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rerum cognoscere causas
THE DANGERS THAT LOOM
Venezuela is not your standard run-of-the-mill debtor. 42% of its external debt is actually issued by PDVSA, a state-owned corporation that owns valuable assets inside and outside of the country and generates a revenue flow that represents 95% of the country’s export revenue. It is not an exaggeration to say that if oil were to become worthless overnight, Venezuela’s economy would not have a significant source of foreign exchange revenue. Therefore, protecting the capacity of that oil industry to continue generating revenue should be a key policy priority of any administration.
Corporations are not subject to the same degree of legal protection that sovereigns are entitled to. Assets generated in the course of commercial activities are not protected by the principle of sovereign immunity and are thus subject to attachment in the case of a default on creditors. Were PDVSA to default and not gain some legal protection, bondholders could paralyze its revenue generating activity in the US as well as in other countries.
PDVSA bonds do not have collective action clauses - the clause that allows a qualified majority of bondholders to make a restructuring agreement binding on all holders. US corporate bonds typically lack CACs because they can use the bankruptcy process for the purposes of debt rescheduling. However, bankruptcy protection would not be available to PDVSA if the court establishes that PDVSA is an instrumentality or alter ego of the government, as seems probable.
Thus, unless PDVSA finds a way to make all its bondholders agree to an exchange offer, it would be vulnerable to attempts by holdouts to attach its assets and receivables in the course of a debt restructuring. Given that 43% of Venezuela’s oil sales (around $12bn annually, using the 1H17 figures) are made in the United States, it is understandable that the country continues to make a Herculean effort to service PDVSA’s bonds.
GETTING OUT OF THE FIX
BG and WC both present alternatives for dealing with this issue. In essence, the central idea in both cases involves creating new legal entities that can be used to shield the assets or receivables for PDVSA from attachment. The basic idea is to leave bondholders facing an “empty shell” while still preserving those revenue flows for the government under another entity.
WC take the more conventional approach, which is to transfer the receivables to another entity. They suggest several possibilities, which include creating an unaffiliated entity that purchases oil from PDVSA and resells it in international markets, receiving loans in exchange for future receivables, or transferring receivables to the Central Bank.
BG have a more novel approach, which is to leave PDVSA as the recipient of the revenue flows but to change the obligor for the bonds to a new company that does not own the assets or receivables and which is thus of little value to bondholders. BG point out that PDVSA bond indentures leave open the space for changing the obligor with the support of a 50% majority of bondholders.
The BG approach is a variant of the exit consent strategy for bond restructurings. This consists in making an offer to bondholders of a new bond while asking them to make a change in the old bond, which makes the bond less attractive for holders, thus reducing the risk that holdouts may want to keep the old bond. Exit consents take advantage of the fact that a qualified majority of holders (50% in the case of PDVSA bonds) can make changes to the bond that significantly reduce the value of the bond – even if they do not actually change the terms of payment.
Venezuela is not your standard run-of-the-mill debtor. 42% of its external debt is actually issued by PDVSA, a state-owned corporation that owns valuable assets inside and outside of the country and generates a revenue flow that represents 95% of the country’s export revenue. It is not an exaggeration to say that if oil were to become worthless overnight, Venezuela’s economy would not have a significant source of foreign exchange revenue. Therefore, protecting the capacity of that oil industry to continue generating revenue should be a key policy priority of any administration.
Corporations are not subject to the same degree of legal protection that sovereigns are entitled to. Assets generated in the course of commercial activities are not protected by the principle of sovereign immunity and are thus subject to attachment in the case of a default on creditors. Were PDVSA to default and not gain some legal protection, bondholders could paralyze its revenue generating activity in the US as well as in other countries.
PDVSA bonds do not have collective action clauses - the clause that allows a qualified majority of bondholders to make a restructuring agreement binding on all holders. US corporate bonds typically lack CACs because they can use the bankruptcy process for the purposes of debt rescheduling. However, bankruptcy protection would not be available to PDVSA if the court establishes that PDVSA is an instrumentality or alter ego of the government, as seems probable.
Thus, unless PDVSA finds a way to make all its bondholders agree to an exchange offer, it would be vulnerable to attempts by holdouts to attach its assets and receivables in the course of a debt restructuring. Given that 43% of Venezuela’s oil sales (around $12bn annually, using the 1H17 figures) are made in the United States, it is understandable that the country continues to make a Herculean effort to service PDVSA’s bonds.
GETTING OUT OF THE FIX
BG and WC both present alternatives for dealing with this issue. In essence, the central idea in both cases involves creating new legal entities that can be used to shield the assets or receivables for PDVSA from attachment. The basic idea is to leave bondholders facing an “empty shell” while still preserving those revenue flows for the government under another entity.
WC take the more conventional approach, which is to transfer the receivables to another entity. They suggest several possibilities, which include creating an unaffiliated entity that purchases oil from PDVSA and resells it in international markets, receiving loans in exchange for future receivables, or transferring receivables to the Central Bank.
BG have a more novel approach, which is to leave PDVSA as the recipient of the revenue flows but to change the obligor for the bonds to a new company that does not own the assets or receivables and which is thus of little value to bondholders. BG point out that PDVSA bond indentures leave open the space for changing the obligor with the support of a 50% majority of bondholders.
The BG approach is a variant of the exit consent strategy for bond restructurings. This consists in making an offer to bondholders of a new bond while asking them to make a change in the old bond, which makes the bond less attractive for holders, thus reducing the risk that holdouts may want to keep the old bond. Exit consents take advantage of the fact that a qualified majority of holders (50% in the case of PDVSA bonds) can make changes to the bond that significantly reduce the value of the bond – even if they do not actually change the terms of payment.
