Odious Debt and “Vulture Funds”: Making a Case for Repudiation of Sovereign Debt

The International financial community has long profited from the current framework of sovereign lending. It may engage in lending to any recognized regime, it may make such loans without any obligation to engage in any due diligence, other than that thought prudent for the protection of their investment. Such loans are negotiated with the agents of the state, but remain the primary obligation of the people. In the best of all worlds, this system works well enough. Citizens ought to be responsible for the actions of their agents. However, where loans are made to non-democratically elected governments, or made for the benefit of the agent responsible for arranging the loan, it is harder to connect the citizens of the state with the agents who arranged the loans. And indeed, in those contexts, the lender, rather then the citizenry, are in the best position to exercise any diligence on the state agents.

However, the global lending system has resisted any effort to unbundled the agents of a state from the state itself. Global debt markets value consistency, predictability and simplicity. More importantly, perhaps, global lending markets are dependant on the protection of its secondary markets for debt. Debts that are not easily negotiated—and especially debts with respect to which defenses follow purchase—are debts whose liquidity, and value, shrink considerably. In a world in which a robust global debt market, a market made up of private and sovereign debt, is essential for the promotion of global trade, any effort to add complexity to any component of the rules for markets in secondary debt, would be resisted.

Yet, at least in the context of sovereign lending, the analysis is a bit more complicated. Like corporate debtors, sovereign debtors are juridical persons. Both operate for the benefit of their stakeholders. Both impose monitoring obligations on stakeholders over the conduct of their agents—agents to whom authority to act on behalf of the entity has been granted. And both ought to be responsible for their obligations. But the public character of a state affects both the character of state debt and the nature of the effects of such debt. Sovereign debt, its servicing and repayment reduces the ability of a state to invest in the economic development of its people. Where the right to development is deemed an important consideration in the structure of the normative relations among states, sovereign debt becomes a political issue. In a world in which it becomes important to facilitate the development of states (and especially poor states) to increase the prosperity of citizens generally and avoid political and social instability that can lead to, among other things, crime, violence, instability and migration, the connection between sovereign debt and benefits to the people on whose behalf they were incurred becomes critically important.

The consequence is difficult to avoid: global political actors and global economic actors work towards irreconcilability different ends in the construction and preservation of stable and wealth maximizing systems of lending and repayment. What is important to one system becomes a critical weakness for the functioning of the other. States, individually, collectively, and through their financial organs, thus seek to tighten control over the validity of debts to sovereigns. To this end they engage in periodic attempts to forgive or reschedule such debt, and conflate political aims (anti-corruption, furtherance of democratic governance, anti-terrorism campaigns, and the like) with lending. They seek to shift burdens of lending from the political actors to the creditors (sometimes private and sometimes public actors). Creditors seek a seamless stability in markets for debts and a normative framework that shifts all burdens to debtors and their principals for illegitimate debt. In a perfect world for global lending, all purchasers of debt would be holders in due course.

And so it comes as no surprise that global economic and political actors have again clashed over the collection of sovereign debts validly incurred, from the perspective of creditors and obtained illegitimately on behalf of the state (and thus ultra vires) by the state’s agents in collusion with creditors (under either a knowing or reckless standard) from the perspective of the collective community of nations seeking to maximize the development opportunities of poor states. This time a string interest in the protection of the integrity of markets for secondary debt clashed with the long-term project of foreign debt forgiveness for the purpose of development implemented by a host of states.

This time, the battle pits Zambia against British Virgin Islands-based Donegal International, a global speculator in debt instruments tied to U.S. based financial corporate entities. (Zambia loses 'vulture fund' case: A High Court judge has ruled that Zambia must pay a substantial sum to a so-called "vulture fund,” BBC News, Feb. 15, 2007 (accessed Feb. 16, 2007). According to the BBC News Report:

In 1979, the Romanian government lent Zambia money to buy Romanian tractors. Zambia was unable to keep up the payments and in 1999, Romania and Zambia negotiated to liquidate the debt for $3m. But before the deal could be finalised, Donegal International, which is part owned by US-based Debt Advisory International (DAI) stepped in and bought the debt from Romania for less than $4m. Id.

