Published: 24 October 2019 Author: Julia Wagner DOI: 10.17176/20220113-170720-0
In an Order published on July 3, 2019, the German Federal Constitutional Court did not admit for decision two constitutional complaints lodged by the Republic of Argentina concerning the Argentine debt crisis. In these complaints, Argentina once again argued that a general principle of international law conferred upon States the right to refuse debt service on bonds held by private creditors who – in contrast to the vast majority of creditors – had not accepted a conversion offer (debt swap) made by the issuing State in the context of a national debt crisis, seeking full payment of the debt instead.
In 2001 and 2002, Argentina experienced the peak of one of the most severe fiscal and economic crises in its history. The country has a long history of debt crises and the national economy was often faced with various ups and downs. Since its independence in 1816, Argentina had repeatedly defaulted and entered into more than a dozen arrangements with the International Monetary Fund (IMF) after joining the organization in 1956. In 1998, Argentina fell into a nearly four-year recession, which, having “issued more bonds, in more jurisdictions, and in more currencies than any other emerging economy” turned out to be the worst economic crisis in its history.
The crisis originated from a variety of reasons: In addition to the incipient global economic recession, the country felt the effects of financial and currency crises in Russia and Brazil. Besides the dependence on the US-dollar and as a consequence thereof the over-valuation of the Argentinian peso, the lack of fiscal discipline, low domestic savings and capital flight, the absence of reforms and the loss in foreign exchanges reserves led to an economic slump. After the measures taken by Argentina and the IMF initially had failed and the IMF had refused payment of an urgently needed credit tranche, by the end of 2001, Argentina declared its sovereign default and proclaimed a moratorium on debt service. A few days later, the federal parliament passed the Public Emergency and Exchange Regime Act, proclaiming a public emergency in “social, economic, administrative, financial, and currency exchange matters” and empowered the government to restructure the Republic’s sovereign debt. As a result – after freezing bank deposits, converting dollar deposits and loans into peso deposits and ending the peso’s dollar parity – Argentina refused (and still refuses to the present day) to service foreign bonds held by private creditors, seeking to negotiate a debt swap. In 2005 and 2010, Argentina launched conversion offers to its creditors which granted the holders the possibility to swap their existing bonds against new bonds with a loss in value. Most creditors – more than 92% – agreed to Argentina’s offer. However, 7% of the bondholders did not participate in the debt-to-debt swap, seeking full compensation based on their “old” titles.
Until the present day, Argentina insists on restructuring, while these holdout creditors insist on full compensation. It is therefore not surprising that the Argentine crisis has become a matter for the courts. Both national and international courts and tribunals have had to address whether and, if so, to what extent Argentina has the right to invoke a state of necessity to justify its interruption of debt service vis-à-vis private bondholders.
In its Order of 3 July 2019, the Federal Constitutional Court once again had the opportunity to address this question. Argentina argued that the German Federal Supreme Court had erred in its finding that there was no general rule of international law in terms of Article 25 of the German constitution dealing with a state of necessity, which Argentina could invoke as a defence against claims brought by private creditors for the country’s default on sovereign bonds. The Federal Constitutional Court held that there was no such general rule of international law. The Court, consequently, followed its much-noticed 2007 decision in which it had concluded that
“[a] general rule of international law which entitles a State to temporarily refuse to meet private-law payment claims due towards private individuals by invoking State necessity declared because of an inability to pay cannot currently be ascertained.”
In the present proceedings, Argentina once again argued that there was a general rule of international law in terms of Article 25 of the German Constitution which conferred upon States the right to refuse debt service on bonds held by private creditors who had not accepted a debt swap made by the issuing State in the context of a national debt crisis and – in contrast to the vast majority of creditors – were seeking full payment of the debt. Argentina submitted that necessity was recognised as a general principle of law precluding the wrongfulness of a breach of payment obligations vis-à-vis holdout creditors. Creditors who did not participate in the dept-to-dept swap offered by the debtor State and brought an action seeking full satisfaction instead, committed an abuse of right. In particular, a right of refusal of payment could be derived from the general principle of good faith, which was characterised by the equal treatment of all creditors and the integrity of formal insolvency proceedings. These domestically recognised principles of insolvency law could be transferred to the international level and thus form an integral part of the international legal order for sovereign debt crisis management. In addition, Argentina referred to massively increased and today well-established use of Collective Action Clauses in States’ debt instruments, whereby holdout creditors are bound by restructuring agreements concluded with the majority of creditors. According to Argentina, a general principle of international law to that effect had emerged in recent decades.
