SANCTITY OF SOVEREIGN LOAN CONTRACTS AND ITS ORIGINS IN ENFORCEMENT LITIGATION, THE

George Washington International Law Review, The, 2006 by Gathii, James Thuo

"While the Costa Rican Banks make light of 'sanctity of contracts' and argue that litigation is but a theoretical right which disappears when a 'friendly' country defaults on its debt obligations, that is simply not the law."1

"Whenever a Court has felt what it believed to be the pangs of justice gnawing at it, the Court has had little difficulty in finding an escape from the sanctity of contracts rule. As a matter of fact, it may be fairly said that the exceptions have, for all practical purposes, consumed the rule."2

I. INTRODUCTION

This Article examines sovereign debt enforcement litigation from a new perspective. It makes the case that while there is a burgeoning academic interest surrounding sovereign debt, there is little or no examination of the sanctity of contracts doctrine which, since the mid-1980s, became the reigning paradigm underlying sovereign debt enforcement litigation. Consistent with this doctrine, an especially strong rule of creditor rights was established under which the baseline for acceleration of creditor rights became simple default. This contrasts with the prior rule which provided that renunciation or repudiation of a debt by a sovereign borrower was a precondition for accelerating payment. Under thenew "hair-trigger rule" of enforcement or acceleration, courts refrain from intervening on behalf of sovereign borrowers on the premise that such non-intervention is required to maintain judicial neutrality in the face of a freely negotiated contract. Sovereign debt litigation is therefore rooted in a contractual model where judicial inaction in the face of an otherwise excusable default is treated as neutral and legally unobjectionable.

The sanctity of contracts doctrine was first definitively pronounced by the United States Court of Appeals for the Second Circuit (Second Circuit) in Allied Bank International v. Banco Credito Agricola de Cartago (Allied II). Under this doctrine, a system of cooperative debt adjustment in which indebted sovereigns readjust their debts to enable them to meet their repayment schedule is treated as an impermissible unilateral abrogation of the contractual rights of sovereign creditors. In addition, granting debt restructuring common law protection as a species of bankruptcy is regarded as an impermissible intrusion on the contractual rights of sovereign lenders. Since Allied II, equitable,3 statutory,4 and affirmative defenses5 to sovereign default were virtually extinguished as every sovereign debt default became susceptible to being construed as a unilateral restructuring of sovereign debt contracts, a repudiation, or a taking that violated the sanctity of the underlying contractual obligation to repay under the loan contract.6

By shifting the baseline for enforcement to simple default, an all too common and foreseeable contingency, the court in Allied II departed from prior cases and established international practice in several respects. First, by adopting simple default as the triggering event for enforcement, the second Circuit departed from the accepted laws and practices in the United States and other countries, as well as international commercial law.7 Under English law, for example, an inadvertent default unaccompanied by a country's desire to disavow or repudiate its debt does not automatically rise to an event triggering enforcement under international commercial law.8

Second, in Allied II the Second Circuit declined to give judicial acknowledgment of the policy of cooperative debt adjustment that had been designed precisely on the premise that defaults of sovereign debt would occur and as such provided a framework under which creditor and sovereign debtor interests would be balanced.9 Under this framework, defaults would lead to cooperative readjustment or refinancing of sovereign debt between both public and private lenders, on the one hand and borrower countries on the other, with the blessing and support of the International Monetary Fund (IMF) and the richest countries in the world. Under this arrangement, private banks would continue lending new money; the IMF would bail out the indebted countries; the indebted countries would, at the direction of the IMF and on a case by case basis, renegotiate and refinance their loans with the voluntary participation of the commercial lenders; and indebted countries would commit to undertake stringent macroeconomic stabilization programs as a pre-condition to qualifying for new money.10

Third, though the Allied II court held that its abstention or inaction was a neutral response to a freely negotiated contract, the court effectively legitimized hell-or-high-water clauses in sovereign debt contracts requiring performance irrespective of default.11 Such clauses serve as an assurance of payment for banks lending to sovereigns and for purchasers of sovereign bonds. Hell-or-high-water clauses undermine the application of equitable relief to delay or excuse default where the default is inadvertent and even if the defaulting party makes an effort to immediately cure the default because such clauses make payment irrevocable and independent of any excuses.12 Thus, as the sanctity of sovereign loan contracts became the reigning paradigm in sovereign debt litigation in the mid-1980s, the defenses to default and balancing considerations such as comity that once were traditionally available to sovereign debtors simultaneously withered away in subsequent litigation.13