Continuing economic volatility in the Eurozone increases the likelihood that more EU states will attempt to force losses on bondholders.
Investors in Greek sovereign bonds and Irish bank debt have already suffered substantial losses by forced state measures, and the deteriorating situation in Italy and Spain makes it seem likely that bondholders face further ‘haircuts’ in those jurisdictions. By examining the steps already taken by the Greek and Irish governments, investors can assess how they might be treated in other jurisdictions, and what legal remedies might be available to them.
With Italian and Spanish borrowing costs threatening to rise above sustainable levels, and with concerns being voiced even about certain French banks, what should bondholders watch for?
Voluntary – well, sort of
As with Irish bank debt, a member state may first attempt to employ the ‘not entirely voluntary tender’ process, whereby bondholders are invited ‘voluntarily’ to tender their bonds for sale back to the issuer at a huge discount from face value. However, the tender may come with the implied threat that if the bondholders do not participate, they will face subsequent legislation that will effectively devalue their bonds.
Alternatively -- or in the event the ‘not entirely voluntary tender’ is unsuccessful -- a more obviously ‘coercive tender’ approach may be adopted. This type of tender purports to use contractual provisions in bond instruments, known as collective action clauses (CACs). CACs allow the bond issuer to amend the terms of bond instruments if a defined majority – typically 66 per cent or 75 per cent – agree.
The issuer invites bondholders to sell their bonds at a huge reduction in face value. Those bondholders who tender their bonds are then deemed to have voted in favour of a change to the bond instruments that are left behind.
Therefore, the coerceive tenders employed by the Irish banks created a ‘prisoner’s dilemma’. Bondholders faced a choice between tendering their bonds at, say, 20 per cent of face value, or run the risk that 75 per cent of other holders did so and that the bond instruments that are left behind would then be significantly devalued. So, with Irish banks, the majority got around 20 per cent of face value, and the minority got practically nothing.
More and less drastic
The Greek coercion was in some ways more drastic -- and in some ways less drastic -- than the Irish coercion. Greek sovereign bonds governed by Greek law did not contain CACs. Controversially, the Greek legislature passed emergency legislation to insert CACs into such bonds.
Bondholders went overnight from a situation where they could not be forced to take any steps with respect to their bonds just because a majority of other holders wanted to do so, to a situation where they could be dragged along with majority will. Following the forced insertion of CACs into Greek-law bonds, bondholders were invited to accept a 68.5 per cent reduction in the face value of their bonds. The terms of the tender stated that any bondholder who wished to participate in the exchange were deemed to vote in favour of the extraordinary resolution that the terms of all of the bonds should be amended to allow the government to redeem all outstanding bonds at a 68.5 per cent reduction. So, in effect, the minority got dragged along with the majority.
As a last resort, if tenders (coercive or otherwise) do not work, a member state may seek to pass legislation forcing haircuts on all bondholders. For example, the Irish Credit Institutions (Stabilisation) Act 2010 purports to allow the Finance Minister to step in and effectively re-write the terms of bond instruments issued by Irish banks, for example, to cancel coupon payments on the bonds, or to extend maturity dates.
State attempts to re-write bond instruments, which are essentially private contractual obligations, has proved controversial. There have been several cases brought against the Ireland and Irish banks in the country’s courts as well as in those of England and the US, and it is expected that there will be similar cases against the Greek state.
Governing law
Crucially, the extent to which the terms of bond instruments can be altered by state action largely depends on the governing law of those bonds. It is one thing for the Irish government to amend Irish instruments, and for Greece to seek to amend Greek instruments, but many Irish and Greek (and, for that matter, Italian and Spanish) bonds are governed by English law and subject to the jurisdiction of the English courts.
It is with respect to these instruments that most litigation battles have been and will continue to be fought. For example, Ireland has argued that European insolvency legislation allows it effectively to amend the terms of investment contracts governed by English law. This position has been challenged in the English courts, for example, in litigation involving the Bank of Ireland, and there are further cases in the pipeline.
Another source of potential disputes, particularly in reaction to the Greek sovereign debt exchange, is found in the many bilateral investment treaties entered into by member states. Several German investors, for example, complain that the Greek debt exchange has infringed their rights under the German-Greek bilateral investment treaty, thereby giving them a right to commence international arbitration for recovery of their losses.
It is clear is that as more forced ‘haircut’ situations arise, bondholders across the Eurozone are becoming more and more likely to bring litigation or arbitration to protect their position. These are cases that will run for years.
Steven Friel is a partner at the London office of international law firm Brown Rudnick. Ben Williams -- a trainee at that office – also contributed to this article
Investors in Greek sovereign bonds and Irish bank debt have already suffered substantial losses by forced state measures, and the deteriorating situation in Italy and Spain makes it seem likely that bondholders face further ‘haircuts’ in those jurisdictions. By examining the steps already taken by the Greek and Irish governments, investors can assess how they might be treated in other jurisdictions, and what legal remedies might be available to them.
With Italian and Spanish borrowing costs threatening to rise above sustainable levels, and with concerns being voiced even about certain French banks, what should bondholders watch for?
Voluntary – well, sort of
As with Irish bank debt, a member state may first attempt to employ the ‘not entirely voluntary tender’ process, whereby bondholders are invited ‘voluntarily’ to tender their bonds for sale back to the issuer at a huge discount from face value. However, the tender may come with the implied threat that if the bondholders do not participate, they will face subsequent legislation that will effectively devalue their bonds.
Alternatively -- or in the event the ‘not entirely voluntary tender’ is unsuccessful -- a more obviously ‘coercive tender’ approach may be adopted. This type of tender purports to use contractual provisions in bond instruments, known as collective action clauses (CACs). CACs allow the bond issuer to amend the terms of bond instruments if a defined majority – typically 66 per cent or 75 per cent – agree.
The issuer invites bondholders to sell their bonds at a huge reduction in face value. Those bondholders who tender their bonds are then deemed to have voted in favour of a change to the bond instruments that are left behind.
Therefore, the coerceive tenders employed by the Irish banks created a ‘prisoner’s dilemma’. Bondholders faced a choice between tendering their bonds at, say, 20 per cent of face value, or run the risk that 75 per cent of other holders did so and that the bond instruments that are left behind would then be significantly devalued. So, with Irish banks, the majority got around 20 per cent of face value, and the minority got practically nothing.
More and less drastic
The Greek coercion was in some ways more drastic -- and in some ways less drastic -- than the Irish coercion. Greek sovereign bonds governed by Greek law did not contain CACs. Controversially, the Greek legislature passed emergency legislation to insert CACs into such bonds.
Bondholders went overnight from a situation where they could not be forced to take any steps with respect to their bonds just because a majority of other holders wanted to do so, to a situation where they could be dragged along with majority will. Following the forced insertion of CACs into Greek-law bonds, bondholders were invited to accept a 68.5 per cent reduction in the face value of their bonds. The terms of the tender stated that any bondholder who wished to participate in the exchange were deemed to vote in favour of the extraordinary resolution that the terms of all of the bonds should be amended to allow the government to redeem all outstanding bonds at a 68.5 per cent reduction. So, in effect, the minority got dragged along with the majority.
As a last resort, if tenders (coercive or otherwise) do not work, a member state may seek to pass legislation forcing haircuts on all bondholders. For example, the Irish Credit Institutions (Stabilisation) Act 2010 purports to allow the Finance Minister to step in and effectively re-write the terms of bond instruments issued by Irish banks, for example, to cancel coupon payments on the bonds, or to extend maturity dates.
State attempts to re-write bond instruments, which are essentially private contractual obligations, has proved controversial. There have been several cases brought against the Ireland and Irish banks in the country’s courts as well as in those of England and the US, and it is expected that there will be similar cases against the Greek state.
Governing law
Crucially, the extent to which the terms of bond instruments can be altered by state action largely depends on the governing law of those bonds. It is one thing for the Irish government to amend Irish instruments, and for Greece to seek to amend Greek instruments, but many Irish and Greek (and, for that matter, Italian and Spanish) bonds are governed by English law and subject to the jurisdiction of the English courts.
It is with respect to these instruments that most litigation battles have been and will continue to be fought. For example, Ireland has argued that European insolvency legislation allows it effectively to amend the terms of investment contracts governed by English law. This position has been challenged in the English courts, for example, in litigation involving the Bank of Ireland, and there are further cases in the pipeline.
Another source of potential disputes, particularly in reaction to the Greek sovereign debt exchange, is found in the many bilateral investment treaties entered into by member states. Several German investors, for example, complain that the Greek debt exchange has infringed their rights under the German-Greek bilateral investment treaty, thereby giving them a right to commence international arbitration for recovery of their losses.
It is clear is that as more forced ‘haircut’ situations arise, bondholders across the Eurozone are becoming more and more likely to bring litigation or arbitration to protect their position. These are cases that will run for years.
Steven Friel is a partner at the London office of international law firm Brown Rudnick. Ben Williams -- a trainee at that office – also contributed to this article
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