A Short History of Vultures

Long before Argentina’s latest default, there was Elliott Associates L.P. v. Republic of Panama.

When Argentina defaulted on its debt for the second time in 13 years this week, the financial world was shocked, both by the default itself and, perhaps even more so, by the fact that a small minority of debt holders was willing to torpedo Argentina's debt restructuring. But while the fight between Buenos Aires and its creditors may be in the headlines now, it's not a new story. It began 18 years ago with a perversion of international law in a New York City court and a then-obscure hedge fund that was called a vulture.*

One firm in particular deserves the blame for Argentina's current situation -- or kudos for its innovation, depending on how you look at it. In 1977, Paul Singer founded the hedge fund Elliott Associates L.P. with $1.3 million from friends and family. For nearly two decades, the firm grew by investing in various equities markets. But in 1995 Elliott Associates transformed from just another New York City hedge fund to a pioneer in the world of international finance. And today, 19 years later, the newest iteration of the same fund has played a crucial role in bringing Argentina to default.

In October 1995, Elliott Associates L.P. purchased approximately $28.7 million of Panamanian sovereign debt for the discounted price of $17.5 million. The banks holding those bonds, a group that included heavy hitters like Citi and Credit Suisse, had given up on repayment from Panama. To cut their losses they sold their holdings to Elliott.

When Panama's government asked for a restructuring of its foreign debt in 1995, the vast majority of its bondholders agreed. Not Elliott. In July 1996, Elliott Associates, represented by one of the world's most high-profile securities law firms, filed a lawsuit against Panama in a New York district court seeking full repayment of the original $28.7 million -- plus interest and fees. The case made its way from a district court in Manhattan to the New York State Supreme Court, which sided with Elliott. Panama's government had to pay the firm over $57 million, with an additional $14 million going to other creditors.

It was a groundbreaking moment in the modern history of finance. By taking the case to a New York district court, Elliott broke with long-standing international law and custom, according to which sovereign governments are not sued in regular courts meant to deal with questions internal to a nation state. Further, the presiding judge accepted the case -- another break with custom. It set the stage for two decades of such cases, including Argentina's default this week.

When Elliott's case against Panama upended established international norms about how to negotiate sovereign default, journalists and researchers didn't pay much attention. But Wall Street did. Following Elliott's victory, other funds emerged trying the same strategy. Dart Container Corp and EM Ltd., both linked to Kenneth Dart, one of the most famous names in the world of vulture funds. NML Capital, a Cayman Islands-based fund associated with Elliott also got into the game.** Gramercy Advisors, a Greenwich, Connecticut-based firm, focused on Ecuadorian and Russian debt.

As these firms emerged, so did a new moniker: vulture funds. The name may sound disparaging, but it was not invented by Argentina or other debtors. Wall Street's older firms came up with the name.*** They could find a profit out of slim pickings.

The emergence of the vulture funds with the 1996 Elliott Associates, L.P. v. Republic of Panama case opened up a new legal option to force sovereign governments to pay the full value of their debts (plus interest), rather than the discounted amounts arrived at through negotiations arbitrated by the International Monetary Fund and other international institutions.

The strategy born in 1996 is the same today, but the prize is much bigger. The face value of the discounted Argentine debt that Elliott bought after the country's 2001 default for $48 million is today $630 million. The fund wants repayment for the full value of the debt to all of Argentina's creditors, as it did in 1995 with Panama.**** This amounts to $1.5 billion, which could rise to $3 billion including interests and fees.

The 1996 decision was a departure from how the international banking system handled debt restructuring of what were mostly poor countries (albeit often with very rich elites) in the sovereign debt crises of the 1970s and 1980s. The International Monetary Fund (IMF), the Paris Club, and other international sovereign debt-related institutions had come to the understanding with creditor banks in the late 1970s and early 1980s that they could not expect re-payment in full. In fact, in 1996 the IMF and World Bank implemented a special debt relief program based on the recognition by lenders that at least 46 highly indebted governments would not be able to repay their debts. In the Panama case, as in Argentina's today, the banks had already accepted that they would withstand major losses.

The original debt holders -- major banks like Citi, Credit Suisse, and others -- had the resources to take Panama to court to try to enforce repayment. But they did not, because, at the time, those were not the rules of the game. The banks felt comfortable relying on the intermediation of the IMF and other international financial institutions. International law is weak law, and so is comity, the customary practice in the international system that assumes mutual respect among sovereign governments. These powerful banks recognized the importance of this kind of law for the functioning of the inter-state system, and hence, in the long run, for their own profits. Further, the banks recognized that sovereign debt differs from corporate, mortgage, or any other kind because of its ability to drag down a whole economy, including its healthy components.

When Elliott forced repayment on Panama, there should have been a robust public debate about the firm's claim against a sovereign country in a local court and about the judge's decision to accept that claim. After all, a sovereign's money is technically its citizens'. Making the Panamanian government pay for the full value of the debt, plus interest, even as the major creditors accepted a discounted payment, meant handing citizens' money to a hedge fund rather than investing in, for example, Panama's roads, schools, or social welfare programs. Proponents of repayment argue that, done in good faith, it should have resulted in better credit ratings and therefore more investment in Panama -- or Argentina. But because creditors had already agreed to accept the losses, this already questionable argument becomes irrelevant.