Examining Argentina’s argument, the Federal Constitutional Court made some general pronouncements on the relationship between general rules of international law in terms of Article 25 of the Constitution and general principles of law. The Court held:
“General rules of international law are rules of universally applicable customary international law, supplemented by the traditional general legal principles of national legal orders. Whether a rule is one of customary international law, or whether it is a general legal principle, is determined by international law itself. Stringent requirements are to be applied to the establishment of a general rule of international law because it enshrines a fundamental obligation of all States.
A general rule of customary international law within the meaning of Article 38 (1) (b) of the ICJ Statute is a rule based on a consolidated practice of many but not necessarily all States (‘consuetudo’ or ‘usus’) in the conviction of an international legal obligation (‘opinio iuris sive necessitatis’).
General principles of law within the meaning of Article 38 (1) (c) of the ICJ Statute are rooted in national legal orders and are transferable to the level of international law. These general principles of law are consistently recognized as leading fundamental precepts in the national legal orders and form the bases of these orders.”
Applying these principles to the question of whether there existed in international law a general principle of a law allowing a State to suspended debt service vis-à-vis private creditors on grounds of a state of necessity, the Court held:
“The purported general principle of law invoked by the complainant, however, presupposes the existence of a comprehensive set of rules governing State bankruptcy at the level of international law. Specifically, the complainant invokes the principle of good faith in the context of (imminent) state insolvency.
Even if it were assumed that the specific requirements derived by the complainant from the principle of good faith – namely the equal treatment of creditors and the integrity of orderly insolvency proceedings – amounted to a principle which was generally recognized in domestic legal orders, and even if it was true that these specific requirements were recognised within the major legal families, the transfer of the principle to situations governed by international law would require at least the existence of a comprehensive set of rules governing State bankruptcy […].The specific requirements that, according to the complainant, derive from the principle of good faith with regard to insolvency law could only be applied accordingly at the level of international law if there was also an independent regulatory or supervisory authority competent to monitor compliance with these rules and capable of ensuring an equitable balancing of the interests of all affected parties.
The principles of insolvency law asserted by the complainant form an integral part of the detailed domestic insolvency law regime, which contains procedural rules, also for the protection of minority creditors, whose compliance is monitored by a neutral court, usually by a bankruptcy court. Without a procedural framework based on the rule of law which allows for the review of decisions adversely affecting the minority [of creditors], an essential prerequisite for a transfer [of the principle] to the level of international law is missing. It follows that it is not possible to invoke individual principles derived from insolvency law in accordance with Article 38(1)(c) of the ICJ Statute.”
In consequence, the Constitutional Court rejected the analogous application of a principle of law derived from domestic insolvency law at the international level. Even assuming that the principles of preserving the equal treatment of creditors and the integrity of orderly insolvency proceedings were recognised within the major legal families, State practice and case law were not sufficient to establish a general rule binding on the international community.
In addition, the Court held that no general principle could be derived from other international documents either. So far, there are no signs for an international regime managing sovereign debt restructuring. The Court stated that
“the documents of various bodies of the United Nations submitted by the complainant are not capable of establishing a general principle of law. Apart from the fact that they are not legally binding, these documents, in particular, do not contain the alleged legal principle. […] All the documents cited by the complainant (Principles on Promoting Responsible Sovereign Lending and Borrowing, UNCTAD, 10 January 2012; Sovereign Debt Workouts: Going Forward. Roadmap and Guide, UNCTAD, April 2015; Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes, UN General Assembly Resolution A/RES 68/304, 9 September 2014; Report of the independent expert on the effects of foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights, UN General Assembly, Human Rights Council, A/HRC/25/50/Add. 3, 7 March 2014; Effects of foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights: the activities of vulture funds, UN General Assembly, Human Rights Council, A/HRC/27/L.26, 23 September 2014) make it clear at best that there are attempts and approval to develop regulations for States in financial difficulties but, at the same time, these documents show that such regulations do not yet exist.”