Thus, an inter-governmental transfer transaction that might not have been characterized as debt in the hands of the original creditor state (see Anna Gelpern, Odious, Not Debt, 70 JOURNAL OF LAW & CONTEMPORARY PROBLEMS – (forthcoming 2007) (the “debt” is as easily characterized as a subsidy for the purchase of tractors and thus a direct payment from Romania to the Romanian entities supplying tractors to Zambia)), when negotiated to a private party, assumes all the characteristics of debt. But this was a debt that the Zambians intimated was tinged with corruption—that is, the deal for Romanian tractors, financed by Romania, appeared to have benefited individuals on both sides of that transaction, perhaps more than Zambia (The BBC News report quoted Zambian sources as suggesting that “The fight against Donegal's claim had been "entirely vindicated and [marked] a significant milestone in the efforts of [the Zambian government] to fight corruption and maintain a stable economic course" Id.). Indeed, a Zambian presidential advisor, “Mr Kalunga-Banda added that while the repayment might be legal, it arose from debts accrued when the country was under "an undemocratic system". Id. Thus, the debt, as to the people of Zambia, might well have been illegitimate, because incurred by its agents, government functionaries, for their own, rather than for the benefit of Zambia.

This debt, whatever its origins, character and legitimacy defects, now in the hands of a holder in due course, the transaction between Zambia and Romania becomes debt, and fully collectable through a judicial action in a state where Zambia might have wealth against which a judgment could be levied. And that is precisely what happened here. Donegal International sued in English courts, sought a freeze on Zambian assets and a judgment of $ 42 million (principle plus accumulated interest and charges), a nice return on an investment of about one tenth of that amount. Id.

After hearing on the matter, the court split the baby. Again, according to the BBC News report:

The judge ruled against Zambia's application to dismiss Donegal's claim, but at the same time proposed to end a freeze of Zambian assets secured by the fund. Donegal, however, will have a chance to argue the case for a continued freeze of Zambian assets. According to BBC economics reporter Andrew Walker, people familiar with the case believe that the judge will order Zambia to pay Donegal between $10m and $20m, less than half what Donegal sought. Id.

Lawyers for Zambia claimed victory, of sorts. “Janet Legrand of DLA Piper called the ruling "fantastic news for both the government of Zambia and its people". Id. Vindication, however, is counted oddly—a $4 million inter-governmental transfer has morphed into a likely obligation to pay a third party creditor anywhere from about $10 to $20. The return for Donegal International on its initial investment is still great—and it is still possible that Zambian assets will be frozen pending payment. From the perspective of financial markets, this was also a great victory, of sorts.

The political community had a very different view of the affair. Since 2002 Gordon Brown, the likely successor to Tony Blair as leader of the U.K. Labour Party has characterized speculators in public debt in secondary capital markets as “perverse and immoral.” Id. In an ironic twist, Mr. Brown suggested that such secondary market speculators ought to have some sort of obligation to act in the interests of the state. “We particularly condemn the perversity where vulture funds purchase debt at a reduced price and make a profit from suing the debtor country to recover the full amount owed - a morally outrageous outcome." Id. But this makes little sense. The U.K. would hardly argue that Donegal International ought to act in the interests of stakeholders other than those with an interest in the entity. Donegal International is not a state actor. Still, as the spokesperson for a debt relief NGO suggested, "Profiteering doesn't get any more cynical than this." Id.

This was a view shared by other elements of the NGO human rights and development community not associated with civil society elements supporting the development and integrity of private capital markets. The problem with these action by private entities pursuing their own economic interests is precisely that—that they are private entities pursuing their own private interests. This is bad, especially where such actions interfere with the foreign policy objectives of government. Thus, for example, the BBC News report noted that “Jubilee Debt campaigner Caroline Pearce said that vulture funds "made a mockery" of the work done by governments to write off the debts of the poorest - a key theme of 2005's Live8 concert.” Id.
Indeed, powerful elements of global civil society went to some pains to suggest the bad faith of Donegal International and its agents. Oxfam International posted the following press release to its web site on the eve of the High Court decision:

By extraordinary coincidence, the amount claimed is almost exactly the sum which Zambia is due to receive this year as a result of the Gleneagles debt deal and is equivalent to six months of Zambia's health budget - something Michael Sheehan is likely to be aware of through his long experience of working as a debt advisor in poor countries. Indeed Donegal is closely connected to a company called Debt Advisory International of Washington DC. Oxfam, Oxfam and Jubilee Call for Action as Vulture swoops on Zambia's Cash (15 February 2007).

And indeed, the effect of this episode severely impacts both Zambia’s ability to deploy its wealth for the betterment of its people, and the international communities efforts to subsidize those activities through programs of targeted debt forgiveness programs. The effective result is that the international community subsidizes payments into the secondary creditor markets. What might annoy the U.K. the most, then, is that its debt forgiveness program has resulted in payments from the U.K. to Donegal International. Indeed, the BBC News story reported Martin Kalunga-Banda as saying that the $42m initially sought by Donegal International “was equal to all the debt relief it received last year.” Thus, according to Jubilee Debt campaigner Caroline Pearce, “’Zambia has been planning to spend the money released from debt cancellation on much-needed nurses, teachers and infrastructure. This is what debt cancellation is intended for, not to line the pockets of businessmen based in rich countries.’” Id.

