35; Krueger (n 22) 12 and 15 ff.
Geithner and Gianviti (n 22) 56.
Rieffel (n 9) 116.
Rieffel (n 9) 122.
Geithner and Gianviti (n 22) 53.
Geithner and Gianviti (n 22) pp. 29 f.
M Hartwig-Jacob, ‘Neue rechtliche Mechanismen zur Lösung
internationaler Schuldenkrisen – Die Vorteile der Anwendung von
„Collective Action Clauses“ bei Staatsanleihen’ in KP Berger, G
Borges, H Herrmann, A Schlüter, and U Wackerbarth (eds), Zivil-
und Wirtschaftsrecht im Europäischen und Globalen
Kontext/Private and Commercial Law in a European and Global
Context – Festschrift für Norbert Horn zum 70. Geburtstag
(De Gruyter 2006) 717, 722 f; Group of Ten (n 22) 2 f.
Hartwig-Jacob (n 56) 722 f and 730; Group of Ten (n 22) 2 f and 13
Hartwig-Jacob (n 56) 723 f.
F Podewills, ‘Neuerungen im Schuldverschreibungs- und
Anlegerschutzrecht – Das Gesetz zur Neuregelung der
Rechtsverhältnisse bei Schuldverschreibungen aus
Gesamtemissionen und zur verbesserten Durchsetzung von
Ansprüchen von Anlegern aus Falschberatung’ DStR 2009, 1914,
1919; F Cranshaw, ‘Internationalisierung und Modernisierung –
Bemerkungen zum geltenden und zum Referentenentwurf eines neuen
Schuldverschreibungsgesetzes (SchVG)’ BKR 2008 504, 509.
Hartwig-Jacob (n 56) 723.
Hartwig-Jacob (n 56) 723 fn 22.
Makipaa (n 34) 26 f.; Müller-Eicker (n 35) 81; Sturzenegger
and Zettelmeyer (n 1) 32 – 35.
Hartwig-Jacob (n 56) 731; Group of Ten (n 22) 6 and 13.
Hartwig-Jacob (n 56) 733; Group of Ten (n 22) 6 and 14.
Hartwig-Jacob (n 56) 732; Group of Ten (n 22) 13 ff.
Wright (n 39) 4 ff.
For the advantages of permanent institutions in debt
restructuring: Eichengreen and Portes (n 9) 20 f and 48.
Geithner and Gianviti (n 22) 29 f.
Eichengreen and Portes (n 9) 43 f; Rieffel (n 9) 120.
Krueger (n 22) 13 and 17 and 28.
Makipaa (n 34) 23.
Krueger (n 22) 13 and 17 and 28.
The concept of the ‘Sovereign Debt Dispute Resolution Forum’
(SDDRF) could be a suitable model. But the decisions of the
arbitral tribunal we suggest only become legally binding when
accepted ex ante in the CAC. Along this lines: C Paulus, ‘A
Standing Arbitral Tribunal as a Procedural Solution for Sovereign
Debt Restructurings’ in C Primo Braga and G Vincelette (eds), Sovereign
Debt and Financial Crisis (World Bank Publications 2010)
317–329; C Paulus and S Kargman, ‘Reforming The Process of
Sovereign Debt Restructuring: A Proposal for a Sovereign Debt
Tribunal’ (Conference Paper 2008) <http://www.un.org/esa/ffd/events/2008debtpanel/KargmanPaulus_SovereignDebtTribunal.pdf>
accessed 21 August 2012. The discussion about arbitration in
sovereign debt restructuring: K Halverson Cross, ‘Arbitration as a
Means of Resolving Sovereign Debt Disputes’ (2006) 17 (3) The
American Review of International Arbitration 335–382
<http://ssrn.com/abstract=1014833> accessed 22 August 2012;
M Waibel, ‘Opening Pandora's Box – Sovereign Bonds in
International Arbitration’ (2007) 101 (4) American Journal of
International Law 711–759.
(n 33) 332; Paulus and Kargman (n 75) 8.
Geithner and Gianviti (n 22) 67.
Geithner and Gianviti (n 22) 30 ff.
C Paulus, Insolvenzrecht (C.H. Beck 2009) 25.
A Bell, Forum shopping and venue in
transnational litigation (Oxford University Press 2003) 19
C Kirchner, ‘Umschuldung in Euro-Peripheriestaaten:
Restrukturierung von Staatsschulden ohne ein „Insolvenzrecht
für Staaten“: Ein gangbarer Weg aus der Krise der
Euro-Peripheriestaaten?’ ifo Schnelldienst Nov 2011, 3, 4.
Kirchner (n 81) 4.
C Paulus, ‘Ein Regelsystem zur Schaffung eines internationalen
Insolvenzrechts für Staaten,’ Zeitschrift für
Gesetzgebung 4 (2010), 313, 328.
L Buchheit and M Gulati, ‘How to Restructure Greek Debt’ (July
2010) Mimeo 8 <http://ssrn.com/abstract=1603304>
accessed 15 August 2012.
Fisch and Gentile (n 16) 1062 f.
Fisch and Gentile (n 16) 1101 ff.
Geithner and Gianviti (n 22) 52.
Group of Ten (n 22) 3; C Ohler, ‘Der Staatsbankrott’ (2005) JZ
590, 598; J Taylor, ‘Sovereign Debt Restructuring: A U.S.
Perspective’ (Statement by John B Taylor, Under Secretary of
Treasury for International Affairs, Institute for International
Economics, Washington DC, April 2, 2002) 2 <http://www.stanford.edu/~johntayl/taylorspeeches/taylorspeeches/Sovereign%20Debt%20Restructuring%20(2%20April%2002).doc>
accessed 12 August 2012.
R Buckley, ‘The Bankruptcy of Nations: Let the Law Reflect
Reality’ (2009) International Lawyer, 20 UNSW Research Paper, 143
ff; S Galvis and A Saad, ‘Collective Action Clauses: Recent
Progress and Challenges Ahead’ (Georgetown University 2004) 3 ff
and 12 fn 24 <http://heinonline.org/HOL/Page?handle=hein.journals/geojintl35&div=29&g_sent=1&collection=journals>
accessed 15 August 2012; Group of Ten (n 22) 2, 4, and 6 f;
Hartwig-Jacob (n 56) 718 f; IMF and World Bank Staff, ‘Guidelines
for Public Debt Management’ in Anwar Shah (ed), Fisical
Management (World Bank Publications 2005) 128; E Koch
(2004), ‘Collective Action Clauses – the way forward’ (2004) 2 f,
6 f, 10, 16 f <http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/01/Collective%20Action%20Clauses%20-%20Elmar%20Koch.pdf>
accessed 15 August 2012; A Szodruch, Staateninsolvenz und
private Gläubiger (Berliner Wissenschafts-Verlag 2008)
M Gulati and L Buchheit, ‘Exit Consents in Sovereign Bond
Exchanges’ (2000) 48 UCLA Law Review 59.
Group of Ten (n 22) 5 and 10 f and 17.
C Blankart and E Fasten, ‘Wer soll für die Schulden im
Bundesstaat haften? Eine vernachlässigte Frage der
Föderalismusreform II’ Perspektiven der Wirtschaftspolitik 10
(2009), 39, 55; Hartwig-Jacob (n 56) 730 f.
Hartwig-Jacob (n 56) 726 f; Group of Ten (n 22) 3 and 16.
Kirchner (n 33) 326; Müller-Eicker (n 35) 81.
Kirchner (n 33) 332.
Buchheit and Gulati (n 84) 10 and 11.
Danny Tricot, ‘English Law Bonds’ in Peter Veranneman (ed), Schuldverschreibungsgesetz
(C.H. Beck 2009) 187, 190 f; H Foulkes, ‘Bond Creation
and Issuance and Bondholder Action under United States Law’
ibid 173, 180 f.
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