Reimagining Zambia’s restructuring in an alternative New York dimension

Would the proposed legislation even help? © Marvel/FTAV montage Reimagining Zambia’s restructuring in an alternative New York dimension

ave current progress 100% Melissa Butler, Ian Clark, Stuart Matty and Dimitrios Lyratzakis YESTERDAY 6

Roula Khalaf, Editor of the FT,

. Melissa, Ian, Stuart and Dimitrios are lawyers at White & Case, Zambia’s counsel in its debt restructuring.

As we finally start to see the light at the end of Zambia’s debt restructuring tunnel, many people have understandably begun to reflect on why it took so long, what could have been done better and whether the international financial architecture for government bankruptcies failed.

These reflections have gained additional piquancy thanks to discussions in New York about the proposed new “Sovereign Debt Stability Act,” which supporters say is designed to: . . . reform New York’s governance of sovereign debt to help secure New York’s economy and protect the most vulnerable around the world from abusive and unfair lending practices.

Anyone that has followed Zambia’s restructuring know it hasn’t been easy, and reforms would be welcomed by the Zambian authorities to spare other similarly situated countries from its nearly four-year ordeal. For a more anodyne description of the NY legislation please read this.

However . . . would the proposed New York legislation actually have made the process quicker, more efficient and most importantly, ended in a better result for Zambia?

The answer to these questions are obviously hypothetical, as

(a) the New York legislation hasn’t passed yet and if it does pass, we don’t know whether it will be in the same form as proposed; and

(b) Zambia’s bonds are actually governed by English law and therefore outside the purview of any New York legislation.

Nonetheless, given that Zambia is brought up nearly every time someone talks about the failure of the international sovereign debt architecture, it’s a pretty good case study to see how it might affect things.

So let’s suspend reality and assume that the New York legislation as currently proposed was in existence at the time that Zambia began to experience debt distress, and that its bonds were governed by New York law.

And with that, let’s see what might lie ahead on the road Zambia never took . . .

The sliding door moment

It is July 2020, and Zambia’s debts are clearly no longer sustainable, so it begins to explore its options — including a novel and promising option recently passed into law in New York designed to help countries just like Zambia.

The last thing the country needs is to be the guinea pig for a well-meaning but inadequate framework for restructuring. However, excited at the prospect of the promised “orderly, collaborative, effective” and “equitable” resolution of its debt crisis, Zambia sets any concerns aside and decides to submit itself (and its creditors) to the New York legislation.

Section 223 Claim versus Section 230 Claim

Now that it has decided to opt into the New York legislation, Zambia has a second decision, as there are two distinct options available to countries in debt distress. Does it:

(a) Submit to the procedures for a comprehensive restructuring of all of its NY law debt (ie a Section 223 Claim), or

(b) Reach an agreement with its bilateral creditors first (through some sort of international initiative like the G20 Common Framework or an ad hoc restructuring process led by the Paris Club), and cap bondholders claims by what the US agrees to as part of this initiative (ie a Section 230 Claim)?

Given that Zambia’s bilateral government creditors have not yet organised, Zambia notifies NY state and its creditors of its decision to make a Section 223 Claim. After all, Zambia can always change its mind later and switch to a Section 230 Claim.

So let’s start discussions with creditors and find a resolution, right? Not so fast! Before discussions with creditors can begin, two important things need to happen: (a) an “independent monitor” needs to be appointed and (b) Zambia needs to make a notice of its intent to make a Section 223 Claim.

The independent monitor

The independent monitor is appointed by the governor of New York — in consultation with the US Department of the Treasury — but needs to be acceptable to both Zambia and the holders of a majority of Zambia’s New York law debt.  The independent monitor will make certain judgment calls about the debt restructuring and help to moderate disagreements among creditors and the debtor country. However, there’s not a lot of definition around the role, so Zambia will have to figure it out as it goes along.

In 2020, there was a Democratic NY governor and a Republican US president, so bickering about the right candidate ensued (sigh). And unfortunately for Zambia, the parties couldn’t come to an agreement until there was a change in the US presidential administration. Following Joe Biden’s inauguration in January 2021 and the appointment of Janet Yellen as Treasury Secretary, an independent monitor was agreed in March 2021.

