Ecuador’s Shenanigans (Part II)

A few days ago, Mitu Gulati (Duke) gave us a guest
post on Ecuador’s recent debt restructuring.  Today, I bring you Adam Feibelman
(Tulane) with a follow-up to that post.

I’m grateful to Kim and the other folks at the Faculty
Lounge for the chance to participate in this small explosion of posts on
sovereign debt by Kim, Anna, and Mitu.  As Mitu notes, Ecuador’s dramatic
default is something of a distant memory, though the ultimate consequences of
that episode may influence the action of other sovereigns now or soon facing
debt crises.  It’s not surprising,
therefore, that most of the commentary about Ecuador’s action has focused on
the costs or benefits to that country of its strategic default.  What’s been more surprising, however, is
that there has been very little discussion of what Ecuador’s default and
invocation of equitable grounds (odiousness or illegitimacy) might mean for the
development of the law of sovereign debt – in particular, the movement to
advance a doctrine or create an institution to address odious or illegitimate
debt.  Arturo Porzecanski is one of
the few who has addressed this, as he does in his forthcoming article
on Ecuador that Mitu discusses.

Odious debt was a legal topic du jour a few short years ago
(thanks to Mitu, of course).  Like
many others at that time, I wrestled with some possible avenues for enabling
sovereigns to repudiate or discharge debts deemed odious or illegitimate, proposing
a contractual approach
and considering the applicability of doctrines of equitable subordination and
fraudulent transfer.  These
and all other approaches face a fundamental definitional problem – what makes
an obligation odious such that it should be subject to avoidance?  After all, one of the important
intended effects of a doctrine or institution in this context would be to
dramatically reduce incentives for people to lend within the definition.  It follows from this that odiousness or
illegitimacy would need to be defined very narrowly (even to the point of being
quite under-inclusive).  Otherwise,
legal actors and policymakers would be reasonably reluctant to unleash a
mechanism that might severely hamper the ability of many sovereigns to borrow
even for beneficial purposes.   

Given these concerns, it seems quite likely that the Ecuador
episode will prove to be a very salient cautionary tale for legal actors or
policymakers who might be inclined to consider employing a doctrine or creating
an institution to address odious or illegitimate debt.  Porzecanski makes this point quite
elegantly toward the end of his article. 
In the essay of mine that Mitu mentions, Ecuador's Sovereign Default: A Pyrrhic Victory for Odious
Debt? (forthcoming, J. Int’l Banking Law and Regulation), I
argue that Ecuador’s justifications for its default may only increase
skepticism that the operational definition of odiousness or illegitimacy can or
will be carefully circumscribed.

[T]he factors that Ecuador relied upon to support its actions
boil down to these: the funds borrowed from external sources disproportionately
benefited privileged interests in the country; the government took over private
obligations, shifting burdens to the broader population; the country spent more
on debt service than it received from external creditors; the government acted
illegally in accepting contractual provisions that waived sovereign rights and
assented to foreign courts and foreign jurisdiction; the government failed to
purchase discounted obligations on secondary markets and restructured
obligations based on nominal values; and current debt service is greater than
public expenditure on other essential public goods … .

[T]hese factors are hardly unambiguous markers odiousness or
illegitimacy.  Most of the funds initially
received from creditors were employed by the private sector or for public
projects (however ill-conceived or tainted with corruption).  Waiving sovereign immunity and
submitting to foreign jurisdiction is, in most contexts, consistent with
legitimate external borrowing. 
Government take-over of private sector debt is, in at last some
circumstances, often a beneficial and justifiable strategy for debt-crisis
prevention/resolution.  Debtors in
distress or default often end up paying significant, seemingly
disproportionate, amounts to service their obligations; restructurings can
reduce these servicing costs, but usually do not eliminate them altogether.  … 
[These factors] may arguably reflect significant inequities in prior
governmental policy and mismanagement of fiscal, monetary, and social
policy.  Yet, they do not indicate
that the Ecuadorean state knowingly incurred obligations that were not for the
benefit of the country’s citizens or that creditors extended resources knowing
that to be the case.

If it is true that Ecuador’s action will heighten concerns
over the scope of an odious debt doctrine or institution, this may have a
silver lining for those, like myself, who are generally sympathetic to efforts
to relieve sovereigns from odious or illegitimate obligations.  It may be that this episode will
encourage some interests that have opposed such efforts in the past to
acknowledge that some obligations
might be odious or illegitimate and subject to avoidance, if only to clarify
that Ecuador’s obligations should fall outside the scope of this category.  This would be at least a small victory
for debt-relief advocates, though I am not holding my breath.

This post is already much longer than I intended to write,
but I want to take the opportunity to note a potential – if somewhat attenuated
– relevance of the Ecuador episode to the unfolding crisis in Europe.  In both cases, foreign financial actors
and institutions are blamed for supporting bad state actions, and they face the
prospect of liability for their support (or collusion, depending on one’s
assessment).   Again, I think
there should be room for imposing liability on private actors who enable
sovereigns to engage in egregious, illegitimate, or odious behavior.  But this is an extremely difficult
thing to achieve without discouraging a broader range of legitimate transactions
and services that many sovereigns and their citizens sorely need.  For that reason, liability should
probably be reserved for actions that are unambiguously egregious, odious, or
illegitimate, or nearly so.

– Adam Feibelman  

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For Related Posts in what has become a veritable virtual mini-symposium, see: