Feature
KEY POINTS
One concern in relation to sovereign issuers is the involvement of their own state

framework (central banks, national banks, public bodies and potentially even quasi-public
bodies) as voting bondholders.
The Euro Area Model CAC disenfranchises those entities “controlled” by the sovereign

issuer: sovereigns who have large shareholdings in their banks will need to be particularly
alert to the risk of being found to control such entities.
The IMF seeks to encourage more orderly sovereign debt restructuring by limiting the

power of the “holdout creditor”.
Authors Stephen Moverley Smith QC and Heather Murphy
Sovereign bond collective action clauses:
issues arising
In a period of continuing economic turmoil, the need for effective and fair sovereign
debt restructuring has become ever more pressing. The role of collective action
clauses (CAC) in that process has correspondingly been under increasing scrutiny.
Attempts to regulate in this area led to the introduction of the Euro Area Model CAC
20121 for Euro government securities issued after 31 December 2012 with a maturity
of more than one year. That was followed in October 2014 by the publication by
the International Monetary Fund (IMF) of a paper designed to “strengthen the
contractual framework to address collective action problems in sovereign debt
restructuring”2 which endorsed the CAC model terms published by the International
Capital Market Association (ICMA). Meanwhile, the previous month the United
Nations had passed a resolution3 “for the intensification of efforts to prevent debt
crises and resolution” and decided “to elaborate and adopt through a process of
intergovernmental negotiations, a multilateral legal framework for sovereign debt
restructuring processes with a view, inter alia to increasing the efficiency, stability
and predictability of the international financial system.”4 This article will examine the
motivation behind these developments, focusing in particular on the issues which
arise when the bond issuer is a sovereign nation.
UNDERLYING RATIONALE AND GOALS
n
The EU rationale for intervening in
relation to CACs is to be found in the
observations of the EFC sub-committee
on EU Sovereign Debt Markets (“the
Committee”). In a note written in 2011 it
explained that the Euro Area Model CAC was
the follow up to a policy measure “intended to
safeguard financial stability in the euro year”.5
Although it was designed to have uniformity
of application it was (and is) not clear how this
will be achieved, given that each sovereign
nation is required only to give effect within the
domestic law to the applicable terms (Common
Terms of Reference (CTR)). This appears
to be the first point of call for a disgruntled
bondholder envisaging litigation: a new regime
being applied by individual states meant to
provide consistency across the Eurozone. The
Committee considered a number of methods
to try and ensure uniformity including a
standardised CAC governed by the law of
one member state or an agreed forum before
concluding that no step could better guarantee
uniformity and, hopefully influenced by “good
market practice” to assist in consistency, the
CAC is governed by the law which governs
the bond. The Committee is not due to report
on the success of the Euro Area Model CAC
until 2016, so it is not clear whether it has
“safeguarded financial stability”. Therefore
the underlying rationale is already beset with
problems before it begins: how to provide
uniformity across states.
In contrast, the focus for the IMF,
expressed in its October 2014 report was
to support reform aimed at “more orderly
sovereign debt restructuring”. The IMF was
concerned that the existing legal framework
might not be sufficiently robust to prevent
“holdout” creditors from undermining the
restructuring process. It also expressed
concern in relation to the pari passu terms;
a feature present in Argentinian sovereign
bonds which gave rise to extensive litigation in
New York.6
Butterworths Journal of International Banking and Financial Law
As the IMF saw it, if “holdout” creditors
had a significant chance of recovering their
claims in full, creditors who would otherwise
have agreed to participate in the restructuring
would become less willing to do so – even
though it would be in the collective best
interest of all creditors. The solutions to this
problem were twofold: first, the introduction
of collective action clauses to force the
minority to be bound by the majority of
the creditors. Secondly reform of pari passu
provisions (which caused such trouble in
relation to Argentina).
The adoption of CACs to prevent holdout
creditors (“they are intended to minimise
the power of a fractious minority to thwart
the general good”)7 appears to be sensible,
although holdout creditors may still gain a
dominant position where a series of bonds
is being negotiated. The position adopted by
both the Euro Area and ICMA Model CAC
is to allow for aggregation to prevent holdout
creditors obtaining a blocking position in
relation to a bond series.
However holdout creditors are not
universally viewed as troublemakers with no
redeeming qualities. As Christian Hoffmann
notes in Sovereign Debt Restructuring in
Europe,8 holdout creditors (such as “vulture
funds”) can have two advantages in the
context of sovereign debt (both demonstrated
in the course of Argentina’s restructuring).
First, they can profit from those bondholders
who are willing to sell their bonds far below
face value because of threats by the sovereign
to default on its debt. Hoffmann considers
the scenario of threatened sovereign default
on its debt to be caused by the accumulation
of debt “beyond the level of sustainability”
and the sovereigns “often lack the political
willpower to improve the financial situation”.
The pressure effected by holdout creditors can
[2015] 2 JIBFL 128A
February 2015
1