But now of course, Zambia and bondholders also have to agree. They will naturally have questions, given that the monitor will be able shape the outcome of Zambia’s debt restructuring — and therefore the country’s future prosperity and whether creditors walk away with a hair cut or a scalping. What is their background? Are they qualified? Have they ever participated in a sovereign debt restructuring?

Zambia, keen to move the process along, quickly agrees to the nominated candidate. Bondholders are less confident. But setting substantive concerns aside, it’s unclear how bondholders will give their “majority” consent to the monitor’s appointment. The bonds themselves don’t actually provide for any such voting. And would bondholders vote on a series-by-series basis, or would they vote in the aggregate as a class?

Who would even decide? At this stage, no independent monitor is in place to make this judgment. Being the only party capable of making this decision, Zambia decides that the intent of the legislation was for holders to vote as a class, not as a series, so it puts the monitor to a vote of all three series of its bonds.

But only one series of Zambia’s bonds contains “aggregate” collective action clauses that permit aggregate voting. Holders of other bonds, which provide for series-by-series voting, are irate. They challenge Zambia’s decision in court, claiming their contractual rights have been unconstitutionally infringed. Not wanting to spend many months in court to adjudicate, Zambia restarts the vote according to the terms of the bonds and not its perceived intent of the legislation.

Unfortunately for Zambia, another setback: bondholders don’t approve the candidate selected by New York’s governor and the US Treasury. With no obvious next step, Zambia makes a second request for another independent monitor. This time, having learned their lesson, the New York governor and the Treasury Department decides to consult with the newly formed bondholder ‘Steering Committee’ before making an appointment.

While the second appointment is approved, it is now September 2021, over a year since Zambia made its first request for treatment under the New York legislation.

Notice to Opt In

To formally commence a Section 223 process, Zambia must provide notice to certify, among other things, that: In the last five years it has not previously sought relief under the New York legislation, nor has it sought relieve under any other law substantially in the form of the New York legislation; Without obtaining debt relief, Zambia’s debt would be unsustainable (while Zambia has just started talking to the IMF and no IMF Debt Sustainability Analysis has been performed yet, it’s pretty obvious to Zambia that it can’t service its debt); It has enacted all legislation required to implement a restructuring pursuant to the New York legislation and The country is co-operating with the IMF to devise an effective, efficient, timely and fair path back to sustainability.

All these should be pretty easy for Zambia to certify and get the ball rolling, particularly as Zambia’s self-certification seems to suffice, right? Again, not so fast.  Will creditors agree to provide debt relief on the basis of Zambia’s own self-certified assessment of the unsustainability of its debts? Or is that something that will be challenged — being a core factor that determines the losses creditors will incur in a restructuring?

Take a guess. Zambia’s creditors could turn to New York courts to challenge the validity of Zambia’s certification. But the court process will probably take several months to resolve, and Zambia’s determination of sustainability would need to be fully adjudicated in court.

Neither Zambia nor its creditors want to waste time settling what is only a threshold issue in the application of the New York legislation. Both parties therefore look to the only alternative: maybe the independent monitor can help. Creditors appeal to the independent monitor, who has the power to dismiss the petition for lack of good faith.

But is the independent monitor even willing and able to do this? At this stage, Zambia is a little disheartened. It’s taken about a year to appoint an independent monitor, and could take at least another year of costly litigation to merely resolve threshold questions of eligibility and good faith in court.

But let’s not be overly pessimistic. Let’s assume that bondholders — who will be asked to take significant losses — have no appetite to challenge any procedural aspect of the legislation so far. The substantive process can begin.

The restructuring plan

Since Zambia is dealing with only one “class” of creditors subject to the New York legislation, this part of the process should be straightforward.  While the New York legislation is light on details on how Zambia should come up with a plan, presumably it does so in consultation with the independent monitor and the IMF. By March 2022 Zambia is ready to submit a deal to its bondholders, which after much consultation, is approved by the required vote — two-third in amount and more than one-half in number, without counting any bonds held by Zambia.

