District Court Stays Debt Litigation Against Sri Lanka at U.S. Request
November 30, 2023
Hamilton Reserve Bank Ltd. calls itself the “hometown bank of America’s founding father Alexander Hamilton.” In a recent case, however, the bank found itself at odds with the Treasury Department that Alexander Hamilton founded.
In Hamilton Reserve Bank Ltd. v. Democratic Socialist Republic of Sri Lanka, the United States filed a statement of interest supporting a six-month stay of Hamilton’s suit against Sri Lanka while that country attempts to restructure its sovereign debt. On November 1, 2023, the U.S. District Court for the Southern District of New York (Judge Denise Cote) granted a stay until the end of February.
I believe Judge Cote’s decision is the first to grant a temporary stay in a case like this to allow completion of restructuring negotiations. Such temporary stays could prove a powerful new tool against litigation by holdout creditors, particularly if coupled with collective action clauses in bonds allowing modified payment terms to be imposed on such holdouts. But temporary stays also raise new questions with which future courts will have to grapple.
In 2012, Sri Lanka issued $1 billion (all amounts in U.S. dollars) of bonds maturing in 2022. During the last few years, Sri Lanka fell into a serious economic crisis. Debt rose to unsustainable levels, and, on April 12, 2022, its ministry of finance announced a moratorium on foreign debt repayments.
On March 20, 2023, the International Monetary Fund (IMF) approved $2.9 billion in financial assistance for Sri Lanka to support economic and policy reforms. The IMF program requires Sri Lanka to restructure its debts with both official and private creditors. Official creditors have traditionally negotiated restructurings through the Paris Club, an informal group of 22 countries, including the United States. Although China is not part of the Paris Club, it also agreed to negotiate. One of the key principles of the Paris Club is that the debtor must seek “comparability of treatment” from private creditors.
Hamilton began to buy Sri Lanka’s bonds in August 2021. Given Sri Lanka’s economic situation at the time, it seems likely that Hamilton bought the bonds at a substantial discount, although the opinion does not say so explicitly. Ultimately, Hamilton acquired more than $240 million of these bonds. After Sri Lanka declared a moratorium on repayments, Hamilton filed suit seeking more than $250 million in principal and accrued interest. Sri Lanka moved to dismiss on the ground that Hamilton was only the beneficial owner of the bonds and not their registered owner. But the district court held that Hamilton had standing to sue because the registered owner had given authorization.
Hamilton moved for summary judgment on June 26, 2023. On July 17, Sri Lanka requested a six-month stay to allow it to conclude restructuring negotiations with official and private creditors. France and the United Kingdom filed an amicus brief on September 6 supporting Sri Lanka’s request for a stay. And the United States filed a statement of interest on October 2 similarly supporting the request.
U.S. Statement of Interest
“In those instances where a sovereign cannot meet its external obligations,” the U.S. statement of interestsays, “the policy of the United States has long been that the orderly and consensual restructuring of sovereign debt, in conjunction with needed macroeconomic adjustments, is the most appropriate response.” This position is not new. One can find a nearly identical sentence in a U.S. amicus brief filed with the Second Circuit in 2012. What is new is U.S. support for a stay of litigation while restructuring negotiations continue.
In 1984, the United States filed an amicus brief with the Second Circuit in Allied Bank International v. Banco Credito Agricola (1985). The question in that case was whether the act of state doctrine required recognition of Costa Rica’s suspension of debt repayments to foreign banks. All but one of the banks agreed to restructuring, but one holdout continued with the litigation. The U.S. position, summarized by the Second Circuit opinion, was to support restructuring through the IMF on “the understanding that, while parties may agree to renegotiate conditions of payment, the underlaying obligations to pay nevertheless remain valid and enforceable.” Consistent with the U.S. brief, the Second Circuit held that the act of state doctrine did not apply and that Costa Rica’s suspension of payments should not be given effect as a matter of international comity because it was inconsistent with U.S. policy.
Although Allied Bank did not involve a stay, the propriety of a stay did come before the Second Circuit in Pravin Banker Associates, Ltd. v. Banco Popular del Peru (1997). The district court had granted a six-month stay of litigation against Banco Popular, to allow liquidation proceedings to be completed, but had denied an indefinite stay of litigation against Peru in support of its restructuring negotiations. Relying on the U.S. brief in Allied Bank, the Second Circuit described U.S. policy as follows:
First, the United States encourages participation in, and advocates the success of, IMF foreign debt resolution procedures under the Brady Plan. Second, the United States has a strong interest in ensuring the enforceability of valid debts under the principles of contract law, and in particular, the continuing enforceability of foreign debts owed to United States lenders. This second interest limits the first so that, although the United States advocates negotiations to effect debt reduction and continued lending to defaulting foreign sovereigns, it maintains that creditor participation in such negotiations should be on a strictly voluntary basis. It also requires that debts remain enforceable throughout the negotiations.
Citing “the federal courts’ longstanding recognition of foreign bankruptcy proceedings,” the Second Circuit held that the six-month stay for Banco Popular was appropriate. The court also held that Peru’s request for an indefinite stay was properly denied, for it “would have denied Pravin its right to enforce the underlying debt—despite clear United States policy that it be able to do so—by making Pravin’s rights conditional on the completion of a process which had no obvious (and reasonably proximate) termination date.”
The U.S. statement of interest in Hamilton relies on Pravin as authority for a temporary stay. But the stay in Pravin was predicated on deference to foreign liquidation proceedings. Hamilton, by contrast, involves no such proceedings. Pravin’s reference to the fact that the restructuring process in that case had no “obvious” or “reasonably proximate” termination date suggests that requests for a temporary stay might be appropriate even in the absence of foreign liquidation proceedings. But the U.S. statement of interest cites no prior case in which such a stay has ever been granted.
It is easy to sympathize with the U.S. position in this case. A lawsuit by a holdout creditor that (presumably) purchased bonds at a discount seeks to cash in and (according to the U.S. government) thereby threatens to derail a restructuring that could help Sri Lanka restore its economic health and debt sustainability. But the stay in Hamilton goes a step beyond Pravin. It also seems to represent a departure from the prior U.S. position that “debts remain enforceable throughout the negotiations.”
Judge Cote’s Decision
Judge Cote did sympathize with the U.S. position in this case, and her decision follows the reasoning of the U.S. statement quite closely.
To decide whether a stay was appropriate, Judge Cote weighed five factors:
(1) the private interests of the plaintiffs in proceeding expeditiously with the civil litigation as balanced against the prejudice to the plaintiffs if delayed; (2) the private interests of and burden on the defendants; (3) the interests of the courts; (4) the interests of persons not parties to the civil litigation; and (5) the public interest.
With respect to the plaintiff’s interests, she noted that the requested stay “is not indefinite” and that, “if Hamilton prevails on its claim at some future date, any judgment will be subject to pre-judgment interest.” The “interests of the courts” also weighed in favor of a stay, she reasoned, because granting summary judgment for Hamilton “would encourage a ‘rush-to-the-courthouse’ by private creditors holding Sri Lanka’s sovereign debt in an attempt to secure priority.”
The remaining factors similarly supported a stay. The impact of an immediate judgment for Hamilton upon Sri Lanka and its other official and private creditors could be severe, the judge stated. With respect to “the public interest,” she looked to the policy articulated in the U.S. statement of interest, quoting the statement extensively.
If Hamilton decided to opt out of the restructuring process, Judge Cote noted, it could renew its motion for summary judgment when the stay is lifted.
What Happens Next?
What happens next depends on Sri Lanka’s restructuring negotiations with official and private creditors and whether any agreement reached can be forced on the holdouts, including Hamilton. The bonds at issue contain a collective action clause under which “reserved matters” such as changing the payment terms may be modified with the consent of bondholders holding not less than 75% of the aggregate principal amount of the bonds outstanding (p. 132).
If $1 billion of the bonds are still outstanding, Hamilton appears to be just shy of the 25% necessary to block modification of the payment terms. However, under these circumstances the remaining bondholders would have to vote nearly unanimously in favor of restructuring. According to the U.S. statement of interest, approximately 55% of private bondholders are publicly supporting the restructuring process.
It seems likely that Hamilton will continue to hold out and perhaps seek to block restructuring of these bonds. It remains to be seen what impact this will have on negotiations with Sri Lanka’s other private creditors and with its official creditors.
Implications for Future Restructurings
Even if the temporary stay proves ineffectual with respect to these bonds, such stays might provide an important new tool in future restructurings. Newer collective action clauses give sovereign debtors a range of options for modifying the payment terms of bonds, including the possibility of aggregating different issuances of bonds for purposes of a vote. Coupled with effective collective action clauses, temporary stays could allow sovereign debtors time to reach agreements that can then be forced on holdout creditors.
Of course, this new tool comes with unanswered questions. How certain must the prospect of successful restructuring negotiations be to warrant stays in future cases? Will U.S. courts be willing to grant such stays only when, as in this case, the United States government files in support? And just how long might “temporary” stays appropriately last?