Feature
provide the impetuous to effect meaningful
change (or at least what the market considers
meaningful change).
Secondly, holdout creditors, particularly
those with financial capacities, such as vulture
funds, can protect other holdout creditors
and act as “a counterweight to sovereigns that
might be tempted to act arbitrarily”.9 We
explore this further below. Surprisingly, the
oppression of creditors by sovereign issuers
appears to have been given scant consideration
by the Committee and the IMF.
The rationale behind the reform of pari
passu provisions appears less justifiable as
a matter of strict English law. The IMF’s
objection appears to be that it “undermined”
restructuring, somewhat implying that the
holdout creditors ought not to insist on their
legal rights. However, if that is the effect of
a term in a bond, sovereign or corporate,
which has been sold, then in our view parties
ought to be able to vindicate their legal
rights, regardless of how inconvenient the
IMF may consider such an action. As the
IMF is proposing a contractual framework
to manage sovereign debt restructuring, a
natural corollary of that position must be that
it also supports creditors who vindicate their
contractual rights. The IMF recommended
the changes to the contractual pari passu
provisions in New York issued bonds after
the New York court held that “pari passu” was
to be interpreted as “rateable” rather than a
question of “ranking”.10 This judgment had
ramifications on the scheme of restructuring
that the Argentinians had embarked on.
However, its suggestion that the pari passu
provision be modified (and incidentally
brought in line with the concept of ranking)
is a sensible suggestion in light of the IMF
considering the New York interpretation
on the current meaning of the clause to have
undesirable legal consequences.
ISSUES ARISING FROM SOVEREIGN
BONDS BY NATURE OF ISSUER
The problems which arise with a sovereign
issuer appear to centre on its position as a
state as opposed to a corporate entity. Unlike
a corporate entity there is no provision for
liquidation should the re-negotiation of
the bond terms fail. It also can legislate to
2
February 2015
change the rules retrospectively (such as
Greece did in 2012) or fail to pay without
the consequences which would attach to a
corporate bond issuer (a paradigm example
being Argentina’s failure to pay in respect
of creditors, despite court orders to the
contrary)11 or plead immunity from suit.12
The positon of Greece and the “retroactive
modification of domestic law governed
contracts through legislation”13 is an approach
which is apparently not necessarily supported
by the IMF, but it also noted with what may
be interpreted as tacit approval,14 in relation
to the benefit of aggregating claims, that
Greece enacted legislation that “aggregated
claims across all of the affected domestic law
issuances, thereby eliminating the power of
creditors to obtain a blocking position in an
individual issuance”.15 This had the result
that in contrast to the position in relation to
all international bonds, all debt governed by
domestic law was restructured. That the IMF
saw this as a satisfactory result is perhaps
not surprising – the mechanism which was
retrospectively imposed resulted in a successful
restructuring; an outcome that demonstrated
that the legislation achieved its objective.
The apparent lack of concern expressed by
the IMF at the use of legislation to impose
retrospectively a term which the IMF itself
concedes ought to have been previously
incorporated in the contractual terms16 is
in our view worrying. If the IMF is going to
recommend contractual terms to facilitate
restructuring logically it ought to also warn
against taking steps outside the contract which
have the effect of negating contractual terms
which have been entered into consensually.
These examples highlight an issue which
seldom arises in relation to corporate bonds
and corporate CACs: the oppression of the
creditors by the issuer. Usually with CACs
the concern is about balancing the tyranny
of the minority against the risk of oppression
by the majority. However, sovereign bonds
add a further dimension: a powerful issuer
who is able to oppress all creditors.17 This risk
explains the need for the disenfranchisement
provisions in the Euro Area and ICMA
Model CACs.
The risk of oppression of the minority
by the issuer in corporate bond CACs is
[2015] 2 JIBFL 128A
mitigated by the presence of a good faith
requirement in English law issued bonds. A
solution may be to adopt a similar inclusion
in sovereign bonds. What is clear is that
proposals to allow countries to restructure
“efficiently” need to be balanced against
ensuring that they restructure in accordance
with the legal terms of the bonds.
Oppression by the issuer:
disenfranchisement of “controlled
entities”
A further issue of concern in relation to
sovereign issuers is the involvement of their
own state framework (central banks, national
banks, public bodies, and even potentially
quasi-public bodies) as voting bondholders.
The Euro Area Model CAC seeks to deal
with this problem by disenfranchising those
entities “controlled” by the sovereign issuer18
which are without autonomy to make their
own decisions. The underlying rationale
of the disenfranchisement clause was “to
prevent an issuer from voting in favour of
the modification of its own securities either
directly or by instructing [bodies] it controls
to so vote their holdings of the issuer’s debt
securities. The ICMA have also adopted the
provisions of disenfranchisement to deal with
this particular issue.
The CAC provisions for demonstrating
“autonomy” include where bodies “may not”
(as opposed to “must not”) take instruction
from the sovereign issuer and where entities
are required to act in accordance with an
objective prudential standard.
It is important to note that “controlled”
can include “directly or indirectly, through
the ownership of voting securities or
other ownership interests, by contract or
otherwise, to direct the management of or
to elect or appoint a majority of the board
of directors”.19 Sovereigns who have large
shareholdings in their banks will accordingly
need to be particularly alert to the risk of
being found to control such entities, and the
disenfranchisement consequences which
would then follow.
However, the question arises as to
whether this goes far enough? What about
those who are indirectly influenced or will
be affected by the lighter debt burden on the
Butterworths Journal of International Banking and Financial Law
sovereign? The Committee considered that
the creditor’s motivation “provides an even
less appropriate basis for disenfranchisement”
and “experience suggest[s] that it is often
difficult, if not impossible to discern a
creditor’s real motivation or to distinguish
among the arguably acceptable and arguably
unacceptable motivations that may together
inform an investor’s decision”.20
The Committee in a supplemental
explanatory note stated that “disenfranchising
an investor is a serious step… the committee
believes that neither an investor’s interests
or motives, nor the predictability of an
investor’s vote for or against a proposed
medication, constitutes adequate grounds
for disenfranchising an investor. For the
committee the litmus test remains: is a
bondholder acting in its own interest.”21
It remains to be seen whether these
provisions, which seek to provide a
compromise of competing interests, provide
a workable solution to a very real practical
problem. What can be predicted with
some certainty, bearing in mind the stakes
involved, is that it will not be long before the
courts will be required to adjudicate on their
effectiveness. n
1 Following the conclusions of the European
Council of 24/25 March 2011.
2 October 2014.
3 Resolution 68/304.
4 As the delegate from the United States
of America commented, the work would
be duplicative of “on-going work on the
technically complex issue in such bodies as
the International Monetary Fund which were
more appropriate venues General Assembly
Sixty – ninth session, 37th Meeting, GA/
EF/3417.
5 EFC Sub-Committee on EU Sovereign
Debt Markets Collective Action Clause
Explanatory Note 26 July 2011.
6 NML Capital v Republic of Argentina 699
F.3d 259 -60 (2d Cir 2012).
7 Hackettstown National Bank v Yuengling
Brewing Co (CCA 2.d. 1896).
8 “Sovereign – Debt Restructuring in Europe
Under the New Model Collective Action
Clauses”, 12/5/2014 , Texas International Law
Journal Vol 49: 383.
9 Hoffmann, 397.
10 NML Capital v Republic of Argentina 699
F.3d 259 -60 (2d Cir 2012): Hoffmann;
429: “A US Circuit court has interpreted
a pari passu clause in Argentine sovereignbond terms to require equal treatment of
restructured and unaltered debt.” This can be
compared to the traditional (and English law)
understanding that pari passu “determines the
rank of a claim and does not grant equality in
the general sense”.
11 See Hoffmann at 396: NML Capital v
Republic of Argentina 699 F.3d 259 -60 (2d
Cir 2012).
12 NML Capital Ltd v Republic of Argentina
[2009] EWHC 110 (Comm).
13 IMF, Sovereign Debt Restructuring, para 6.
14 The IMF stated that in relation to retroactive
modification, the Fund would not “necessarily
… support a retroactive modification of
domestic law governed contracts through
legislation”: p 6, para 6. It does note that
proper contractual provisions in domestic law
bonds “may, depending on the circumstances,
limit the need for such legislation”. In respect
of Greece, the IMF noted that “it is unlikely
Butterworths Journal of International Banking and Financial Law