This result is miraculous to Zambia, which was worried that disgruntled bondholders who rejected the deal could challenge the implementation on the basis that the legislation applies the voting mechanism retroactively to impair their existing contractual rights. But — by sheer luck and persistent prayer by the country’s humble, hard-working advisers — this did not happen. So we have a deal!

Oh wait . . . what about Comparability of Treatment?

OK, so while Zambia was going through the process in respect of the New York legislation, it also had to negotiate with all of its other creditors, creditors whose obligations are not subject to the New York legislation. These are other governments, like France, the US, or China.

Zambia officially applied for relief under the G20’s Common Framework in February 2021 and its Official Creditor Committee was formed in June 2022. By August 2022, Zambia also has an IMF-approved credit facility and a published DSA, allowing bondholders for the first time to see the full extent of Zambia’s debt distress (remember, prior to this Zambia only had to self-certify its debt sustainability).

So now there are questions about whether Zambia’s deal with bondholders was in fact the right deal — did it provide too much or too little debt relief? First up is the IMF, who declares that the bondholder deal is not compatible with its own assessment of the sustainability of Zambia’s debts. If the country wants the Fund’s aide it will have to renegotiate its bondholder restructuring agreement. Then the OCC, which (for reasons too tedious, complicated and annoying to discuss here) only reached its own deal with Zambia in June 2023, also declares that the bondholder deal isn’t compatible with its own agreement. Everything appears to be unravelling and quickly.  Ugh. Can Zambia change tack?

Section 230 Claim

As discussed earlier, Zambia actually had two choices — to pursue a Section 223 Claim as we just detailed, or a Section 230 Claim — and they have the option to make a one-time switch between the two, at any time before the restructuring plan becomes effective.

A Section 230 Claim allows countries participating in an international initiative (such as the G20 Common Framework) to limit their creditors’ recoveries to the amount that would have been recovered by the US government under such international initiative as if the US government had been holding the claim. So can Zambia make a Section 230 Claim?

There are two main requirements.  Firstly, it can do so to the extent that its bondholder deal meets the “burden-sharing standards” of the international initiative (for Zambia, that would presumably be the “comparability of treatment” principle under the Common Framework).

Secondly, Zambia would be required to meet “robust disclosure standards, including intercreditor data sharing and a broad presumption in favour of public disclosure of material terms and conditions of such claims.” With this in mind, Zambia begins negotiations with the IMF and its OCC to ensure it can present a plan to its bondholders in line with the IMF DSA and the OCC’s CoT principle. In March 2024, Zambia finally reaches an agreement with bondholders that the IMF and the OCC are happy with.

However, despite multiple requests to the OCC to make the terms of the their deal public — in order to comply with the robust disclosure standards of the New York legislatio — the OCC refuses. Zambia is therefore unfortunately not able to make a Section 230 Claim.

The premature termination of a Section 230 Claim was perhaps a blessing in disguise, as the making of a Section 230 claim would have likely engendered another bondholder litigation saga, this time over the constitutionality of the cap on the bondholder recoveries.

Fortunately, bondholders — understandably frustrated with this length and no longer wishing to hold Zambia’s defaulted debt — decide to approve the deal anyway according to the original voting provisions of the bonds.

Following completion of the restructuring, many commentators say that it would have been better if Zambia’s bonds were governed by English law, so that Zambia wouldn’t have been tempted to go down the New York legislation road in the first place.

Snap back to reality, oops there goes gravity

So back to the real world, where Zambia has finally reached agreements with all its creditors and the direction of travel is looking positive.  This post isn’t meant to be a critique of the New York legislation, but rather to demonstrate that the proposals create more questions than they answer, adding layers of complexity and uncertainty to a process that already massively challenging.

We’ve seen first-hand the damage that protracted debt restructurings can cause to countries. If there was a panacea, everyone would welcome it. But in reality, as the saying goes, hard cases make bad law. And probably equally apt here, bad law makes hard cases.