Committee Reports

Sovereign Debt Stability Act Report

BILL INFORMATION

A.2970-A (AM Fahy) / S.5542-A (Sen. Rivera) – Provides for restructuring unsustainable sovereign and subnational debt; provides a voluntary petition for relief may be filed with the state (NYS 2023-24).

REPORT

REPORT ON LEGISLATION BY THE COMMERCIAL LAW AND UNIFORM STATE LAWS COMMITTEE

A.2970-A (AM Fahy)
S.5542 -A (Sen. Rivera)

AN ACT to amend the debtor and creditor law, in relation to restructuring unsustainable sovereign and subnational debt

Sovereign Debt Stability Act

The New York City Bar Association (“City Bar”), led by the Commercial Law and Uniform State Laws Committee, urges the New York State Legislature to pause action on the current version of the proposed New York Sovereign Debt Stability Act (A.2970-A / S.5542-A) (the “Bill”) to allow additional hearings and public comment on the serious issues surrounding this legislation.  Based upon the materials submitted to the Legislature in opposition to the Bill from highly credible parties,[1] caution and further study of the Bill are warranted for at least three important reasons:

  • The problem the Bill is designed to solve – the disruption of consensual sovereign debt restructurings by “holdout” dissident bondholders – appears already to have been addressed by international initiatives and developments in commercial practice;
  • The Bill appears likely to increase the credit expense for new issuances of sovereign debt, while providing little or no effective relief for sovereigns who default on existing debt because the Bill has no clearly effective mechanisms to bind creditors in other jurisdictions and will be subject to serious constitutional challenges in the United States; and
  • The Bill appears likely to damage New York credit markets, injure New York investors in outstanding sovereign debt, and undermine New York’s position as a preeminent financial and legal center for existing and future issuance of sovereign debt, as sovereigns and investors seek to avoid the potential adverse impacts of the Bill by choosing laws of jurisdictions other than New York.

The City Bar therefore recommends that before taking any further action on the Bill, which may have highly detrimental unintended consequences for both sovereign debt issuers and the State of New York, the Legislature further conduct a careful factual study to determine whether such legislation is necessary and appropriate at the New York state level and fully consider and evaluate the potential consequences of the Bill for developing nations and the New York capital and financial markets and legal community. The City Bar also would greatly appreciate the additional information such hearings would elicit that will assist the City Bar in developing its own analysis and recommendations regarding the Bill.

I. What the Bill Proposes to Do Versus What It May Actually Do  

The Bill would add a new Article 8 to the New York Debtor and Creditor Law to give foreign countries a unilateral right to attempt to restructure their eligible sovereign or “subnational” debt under New York law.  The Bill would allow a debtor state to choose one of two sovereign debt restructuring options: (a) a plan mechanism (“Section 223 Plan”) under which the sovereign would submit its own proposed restructuring plan to be approved by creditors, or (b) a limitation on recoveries mechanism (“Section 230 Limit”) that would limit creditor recoveries to the amount “recoverable by the United States federal government under the applicable international initiative” for sovereign debt relief.  Under the Section 223 Plan option, an independent monitor appointed by New York’s Governor would attempt to reconcile debt claims, specify the treatment of claims, and certify that the sovereign’s state debt will become sustainable if the plan becomes effective.  Under the Section 230 Limit option, bondholders would be required to take mandatory reductions on their debt instruments in accordance with “burden-sharing standards” set by international initiatives such as the International Monetary Fund (“IMF”) and World Bank’s Heavily Indebted Poor Countries Initiative, the G-20’s Debt Service Suspension Initiative, and the Common Framework for Debt Treatments.

The Bill contains an unprecedented provision that would retroactively strip creditors holding debt issued under New York law of their express contractual right to enforce the terms of their contracts by legal proceedings upon default of the issuer of the debt. The Bill also would bar the sovereign and its creditors from negotiating a voluntary waiver of this provision at the time the debt is issued.   The Bill would give a sovereign issuer the exclusive right to propose a restructuring plan and permit the sovereign issuer to switch its choice between the two restructuring options at any time during the restructuring process.

Some market participants involved in the issuance, purchase and restructuring of sovereign debt contend that the Bill would make sovereign debt governed by New York law uncertain and unattractive to investors and would damage the New York credit and capital markets.[2]  Legislation that undermines the enforceability of obligations governed by New York law or traded on the New York markets would jeopardize New York’s status as a stable and predictable commercial jurisdiction.  That, in turn, could dramatically undermine the position of New York as a legal and commercial center.

Rather than assisting sovereign issuers in facilitating a restructuring, if enacted, opponents believe the Bill likely will lead to increased and protracted litigation between the sovereign issuer and creditors and increased costs and expenses (including interest expense) for sovereign issuers.[3]  In fact, members of the City Bar involved in drafting this Report are aware of instances where sovereign issuers and investors are hesitant to have new sovereign debt issued under New York law and are considering what steps, if any, can be taken to avoid application of the Bill if it were to be enacted.

II. The Bill May Be Unnecessary

The apparent aim of the Bill is to stop dissident bondholders from disrupting sovereign debt restructurings, as happened, for example, when bondholders won a New York court injunction in 2012 to prevent Argentina from repaying its restructured bonds.  See NML v. Argentina, 727 F.3d 230 (2d Cir. 2013).   Notably, that decision arose in a case in which the court held that the sovereign issuer was a “uniquely recalcitrant debtor.”

But the problem of bondholder disruption of sovereign debt restructurings has been and can continue to be effectively addressed by initiatives of the IMF, US Treasury Department, and other international policy bodies that have introduced enhanced collective action clauses (“CACs”)[4] and promulgated international guidelines, such as the Institute of International Finance’s Principles for Stable Capital Flows and Fair Debt Restructuring, which allow for consensual resolution of sovereign debt defaults.[5]  Today, a large majority (in dollar value) of foreign sovereign debt governed by New York law uses enhanced CACs, and sovereign issuers and their creditors have employed the new guidelines in negotiating debt restructurings. Thanks to these developments, recent sovereign debt restructurings – including Argentina’s restructuring in 2019 – have proceeded consensually and without the disruptive litigation of the past.

III. The Bill May Have Limited Effect and May Be Unconstitutional

Unlike the US Bankruptcy Code, the Bill does not provide an extraterritorial “automatic stay” to stop all creditor enforcement actions against a debtor on a defaulted debt.  Nor could it, as New York courts do not have the power to enjoin non-New York parties from enforcing their rights to repayment of sovereign debt.  Similarly, it is unclear how a New York court could enforce the terms of any Section 223 Plan or adjudicate disputes arising in a restructuring process absent personal jurisdiction over all the affected creditors.  Creditors not subject to jurisdiction in New York could simply ignore New York restructuring proceedings and seek to enforce their rights elsewhere.  Consequently, New York creditors could suffer losses or be delayed from enforcing their rights to repayment while other creditors not subject to New York law would not.

The Bill also may be unenforceable under the US Constitution and federal law.  The Bill may be challenged under the US Constitution’s Supremacy, Bankruptcy and Foreign Commerce Clauses.  The Bill also may be challenged under the US Constitution’s Contracts and Takings Clauses based on its intent to apply retroactively to existing contract rights under sovereign debt instruments.  Because of the extent of these potential challenges, the Bill’s severability provision may not save it from being declared unenforceable.

IV. Potential Unintended Adverse Consequences for Sovereign Issuers and New York Investors

Rather than achieving its stated goal of reining in bondholder litigation, enactment of the Bill could instead lead to increased costs and protracted sovereign debt restructurings.  Creditors and other stakeholders likely will challenge the Bill’s restructuring mechanisms on constitutional and other grounds discussed above.  Even if it were constitutional and enforceable, the Bill contains key terms and provisions that are vague, unclear, or ambiguous.  For example, the Bill does not clearly define the meaning of the standard “recoverable by the United States federal government under the applicable international initiative” in the context of a Section 230 Limit on recoveries. Many sovereign issuers have no debt outstanding to the United States federal government. Nor does the Bill clearly define the powers and responsibilities of the Governor-appointed monitor under the Section 223 Plan option.  The Bill requires bondholders to take mandatory reductions on their debt instruments in accordance with “burden-sharing standards.”  The burden-sharing standards are complicated and ambiguous and their determination for purposes of the Bill, if enacted, may need to be litigated.  These and other questions left open by the Bill may lead to protracted and expensive litigation.

Confronted with the prospect of protracted litigation over the validity and meaning of an unprecedented new restructuring regime if the Bill were enacted, investors may impose increased costs (including higher interest rates) and additional terms on sovereign debt issued under New York law.  Given these potential increased costs, sovereign issuers may avoid issuing debt under New York law or subject to New York jurisdiction. This may raise the cost of sovereign debt issuances for the countries least able to afford it, the very countries the Bill was intended to help. The uncertainties and retroactive operation of the Bill if enacted will also likely decrease the value of existing sovereign debt, thereby imposing losses on ordinary investors, pension funds and insurance companies.

The potential damage to investors and credit markets centered in New York could be enormous. Thanks to its history of consistent enforcement of international financial contracts by neutral and commercially sophisticated courts, New York has long enjoyed its status as the jurisdiction of choice for sovereign debt issuances.  Today, a large majority of foreign sovereign debt is issued subject to New York law and with New York designated as the forum for adjudication of disputes. Concerned by the mere possibility of the Bill’s enactment, some parties to new sovereign debt issuances are already considering whether their transactions should be governed by the law of other states or other countries.

V. Conclusion

For the foregoing reasons, the City Bar recommends that the Legislature refrain from action on the Bill until it has conducted further investigation into how the proposal might work in practice, whether concerns raised about potential unintended and negative consequences of the bill are warranted, whether there is still a need for a New York law governing sovereign debt restructurings or whether any remaining need for reform is better addressed by the IMF, US Treasury, expanded use of CACs, and possibly other legislative alternatives.

Commercial Law and Uniform State Laws Committee
Curtis C. Mechling, Chair

June 2024

Footnotes

[1]  The City Bar is aware of oppositions submitted by the American Council of Life Insurers, The Credit Roundtable, the Investment Company Institute, the International Capital Market Association, the Institute of International Finance, the Life Insurance Council of New York, the Partnership for New York City, and the Securities Industry and Financial Markets Association. See, ACLI, CRT, ICI, ICMA, IIF, LICONY, PFNYC, and SIFMA Oppose New York Legislature Bill on Sovereign Debt (Mar. 13, 2024),  https://www.iif.com/About-Us/Press/View/ID/5701/ACLI-CRT-ICI-ICMA-IIF-LICONY-PFNYC-and-SIFMA-Oppose-New-York-Legislature-Bill-on-Sovereign-Debt (All websites last accessed on May 31, 2024).

[2]  See, Cleary Gottlieb Discusses New York Sovereign Debt Restructuring Legislation (May 6, 2024),   https://clsbluesky.law.columbia.edu/2024/05/06/cleary-gottlieb-discusses-new-york-sovereign-debt-restructuring-legislation/.

[3] Id.

[4] CACs protect funds dedicated to payment of the creditors who accept a compromise restructuring from the claims of dissenting holders.  Holders of a debt instrument subject to a CAC are bound by the agreement of a specified majority (usually much greater than 50%) to accept a reduction of the amount due on the debt.  The CAC thereby prevents a small minority of holders from frustrating the debt relief sought by the issuer and agreed to by the designated majority of holders.

[5] See, Institute of International Finance, The Principles for Stable Capital Flows and Fair Debt Restructuring, April 2022 Update (Apr.28, 2022), https://www.iif.com/Publications/ID/4887/The-Principles-for-Stable-Capital-Flows-and-Fair-Debt-Restructuring-April-2022-Update.