All documents mentioned above were endorsed only by parts of the international community, but were not supported by most developed economies.
Particularly, there was also no support for such a rule in Principle No. 7 of the UNCTAD Principles. These principles served the purpose of creating new international law, not codifying existing law. The Court stated:
“Moreover, Principle No. 7 of the UNCTAD Principles deals with creditors who acquire a debt instrument of a sovereign in financial distress with the intent of forcing a preferential settlement of the claim outside of a consensual debt rescheduling process. The General Assembly, in its resolution of 9 September 2014, expressed concern about the actions of commercial creditors, such as hedge funds, which speculated on distressed debt securities, which had been bought at greatly reduced prices (cf. Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes, UN General Assembly Resolution A/RES 68/304, 9 September 2014, preambular paragraph 16). Similarly, the Human Rights Council, which also emphasizes that the international financial system does not possess a sound legal framework for the orderly and predictable restructuring of sovereign debt, relies exclusively on such commercial, speculative creditors (cf. Effects of foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights: the activities of vulture funds, UN General Assembly, Human Rights Council, A/HRC/27/L.26, 23 September 2014). However, the situation of private investors who, as the plaintiffs in the present case, have acquired bonds directly from the issuer, at the issue price and before the onset of a debt crisis, is clearly different from that situation […]. It is not clear why the ratio of these documents could be generalized and, for that reason, could also include private creditors such as the plaintiffs in the main proceedings. Thus, nothing in the documents submitted supports the legal rule asserted by the complainant.”
In contrast, voices in the literature have promoted the development of international law and argued, “there is an emerging general principle of law backed by reasons of legitimacy according to which authoritative international sovereign debt restructurings lead to a stay of international and domestic enforcement actions against sovereign debtors.”
Finally, the Constitutional Court also dismissed Argentina’s argument concerning the increasing use of so-called Collective Action Clauses allowing a majority of bondholders to agree to a debt restructuring that is legally binding on all holders of the bond, including those who vote against the restructuring. According to the Court, such a private law approach proved exactly the opposite, namely that such clauses were employed as an alternative to a non-existent international State bankruptcy law. The Court stated:
“If the general principle of law existed, as asserted by the complainant, the introduction of collective action clauses would not have been necessary, as the State in distress would in any case have had a right to refuse payment to so-called holdout creditors. Incidentally, the UNCTAD Principles also do not assume that the minority of creditors will be bound by the rescheduling result negotiated by the majority without having agreed on Collective Action Clauses. As explained under principle No. 15 of the UNCTAD Principles (‘Restructuring’) such clauses can facilitate sovereign debt restructuring and their inclusion in multi-party debt securities is therefore recommended.”
In consequence, the Constitutional Court declined to accept that a general principle of law existed allowing States to refuse debt service on bonds held by private creditors who – in contrast to the vast majority of creditors – had not accepted a conversion offer made by the issuing State in the context of a national debt crisis. The Court dismissed Argentina’s arguments as unfounded, referring principally to its 2007 decision.
To sum up, due to the fact that until today international law does not provide either uniform or codified rules on State bankruptcy, the Constitutional Court held that no such general principle of law existed.
Finally, it should be noted that in view of the recent financial crises throughout the world and given that State bankruptcy is anything but a rare phenomenon, there are good reasons to enquire whether or not a general principle of law exists that allows a State to refuse payment in case of State insolvency. The other sources of international law, customary international law and treaties, only provide some rather rudimentary rules, which govern relations between the debtor State and its sovereign or private creditors. While a debtor State should not be able to play individual creditors off against each other, there are good arguments that debt restructuring also needs to protect elementary human rights such as the protection of the life and health of the debtor State’s citizens. International law has not yet found a satisfactory answer on how to balance these conflicting interests. Unfortunately, for the second time, the German Constitutional Court has missed the opportunity to make a substantive contribution to this debate.
Category: Sources of international law
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Thank you for the analysis, very interesting!