‘Vulture funds’ circle but debtors stay a moving target

London’s Royal Courts of Justice had an unusual visitor last Thursday – a four-year-old African white-back vulture improbably named Nigel.

Nigel and his handler were hired by the charities Oxfam and the Jubilee Debt Campaign to highlight a judgment in the High Court. Zambia, the impoverished southern African state, was sued for $55m by an investment fund to force it to pay the full value of government debt bought at a huge discount.

The case has raised again the profile of what critics call “vulture funds” – companies that, they say, prey on poor countries by buying up defaulted debt and seeking full payment. But while the funds’ financial and legal strategies have become increasingly sophisticated, they still have problems extracting money.

A traditional tactic, which some funds are currently trying in Argentina, is to buy defaulted debt at a discount, refuse to participate in any general restructuring where the value of the debt is written down, and sue for a higher payback. It was one such case that brought the funds’ activities to general public attention. Elliott Associates, a New York-based investment fund, forced payment of $55m from Peru in 2000. A country desperate to regain respectability and borrow again from international capital markets has a strong incentive to pay off a minority of litigious bondholders for a quiet life.

The funds have to invent new strategies as previous ones are closed off. Elliott’s creative legal move in the Peru case was to argue that Peru was ignoring so-called pari passu clauses in bond contracts, which hold that all creditors should be treated equally. A Brussels court agreed, and rather than appeal Peru paid up. But since then Belgian law has been changed to prevent a repetition, and the US administration has weighed in to the issue, arguing against this interpretation of pari passu under New York bond law.

New York law was also changed in 2003 to allow “collective action clauses” in bonds. Long a feature of English law, the clauses allow a majority of creditors to overrule a minority holdout. The central American state of Belize is currently concluding a restructuring using the clauses.

In very poor countries, the tactics are often more complex and involve cases being shifted from one jurisdiction to another. “The vultures generally take a very aggressive line in litigation against governments of poor countries that are inexperienced in litigating abroad,” says Janet LeGrand of DLA Piper, Zambia’s lawyers.

In the Zambia case, a company called Donegal International, registered in the British Virgin Islands, bought up a bilateral official debt owed to Romania. Zambia signed a settlement deal with Donegal in 2003, in which it agreed to waive sovereign immunity from litigation and pay around $15m of the then $44m full value. It agreed to penal rates of interest in case of default, and to have any disputes dealt with under English law. Zambia, which later claimed in court that the transaction involved bribing civil servants – an allegation rejected by the judge – stopped paying. Donegal sued and last week won a partial victory, mitigated by the judge criticising the trustworthiness of its evidence.

Oxfam argues that the law should be changed to prevent such litigation against poor countries. Gordon Brown, the UK chancellor of the exchequer, has repeatedly criticised so-called “vulture funds” but the Treasury says there are no firm plans to legislate.

Because many of these cases are unique, it is hard to see a general pattern in fund activity. But experts say there is no reliable winning strategy. “By the nature of the field we are not seeing any consistent precedents set. We are seeing one exotic case after another,” says Anna Gelpern, a law professor at Rutgers-Newark university. But she goes on to say: “Overall it is hard to conclude that these funds are getting more successful at enforcement.”

For the funds, that is the rub. It has in fact become easier to get judgments against governments, as courts have progressively stripped away sovereign immunity from litigation. Enforcing them by seizing property is a different matter. Many state assets, such as embassies, are shielded by sovereign immunity laws. In the case of Zambia, Donegal got the court to freeze the assets of a private company owned by the Zambian ministry of finance, which receives less protection.

A more familiar tactic is to go after government money moving round the international payments system. But funds have also found obstacles to collecting under this strategy. Last month a New York court ruled that litigators could not seize Argentine money at the New York Federal Reserve, due to be paid to the International Monetary Fund. In 2005, courts rejected a similar attempt to seize defaulted bonds being transferred back to Argentina as part of a debt exchange.

Moreover, there has rarely been a better time for countries to defy hold-out litigators, given the ease with which they can borrow. Argentina, which went into the biggest sovereign default in history in 2001, settled with most of its bondholders with a huge debt exchange in 2005 that paid about 34 cents on the dollar. It has since ignored investors holding $20bn-worth of bonds who refused to participate in the exchange.

The demand for emerging market assets, even from a borrower as traditionally risky as Argentina, means that Buenos Aires can issue both peso- and dollar-denominated debt in its domestic market without worrying about international payments being seized. Ecuador’s government is currently contemplating a voluntary default on its debt.

Brad Setser, a former IMF official, now head of global research at Roubini Global Economics, says: “The lesson of Argentina’s ongoing refusal to pay those bondholders who did not participate in the 2005 exchange for countries like Ecuador is that if you don’t intend to access international capital markets, there is not a great cost to ignoring hold-out investors.”

Donegal’s parent company Debt Advisory International, its lawyers and Elliott Associates all declined comment for this article, although Elliott has said that its recent case against the Congo-Brazzaville performed a valuable role by revealing widespread corruption there.

The damage that litigation inflicts is generally less than catastrophic. Losing $55m (in any case likely to be cut heavily by the court) would be damaging but not crippling for Zambia, which received debt relief with a net present value of $2.5bn in 2005. This does not stop campaigners and some donor governments arguing that debt relief efforts for the world’s poorest countries are being undermined. More cases like this may well produce a steady stream of business for Nigel and his handler in the coming years.

Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.