But what can be expected when multiple systems of law and legal norms, one private and economic and the other public and political, function simultaneously on different aspects of a complicated transaction? An unintended consequence of globalization—in its aspect as privatization of economic transactions and public support of free movement of capital within stable capital markets—is to limit the effectiveness of interventionist state economic policies. It is precisely this development of global capital markets, and specifically robust markets for debt, that makes it possible for states to leverage their wealth for the good of their people, or squander it. Once in the debt markets, states become, to a certain extent, market participant like any other juridical person. But states are not quite like any other juridical person—at least not just yet. And thus is presented a great tension. The global capital markets tend to flatten formal hierarchy—all debtors are the same for the purposes of protecting the integrity of the market. The public and political nature of states suggests a vertical hierarchy to which capital markets ought to be subject. Those elements of civil society seeking to defend Zambia rely principally on this second conception. That is the only way it is possible to understand Oxfam’s Director of Campaigns, Adrian Lovett’s, statement: “It defies belief that commercial creditors are able to bypass poor countries’ debt cancellation schemes for their own gain. Zambia desperately needs investment in nurses, doctors and teachers. This is an outrageous injustice which could and should be addressed by the international community.” Oxfam, Oxfam Press Release, Oxfam and Jubilee call for action as Vulture swoops on Zambia’s cash, (14 February 2007).

Yet, this is precisely the sort of transaction with respect to which the emerging doctrine of odious debt might be particularly useful. I have written how the doctrine as developed in the academic literature and as supported by global elements of civil society, though not yet widely accepted among public entities, would distinguish between legitimate and illegitimate state debt on the basis of the purpose for which it was incurred. Debt incurred for the benefit of the nation, whether or not well used, would remain the obligation of the state. Debt incurred for the benefit of the agents of a state, whether as a consequence of corruption or for some other illegitimate purpose, would be deemed to be the personal debt of the agent, against whom the creditors could proceed. Creditors making loans to a state would have the obligation of satisfying themselves of the legitimacy of the loan before it is incurred. See Larry Catá Backer, Odious Debt Wears Two Faces: Systemic Illegitimacy, Problems and Opportunities in Traditional Odious Debt Conceptions in Globalized Economic Regimes, 70 DUKE JOURNAL OF LAW & CONTEMPORARY PROBLEMS – (forthcoming 2007).

As a consequence, the application of the odious debt doctrine in this way can continue to support the integrity of the secondary capital markets—the Zambian debt can still be collected. But it also furthers international public economic policy—the Zambian state is relieved of the obligation for the debt, repayment falls to the party actually responsible for its incurrence, that is the officials who acting for their own interests purported to incur a debt for Zambia. Donegal International ought to be able to seek repayment of the debt—but only from the agents of the state for whose benefit the loans were made, and not against the Zambian state itself. In the future, Donegal International will assess the value of secondary market transactions with this in mind.

The story, as it has thus made the rounds of media and civil society land, is almost too good to be true. And it is. Were this the end of the story, one might be tempted to congratulate oneself on the construction of what could be viewed as a fairly elegant advocacy of the application of a form of the odious debt doctrine now percolating in the academic community and among global elements of civil society. But a review of the 137 page opinion of Mr. Justice Andrew Smith for the High Court of Justice Queen’s Bench Division, Commercial Court, in Donegal International Ltd. v. Republic of Zambia, Case 2005-190, [2007] EWHC 197 (Comm.) [hereafter “DIL v. Zambia”], organized in 548 paragraphs, reveals a more complicated picture. I highlight here some of those complications and their ramifications for odious debt doctrine in the context of a multi-jurisdictional analysis of sovereign lending.

1. Settling Sovereign Debt and Sovereign Immunity. A careful reading of the case reveals that the equities might not entirely rest with Zambia, whatever the rest of the world believes Zambia’s duty to its own people. This is not quite a case of vultures swooping down to buy “worthless” national debt and then seeking to compel payment from a nation unable to deal with the debt. It is true enough that the debt started off in 1979 as an obligation between sovereigns (Romania and Zambia) incurred to finance Zambian purchases of Romanian farm machinery. And it is also true that this obligation, now a debt, was assigned by Romania to Donegal International in 1999. It is also important to note that though international convention required debtor states to consent to assignment of state to state debt, and that such a consent at the time of its purported assignment might not have been forthcoming, “it is not suggested that there is any legal restraint that prevented the assignment of the debt without Zambia’s consent.” (DIL v. Zambia at ¶ 240). In any case, Zambia almost immediately acknowledged the assignment (id., at ¶ 241). Yet, neither the original debt nor its assignment, the history of which takes up the greater portion of the opinion in DIL v. Zambia, that ultimately is at issue!