Elliott and other vulture funds have employed the same legal innovation used to squeeze Panama in 1996 again and again. Mostly, the funds have been successful. In 1998 alone, vulture funds took Ecuador, Ivory Coast, Poland, Congo, Vietnam, and other countries to court demanding payment on defaulted debt.***** Further, in what became a de facto, if not necessarily legal, precedent that affects the current Argentina case, the firm has gotten legal injunctions preventing creditors in Canada, the Netherlands, Germany, Luxembourg, and Belgium from collecting before Elliott did. In the current case, the judge in a New York City court enabled Elliott to prevent Argentina from paying the other creditors -- who account for over 90 percent of its debt holders -- without paying Elliott.

Elliott's 1996 victory was significant, but there have been other important cases since, including the firm's most recent win against Argentina. In 2012, Judge Thomas Griesa of the Southern District Court of New York ruled that whenever Argentina paid the majority of its creditors it would have to pay its holdouts, too. The U.S. Supreme Court rejected Argentina's appeal. This case has been yet another massive step toward enabling private firms to sue sovereign governments in regular courts, rather than going to international financial institutions for arbitration.

Occasionally, vulture fund strategy did not work and courts stood up for sovereign governments. In 1996, soon after its successful move on the Panamanian government, Elliott bought $20.7 million of Peruvian debt for $11.4 million. As usual, Elliott sued for the full value, plus interest. Initially, the New York southern district court ruled in Peru's favor. The judge found that creditors had some responsibility for taking on bad debts. But the U.S. Court of Appeals in New York City reversed the verdict and, in the end, the parties settled the case.******

There may be hope, though. On July 31 there was a first step towards reversing the precedent that began in 1996. Argentina indicated that it might take its fight with the vulture funds to the International Court of Justice in The Hague. That, rather than a New York court -- or even the United States Supreme Court -- is the proper venue for taking on a small number of funds that are keeping the vast majority of its creditors from being paid and holding a country ransom.

* Correction: Elliott has not "called itself a vulture." An earlier version of this article stated that it did. (Return to reading.)

**Correction: Elliott's Cayman Islands-based subsidiary is called NML Captial. An earlier version of the article stated that Elliott's subsidiary is MNL Ltd. (Return to reading.)

*** Correction, Oct. 9, 2014: So-called vulture funds did not embrace the moniker. An earlier version of this article stated that they did. (Return to reading.)

**** Clarification, Oct. 9, 2014: Elliott owns approximately half of Argentina's $1.5 billion in debt. An earlier version of this article suggested that Elliott owned the full value. (Return to reading.)

***** Correction, Oct. 9, 2014: Elliott has not sued Ecuador, Ivroy Coast or Poland. An earlier version of this article attributed those 1998 lawsuits to Elliott. They were brought by other investment firms. (Return to reading.)

****** Correction, Oct. 9, 2014: While a district judge found in Peru's favor in 1996, a Circuit Court reversed the decision. An earlier version of this article reversed this sequence of events. (Return to reading.)


Democracy Lab

Back to the Future in Libya

Why some Libyans see a solution to the country's political crises in a document that was published 63 years ago.

As Libya's temporary governing institutions struggle for survival amid political, legal, and security problems that threaten civil war, an oasis of order can be found in the small eastern city of al-Baida, where a committee of 55 has been quietly writing a constitution. Specially elected by various constituencies but equally representing Libya's three regions, they bear the responsibility for writing a new constitution. Paradoxically, however, the greatest obstacle to their work may be less their country's troubled present than widespread nostalgia for its past.

The reason is that, despite the convening of the National Constituent Assembly (NCA), Libyans from all walks of life have been calling for restoration of the country's last pre-Qaddafi constitution, which was established in 1951. The widespread devotion to the document might be surprising: It establishes a monarchy and declares Islam to be the official state religion without specifying the role of sharia, or Islamic law. Both aspects are, in fact, controversial. The overwhelming majority of Libyans reject the restoration of the king, and Libyans differ widely on whether sharia should be the only source of law and legislation, a source among many, or left out of the constitution altogether. Yet a pending General National Congress (GNC) proposal backed by GNC member Ahmed Langhi -- whose family was closely tied with the pre-Qaddafi regime -- is urging a referendum on whether the 1951 constitution should be used as a basis for a new constitution. (This is the second such effort by GNC members within a year.) If it were put to a popular vote, Libyans would likely choose reinstatement.

Others have distanced themselves from the 1951 constitution. Amr Ben Halim, whose father served as prime minister under the former king, has personal experience with the shortcomings of the 1951 constitution. He remembers the monarchical period through the eyes of his father, who experienced the disarray of the government created according to the tenets of the old constitution. In his authoritative history of 20th-century Libya, American scholar Dirk Vandewalle describes a system in which regions received federal monies without accountability, leaving the national government with almost no ability to enforce its own law. While he does not support reinstatement of the 1951 constitution, he views its drafting process as a model for today. The process ensured that Libya's regions were represented equally and that the public was consulted at the early stages. Support for the 1951 constitution's drafting process by people like Ben Halim is precisely why the NCA's drafting process ensures equal representation from Libya's three districts.

