Just yesterday, Ricardo Hausmann and Mark Walker published a piece in Project Syndicate, on how Venezuela and PDVSA should deal with a debt default in the post-Argentina world. The piece is sure to cause as stir, as it moves the debate about Venezuelan debt restructuring down from the Olympian heights of economic philosophy and into the legal trenches of the how-exactly-do-we-do-this.
There are a lot of questions about the scenario Hausmann and Walker set out, and we’re here to try to walk you through some of the intricacies.
The Hausmann Way hinges critically on a bit of bond prospectus boilerplate that’s obscure even to people who follow these things: invoking “exit consent clauses” in the context of debt restructuring.
It works like this: if a majority of bondholders apply “exit consents” set out in the prospectus of the bonds they’re getting out of, they’re legally able to amend some of the bond’s terms. In effect, they’re able to amend the bonds they’re dumping to make them less attractive to potential “vulture funds” or holdouts planning to sue the Republic or PDVSA to force a full cash payment.
The idea is to change the conditions of the old bonds to make them unattractive. Like tattooing your ex’s forehead so she won’t be desired by anyone else.
Sounds easy enough, right? Well, there are some major caveats.
First, you need to arrange a debt restructuring that a sufficient majority of bondholders will go for: two thirds in the case of sovereign bonds and more than half in PDVSA bonds. Those negotiations are never easy.
Turns out the pari passu clause is precisely the type of non-payment term clause you can amend with an Exit Consent Clause.
Second, you need to pick out the points in the bond prospectus (the contract) that you can change to render the bond toxic for holdout creditors. This isn’t as straightforward as just “amending” the bond’s face value down to zero: Exit Consent clauses can’t be applied to payment terms like the payment date, the face amount of the bond, the currency the bond is denominated in or the majority threshold to vote on substantive matters. All you can amend is the nuances of non-payment terms.
That sounds pretty bad, until you have the ah-ha! moment Ricardo Hausmann had at some point these last few weeks over coffee with Mark Walker: turns out the pari passu clause is precisely the type of non-payment term clause you can amend with an Exit Consent Clause.
This is a big deal. Pari passu — the principle that you have to pay off all bondholders on an equal footing, without cherry picking favorites — was the clause at the center of Argentina’s troubles. The way tribunals have interpreted it after the Argentine default, pari passu became a deal-breaker to any attempt at a negotiated debt restructuring. In Argentina’s case, courts actually blocked the country’s attempts to pay off the bonds of holders who had accepted a restructuring deal if the Republic didn’t also simultaneously payoff the holdouts at the old, higher rate.
Of course, with that precedent around, no holder will ever agree to a restructuring again: there’s zero incentive to, if you can demand full payment just for refusing to sign a piece of paper.
Venezuela’s has three bonds series with pari passu clauses very similar to the ones that put Argentina through restructuring hell for two decades. Those bonds are also the same ones that lack Collective Action Clauses – meaning a majority of bondholders can’t force a minority to restructure. The gory details are here.
PDVSA can’t even convince bondholders to accept $1.22 in new bonds for every $1.00 in old bonds it had: how are we supposed to convince creditors to accept $0.80 on the dollar?
The strategy Hausmann and Walker set out would be controversial, and the road to implementation is full of hazards. To note just one pitfall, public-sector bondholders holding sovereign or PDVSA bonds are not normally entitled to vote as regular bondholders on these issues. But we know Venezuelan state and parastate bodies have been buying up bonds left and right, which will complicate claims to have gotten to the appropriate thresholds to invoke an Exit Consent clause.
And there’s the ever-so-dicey proposition of getting creditors to accept restructuring in the first place, which is never easy since restructuring is really a euphemism for partial, orderly default. PDVSA can’t even convince bondholders to accept $1.22 in new bonds for every $1.00 in old bonds it had: how are we supposed to convince creditors to accept $0.80 on the dollar?
Luckily for Venezuelan sovereign bonds, out of 15 outstanding bonds series, only three have old fashioned pari passu terms and lack Collective Action Clauses (CAC). The bad news is that two of those three bonds series are due relatively soon in 2018, and that they’re the favorite pick of potential vultures.
What about PDVSA?
PDVSA’s case as a corporation is different. Since they’re technically corporate bonds rather than sovereigns, there are no CACs on them. Given that PDVSA’s assets are attractive to bondholders, it can be more difficult to negotiate a restructuring and exit consent amendments. There’s just too much meat left on that carcass for it to be easy to scare the vultures away.
The toxic overtones of the word aside, bankruptcy protection could make a lot of sense for PDVSA.
But Hausmann & Walker have a solution: PDVSA can just declare bankruptcy. That would be one hell of a cadena. The key here isn’t the bankruptcy, though, it’s the bankruptcy protection. After declaring bankruptcy, a company’s assets can’t be picked over by creditors willy-nilly: a judge can shield those assets while he imposes an orderly framework for repayment. The toxic overtones of the word aside, bankruptcy protection could make a lot of sense for PDVSA.
There are two ways PDVSA can do this.
First, PDVSA would have to file a debt moratorium in Venezuela (under local law) and then, file for bankruptcy in the US under Chapter 15 of the US Bankruptcy Code.
This allows PDVSA to seek recognition of a foreign bankruptcy proceeding in a US bankruptcy court. If the court grants it and recognizes the Venezuelan moratorium procedure, that would stop any litigation from bondholders against the debtor (PDVSA) in the US. Sounds crazy, I know, but Brazilian companies have been able to pull this off in the recent past.
But it’s risky. There’s no guarantee the U.S. court would recognize PDVSA’s Venezuelan moratorium. In addition, it’s likely that CITGO would have to file bankruptcy too: it’s a PDVSA subsidiary, and to declare PDVSA bankrupt without having CITGO follow suit would be to invite bondholders to train their fire there.
As a U.S. company, CITGO would have to file under a different part of the U.S. Bankruptcy code: the famous Chapter 11. This would make it easier to hold off creditors seeking to attach CITGO assets, and would open the door to obtaining financing while under bankruptcy. Not that that’s likely, given PDVSA’s current condition.
Again there are risks: if implemented badly, the longer the company fails to restructure its debt, the longer it remains in bankruptcy. This is why some Latin American companies have used chapter 11 as a part of a “pre-packaged” debt restructuring: the debtor presents a bankruptcy and reorganization plan to bondholders before actually filing it, in order to secure enough votes in favor of it once it’s implemented. Pre-packaging can save a lot of time.
But it all comes down to the company’s willingness to make some concessions to bondholders to get them to agree to the plan. Things like a lower “haircut” on the debt exchange, cash distributions to bondholders, or even as Hausmann suggests, to modify or withdraw “PDVSA’s exclusive right to exploit Venezuela’s hydrocarbon reserves”. So, another crazy cadena in the works there.
None of this is simple
Hausmann, along with Walker, has launched an important debate here. The road to restructuring is never simple, and never straightforward: you’re announcing outright your decision not to pay back billions of dollars you’ve legally committed to paying back, and you better believe creditors are going to push back against that. Take one wrong turn and you can find yourself mired in an epoch-defining court fight: just ask the next Argentino you run into.
El camino es duro, pero es el camino.