The problem here was that “In April 2003 Donegal and Mr Kasonde executed the Settlement Agreement which set out an agreement about the discharge of the debt.” (DIL v. Zambia at ¶ 6). According to the High Court, “Mr Emmanuel Kasonde, . . . was then the Zambian Minister of Finance.” (DIL v. Zambia at ¶ 1). That Settlement Agreement, rather than the Romanian Debt previously assigned to Donegal International, now superceded, was the basis of the action for recovery.

I add that the fact that Zambia do not have immunity in respect of Donegal’s rights under the Settlement Agreement but would have been able to assert a claim to immunity in respect of the assigned debt is not simply a procedural matter removed from the nature of their substantial obligations but is an incident of the fact that previously their obligations were in respect of the assigned debt whereas Zambia’s obligations now arise under the Settlement Agreement. Because of this, the rights in respect of which Donegal now claim are not rights which were originally owed between states and which were therefore subject to state immunity even though relating to commercial transactions and even though assigned to Donegal. They are new and distinct. These new rights were never owed between states, and it appears to me strongly arguable that they relate to commercial transactions. If so, regardless of any waiver, they would not attract state immunity. Donegal would have been able to argue that Zambia could not claim state immunity in respect of Donegal’s claim because new rights arise under the Settlement Agreement even in the absence of the waiver in clause 12. DIL v.Zambia at ¶ 522.

Indeed, the High Court suggested that Zambia might have been better off, at least before U.K. courts, had it not entered into the Settlement Agreement, but merely defaulted on its now assigned Romanian debt.

Donegal accepted before me that before the Settlement Agreement Zambia would have had state immunity in respect of the assigned debt. They do so because, even assuming that the debt was of a commercial nature, before assignment it was a debt between states and Zambia would have had state immunity in respect of it. Donegal accept that, since the debt was assigned, in the conventional phrase, “subject to equities”, it would have continued to attract immunity after assignment. The point having been conceded by Donegal, I did not hear argument about this from Zambia. It seems to me right as a matter of general principle that the assignment of a debt should not adversely affect the creditor’s position in any way, but I confess that, as far as English law is concerned, I do not find it easy to find this in the wording of the State Immunity Act 1978 (see section 2(3): “This section [which provides that a State is not immune as respects commercial transactions entered into by the State] does not apply if the parties to that dispute are States...”. However, the assigned debt was not governed by English law and there had been no agreement that claims to recover it were subject to English jurisdiction, and in these circumstances I must proceed on the basis that Donegal’s concession was rightly made. (DIL v. Zambia at ¶ 20).

This case, then, had little to do with assignment. Or the protection of secondary markets in debt, or with markets in general. It essentially reduced itself to a direct commercial transaction between a sovereign and a private entity, with respect to which there was no sovereign immunity, and as to which the circumstances and capacities of the government at the time of the settlement, rather than those circumstances and capacities at the time of the incurrence of the original debt, control. This serves as a great lesson for sovereigns contemplating the repudiation of debt that is arguably illegitimate or otherwise odious. Any acknowledgment or settlement of such debt appears to “clean” it—or in the language of corporate law, to ratify the original incurrence—and make it substantially more difficult to avoid it. Settlement extinguishes the taint of the original debt.

2. Layers of Corruption and Debt Illegitimacy The Zambians suggested that virtually the entire series of transactions from 1998 through the completion of the Settlement Agreement were tinged with corruption. Zambia sought to show Donegal International was an eager party to some of that corruption at the time of the assignment of the debt to it by Romania. See DIL v. Zambia at ¶ 115-189). Zambia also sought to show that acknowledgement of the assignment was also tainted by corruption (DIL v. Zambia at ¶ 275-277). Zambia also suggested bribery in the context of the Settlement Agreement. (DIL v. Zambia at ¶ 490). Taken together, the various allegations of improper, corrupt and otherwise illegitimate conduct, Zambia argued, ought to have made the Settlement Agreement unenforceable “because it would be contrary to public policy to do so or because their claim arises ex turpi causa” (DIL v. Zambia at ¶ 472). This point is important to the development of an Odious Debt doctrine. If applied by the courts, it might suggest that debt tainted by illegality or corruption might be unenforceable. Applied to sovereign debt, it could serve as a major step toward the adoption of a “void for illegality argument.” And the High Court appeared to take a big step in that direction:

This does not, however, mean that the question whether illegality defeats a claim can be answered simply by an examination of the claimant’s pleadings. The test of whether a claim is founded on an unlawful or immoral act is less mechanical than that. However, a claim will not be regarded as founded on an unlawful or immoral act because there is some remote causative connection between the claim and an unlawful or immoral act on the part of the claimant. It is not enough to show that Donegal would not have been able to make their claim but for improper conduct on their part. . . . 65. The court will disregard unlawful or immoral conduct if the illegality or immorality is collateral to the facts relied upon in support of the claim LJ. (DIL v. Zambia at ¶486).

But this step has substantial limitations arising from its origins in equity. There must be a direct tie between the claimant and the bad acts. Thus a creditor that directly facilitated corruption or illegal conduct in the course of inducing official to incur debt may relieve the state from an obligation to pay that creditor. But it may not relieve a good faith purchased and holder in due course. Thus, the focus of the exception is the conduct of the claimant and not the effect on the state. This approach does not portend well for an expansive odious debt doctrine grounded in the condition of the debtor.

3. The problem of authority. Zambia sought to challenge the legitimacy of the debt, at virtually every step of its evolution toward the Settlement Agreement on the grounds that those who purported to negotiate of and bind Zambia had no authority to do so. An example discussed by the High Court, for instance, touches on the authority of Mr. Kasonde to execute the Settlement Agreement on Zambia’s behalf. (DIL v. Zambia at ¶ 431-456). Odious debt doctrine as being developed would likely provide incentives for state’s to attempt to disavow the actions of their agents and thus raise the costs of recovering debt. On the other hand, it might also require the development of a global consensus, at least among creditors of the diligence, covenants and undertakings necessary to give rise to strong presumptions that signatories had authority.

4. Freezing Sovereign Assets Abroad. The High Court suggested that asset freezing will not be automatic in cases of sovereign debt. Applying equitable principles, the High Court determined that Donegal International had to some extent misled the court. (DIL v. Zambia at ¶ 544). The irony was that the misleading had been unnecessary. Id. But having been found out, there are consequences:

If there has been material non-disclosure or material misrepresentation, the court will be astute to ensure that the applicant gains no advantage from is breach of duty. In assessing whether the breach is such as to justify or require the discharge of any order obtained and whether it is such as to preclude the applicant from further relief, it is relevant to consider the importance of the matter that was not disclosed or misrepresented, and also to consider whether the breach of duty was innocent in the sense that the deponent and applicant were unaware of the error or omission, or unaware in the case of non-disclosure of the relevance of what was not disclosed. Id., at ¶ 545.

But the High Court’s bark was worse than its bite. The High Court would dissolve the freeze order but permit Donegal International to reapply for a freeze. Id., at ¶ 546. “It will be for argument whether, if Donegal do apply for a new freezing order, I should take into account this history and if so what weight I should give it. I add that I shall not discharge the order presently in force until Donegal have had a reasonable chance to make such an application.” Id. This may be cold comfort for a state seeking to avoid an asset freeze, and provide a simple (if powerfully imparted) lesson for creditors seeking a freeze.

5. Penalty Provisions in Settlement Agreements. One bit of good news for Zambia, the High Court read the penalty provision rules of English law to find that the default provisions of the Settlement agreement were likely penal in character, and thus unenforceable as written. (DIL v. Zambia at ¶¶ 502-524). It was on this basis that the press suggested a reduction of the likely collection to about half the amount sought in the litigation.

The case, thus appears both more and less important than the press and those who have sought to characterize it from the perspectives of global civil society have made out. The High Court failed to address any of the political issues stressed by Jubilee and Oxfam. It never acknowledged tensions between global political strategies for development of poor states and the network of contracts supporting an integrated market in debt. The focus of the High Court were the contracts leading to the single contract to be enforced—the Settlement Agreement. In that context, any advances for an odious debt doctrine were incidental. But perhaps that was all one could hope for as long as the focus of law is on the contract and the creditor. Still, to the extent that issues of legitimacy and corruption play a greater role in the validity of debt contracts and to the extent that courts take seriously the separability of a state from its officials (and thus apply more vigorously an ultra vires rule) courts will begin to apply some of the great insights of modern odious debt doctrine. And that is a step in the right direction.