A Bankruptcy Procedure for Sovereign Debtors?

This article explores whether a more formal bankruptcy procedure, the "Sovereign Debt Restructuring Mechanism" (SDRM) as proposed by the IMF, or in some modified form, is needed to deal with sovereign debt problems. The key consequences of the invocation of such a procedure would be a standstill on creditors' collections of principal and interest, a stay on creditors' attachments or foreclosures on assets, and new money priority for any funds lent to a sovereign during the duration of the procedure. Negotiations would ensue between the sovereign and the creditors over the terms of restructuring, with super-majority voting on acceptance of any restructuring plan. Once accepted, creditors could not holdout by asking courts to enforce the original terms of their debt instruments. The article also explores whether more widespread use of collective action clauses (CACs) in sovereign bonds would be an alternative to SDRM. The article proposes that credible restraints be placed on IMF and official lending since without such constraints sovereigns will not have sufficient incentives to restructure. It further proposes that the G-7 efforts to encourage CACs be abandoned since they will not be adopted and cannot solve the restructuring problem. It then recommends a modified SDRM that is more creditor friendly. The modifications would require: (1) the development of a benchmark on debt valuation to insure creditors receive fair value in a reorganization; (2) the inclusion of all debt, except secured debt, in the process - specifically multilateral, official and domestic debt - to eliminate debt discrimination; (3) the use of cramdown; and (4) minimization of the role of the IMF.