Feature
Biog box
Stephen Moverley Smith QC and Heather Murphy practise from XXIV Old Buildings,
Lincoln’s Inn, London.
Email: Stephen.moverley.smith@xxiv.co.uk and heather.murphy@xxiv.co.uk
that the restructuring would have proceeded
as smoothly had the claims not been
aggregated in such a manner”: p 19, para 27.
15Para 27.
16 For an article exploring the fallout with
such a violation of the rule of law and
discussing whether the “retrofit Collective
Action Clauses” amounted to expropriation
triggering compensation under bilateral
investment treaties, see “Haircut Undone?
The Greek Drama and Prospects for
Investment Arbitration” by Ioannis Glinavos,
J. Int. Disp. Settlement (2014) 5(3): 475.
17 Some consider that the IMF’s proposal leans
too far in favour of the sovereign nation: see
the IIF Special Committee on Financial Crisis
Prevention and Resolution January 2014.
18 Or any of its ministries, departments or
agencies”. Ibid, Section D.
19 Clause 2.7(c)(ii) of the Common Terms of
Reference (CTR) dated 17/02/2012.
20 EFC Sub Committee on EU Sovereign Debt
Markets Model Collective Action Clause
Supplemental Explanatory Note, 26 March
2012, p 6.
21 Ibid.
Further reading
Challenges to collective action

clauses: can any parallel be drawn
with unfair prejudice petitions and
oppression of the minority? [2012] 8
JIBFL 479
Recent developments in Sovereign

Debt Restructuring: A step in the
right direction? [2015] 1 CRI 42
Lexisnexis Loan Ranger blog: Argen
tina’s default on its sovereign debt
[2015] 2 JIBFL 128A
February 2015
3