Vulture Funds

Sovereigns under scrutiny amid precedents and settlements

Originally published in the April 2012 issue

Distressed debt or special situation funds, otherwise known as vulture funds, are once again being scrutinised by the courts, the media and the legislature in many parts of the world. These are private equity or hedge funds which invest in debt, often owned by sovereign states, which are, or are about to be, in default and which then take steps to affect recovery. If an individual company becomes insolvent, most countries have domestic laws which compulsorily apply an insolvency scheme to all creditors who then bear a proportionate part of the loss, subject to any security they might have. There is no equivalent global scheme which applies to debts owned by countries or sovereign states. Thus if one creditor, or its assign, invests the time and money to recover these sovereign debts, it does so in preference to the other creditors.

The 1996 Heavily Indebted Poor Countries (“HIPC”) Initiative aimed to ensure that no “poor” country faced debts which it could not manage. The IMF and the World Bank calculated the proportionate reduction required in a country’s external debts in order to return to them 150% of the value of the country’s annual exports. There are currently 40 eligible or potentially eligible countries in the HIPC Initiative, many of them African. On a voluntary basis, members of the Paris Club and certain multilateral institutions may cancel their debt.

The UK went further and introduced the Debt Relief (Developing Countries) Act 2010 and in so doing is the only jurisdiction in the world to have enacted such legislation. It came into force on 8 June 2010, originally with a ‘sunset clause’ which meant it was only in force for a year. However, it has subsequently been made permanent. The Act seeks to limit the proportion of debts owed by an HIPC which a commercial creditor can claim through the UK courts by reference to the criteria established by the International Monetary Fund and the World Bank. It also actively seeks to encourage HIPC governments to negotiate solutions for these debt issues.

The Act does not apply in Jersey and currently there is no equivalent legislation in the Island. It is for that reason that a New York fund established under the laws of Delaware, FG Hemisphere Associates LLC was able to bring proceedings in the Royal Court of Jersey against The Democratic Republic of Congo (DRC), La Général des Carrières et des Mines (Gécamines) and Groupement pour le Traitement du Terril de Lubumbashi Limited (GTL).

The origins of the case began in the 1980s when a Yugoslav company, Energoinvest DD, constructed and extended credit for the funding of a hydro-electricity facility and electric transmission lines in the DRC. Both the DRC and a state-owned electricity company defaulted on the payments under the credit agreements and so the matter was referred to a contractually agreed arbitration before the International Chamber of Commerce. The DRC did not participate in the process although the electricity company did, and in 2003 awards were made against both entities. The benefit of those awards was then assigned to FG Hemisphere which took steps in various jurisdictions – Belgium, Bermuda, South Africa and Hong Kong – to enforce them.

Over $100 million was still outstanding together with daily accruing interest when FG Hemisphere commenced the Jersey proceedings. As well as suing DRC, it sued Gécamines, a DRC state-owned mining company, and GTL, a joint venture company incorporated in Jersey. Gécamines was one of the partners, the others being two Dutch and Luxembourg companies. The object of the joint venture was the commercial exploitation of cobalt-rich slag produced by Gécamines from its operations in DRC. This resulted in considerable income for Gécamines from GTL.

Thus the purpose of the Jersey proceedings was for FG Hemisphere to obtain leave to enforce the awards (under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958) as a judgment against DRC and Gécamines, and to execute any such judgment against the assets of Gécamines in Jersey. The Royal Court gave leave and granted a freezing order which prevented GTL from making certain payments in respect of the slag production to DRC and Gécamines, and gave leave to enforce the awards against Gécamines’ shares in GTL. The latter two appealed and the Court of Appeal gave judgment on 14 July 2011. The appeal by Gécamines was refused subject to one point relating to interest. Gécamines was found to be an organ of the DRC and thus liable for its debts. GTL’s appeal as to the nature of the freezing order granted was also refused. A further appeal is however pending to the Privy Council.

FG Hemisphere also pursued its claim against DRC in Hong Kong. This time by seeking to intercept a payment of $104 million due to the DRC from China Railways, a company owned by the central government of the People’s Republic of China. The payment was in connection with an infrastructure project in DRC. The latter sought to set aside court orders permitting the interception primarily on the grounds of sovereign immunity. The case went as far as the Hong Kong Court of Final Appeal which, in a provisional judgment given in June 2011, held that absolute sovereign immunity applies in Hong Kong. It further held that a foreign state cannot waive its immunity by an agreement with a private party in advance of any proceedings in the Hong Kong courts, thus there had been no waiver in this case. A final judgment will not however be rendered until the question of absolute sovereign immunity has been referred to the Standing Committee of the National People’s Congress, which is expected to confirm the court’s finding.

In September 2011, shortly following Jersey’s Court of Appeal judgment, the States of Jersey issued a Green Paper. The consultation paper asks whether Jersey should enact legislation equivalent to the UK Act and if so whether the same benchmarks and other criteria (e.g. the list of countries involved) should be different from the UK. It notes that: “Jersey is, in myriad ways, a jurisdiction different from that of the UK, not least in its commercial, fiscal and international profile.” The authors of the Green Paper seem to consider that there is a dilemma: “It will be necessary both to preserve Jersey’s commercial reputation as a jurisdiction which honours and enforces the sanctity of contractual relations and to maintain Jersey’s political reputation as a transparent, well regulated and respected international finance centre.”

Interestingly, Jersey’s sister Channel Island, Guernsey, issued a HPIC Initiative consultation paper in August 2011, even though it had not seen the same type of litigation as Jersey. Guernsey’s Policy Council has already agreed that a report should be prepared recommending the enactment of legislation to prevent vulture funds operating through the Guernsey courts with the aim being to bring proposals before Guernsey’s Parliament at the earliest possible opportunity. The policy makers in Guernsey did not seem to perceive there to be the same type of dilemma as Jersey.

It is also of note that countries such as France and the US have considered and rejected legislation of this nature. Belgium has a law promulgated in 2008 which provides limited protection to low income countries by ensuring that Belgian development loans cannot be seized or transferred, but it would appear that non-legislative action is a more popular way of dealing with this issue.

Whether it is through voluntary initiatives brought about by the World Bank or by legislation in jurisdictions which follow the UK’s lead, it appears that distressed debt funds may increasingly be limited to debts owed by companies or by non-HIPC sovereign states. However, given the turmoil caused by the ongoing Euro zone crisis just as some doors may shut, so may others open.

Gillian Robinson is a partner in Appleby’s Litigation & Insolvency team in Jersey.