This "realistic nostalgia" -- a term coined by Ahmed Langhi's daughter, Zahra, a women's rights activist -- has given hope to Prince Mohammed el-Senussi, the man who would be king if the old constitution is restored. In June, the leaders of Libya's 40 tribes convened, ostensibly to "pray for peace and unity" at the Zawia Baida, the white monastery in the same small town accommodating the NCA. The private purpose of the meeting was to begin harmonizing the tribes to ultimately oppose radical elements within Libya. Given the alleged architect of the meeting, Prince Senussi himself, it is not difficult to guess how this harmonizing might have been done: The tribal leaders aimed to influence the NCA to adopt the 1951 text or to vote on its adoption among themselves. Prince Senussi is the great-nephew and heir apparent of King Sayed Mohamed Idris al-Mahdi el-Senussi, who heralded Libyan independence and its first constitution in 1951. A restored and un-amended 1951 constitution would reinstate the Senussi monarchy.

The push from tribal leaders, coupled with the popular cry for restoration of the 1951 constitution, does not bode well for the NCA, which has established a committee to determine the governing structure of a new Libya. (The photo above shows Libyan officials, tribal leaders, and civil society representatives at a ceremony launching the constitution-drafting process in April.) A fully resurrected 1951 document would preclude any choice in the matter. The NCA, elected by the people, should be able to determine Libya's constitutional future, including its form of government, constitutional monarchy or otherwise. That said, the NCA would do well to consider using healthy portions of the 1951 text and structure to capitalize on its popular support in legitimating the final document.

Libyan's hankering for a 60-year-old constitution seems at odds with current constitutional trends toward the expansion of human rights and the reduction of the number of constitutional monarchies. Indeed, from most scholars' viewpoint, reinstatement of the 1951 constitution, in the words of one influential international authority in Libya, "makes no sense."

Above all else, the 1951 constitution establishes an incredibly powerful head of state. While such power was safely entrusted to Sayed Idris, a man who consistently put the interests of the greater good ahead of his own, there is always a risk that Libya may not be so lucky with future monarchs. Putting such faith in the lottery of genetics -- with the added temptation of potentially corrupting oil wealth -- will lead to disaster.

Libya has the world's ninth-largest crude oil reserves, the largest in Africa. Qaddafi was happy to exploit these assets to bolster his own dictatorship. Libya's recent past, including its experience of the "resource curse," reinforces the urgency of the need for the separation and balance of powers. Oil wealth invariably encourages the head of state to expand executive power to rake in more profits: Witness the careers of regional leaders such as Qaddafi, Nasser, or Ben Ali. To curb executive expansion, the new constitution must dole out equal amounts of power -- and protective checks -- to the other branches of government. It should also include better provisions on open meetings, record keeping, and a right to access information, not to mention specifics on how oil revenues will be distributed and contracts kept transparent.

Other major issues of the 1951 text are regional power and governance structures and the role of sharia. As "progressive" as the 1951 constitution is, its singular recognition that "Islam is the religion of the state" will likely not attract the kind of Libyan consensus that will be required for constitutional longevity. The old constitution also prohibits dual citizenship; limits freedom of religion and thought; bans teaching anything "contrary to morality"; lacks any accommodation for minority languages; and establishes two capitals, an unworkable setup. It also guarantees an "appropriate standard of living" for everyone, which, while admirable, might not be economically feasible. Its inclusion of the rights to work and education might be unenforceable and would effectively award legislative powers to the judiciary by allowing unelected judges to dictate complex employment and education policies. Meanwhile, the 1951 constitution fails to ensure judicial independence, a problem that could be remedied by including articles on life tenure and judicial review.

In some respects, nevertheless, the 1951 constitution can serve as a useful model. For instance, its legislature arrangement -- a proportionally elected Chamber of Deputies and a regionally elected Senate -- could provide a workable compromise between federalists and non-federalists (or those in favor of proportional representation, largely those in population-dense Tripolitania). The human rights section, which includes provisions banning torture and guaranteeing public trials, equal opportunity, and freedom of conscience, also provides a good first draft of a bill of rights.

Perhaps the greatest strength of the 1951 document is its place in history. Libya has been free only once in its pre-Qaddafi history, and the 1951 constitution is a potent symbol of liberty to Libyans. With good reason, the Senussi era of independence has a firm hold upon the minds of Libyans. Including passages from this constitution could unite Libyans around the new constitution as a representation of a hard won freedom.

When revolutionary stirrings first began in Benghazi on February 17, 2011, some accounts witnessed Libyans flocking to the Benghazi courthouse, raising the Senussi flag, and calling for the Senussi constitution. Those who have since waved the 1951 flag -- which is ubiquitous in Libya -- would certainly support a constitution that preserves the old charter's elements and character. Popular support of a new constitution is no small matter in producing an enduring text, a consideration the NCA would be wise to take seriously in its deliberations.