Posting some old stuff this week.
In sovereign loan agreements there are several critical legal clauses that can impact how debt is treated in the case of a debt restructuring. Some of these terms do not receive much attention in the drafting process, but may have a significant impact in the event of default, restructuring or vulture fund litigation. The ALSF is publishing a series of brief articles where it will focus on one particular clause each month with the goal of educating our readers on how this term fits into the larger picture of the debt agreement. The first installment focused on Pari Passu Clauses, next month’s installment will focus on negative pledge clauses.
Collective Action Clauses (CACs) allow a majority of bondholders to act on behalf of the entire group of bondholders. More specifically, CACs allow a qualifying majority of bondholders to agree to restructure the payment terms on their bonds. If the majority threshold is reached, the terms become binding on the dissenting bondholders. Here are some examples of CACs from emerging markets.
CACs were invented as a way to protect sovereigns from holdout commercial creditors who refused to participate in sovereign debt restructurings. In particular, without CACs, vulture funds often would buy up non-participating debt in restructurings and sue the sovereign for the full-value of the debt to the detriment of the other bondholders or with the threat of derailing the restructuring process. CACs most recently entered the news with respect to the Greek debt restructuring process as a tool to ensure that participation in the restructuring would leave no bondholders left behind.
Without a CAC, in the event of a debt restructuring the sovereign may not be able to modify the terms of the debt instrument without obtaining 100% participation of the bondholders. With a CAC, the sovereign can modify the terms with a lower participation (66-90% participation depending on the specific clause). With a CAC in place, the sovereign has a strong legal mechanism to force vulture fund creditors to comply with the terms of a restructuring that a super majority of other bondholders deem acceptable.
The CACs alone do not allow the sovereign to change the terms of the loan agreement on a whim. CACs are in place to allow a sovereign a chance to restructure the terms of an agreement rather than be held hostage by a small minority of bondholders (e.g. vulture funds).
There are several points of negotiation that must be considered when including a CAC in an agreement: (1) what is the voting threshold (66, 75, 85 or 90 percent); (2) are there reserved matters which may require a higher voting threshold; (3) does the vote relate only to a single issue or does it aggregate across other bond issuances (previously issued bonds with varying term lengths and interest rates); (4) who can vote (disenfranchisement); (5) governing law; (6) coercive exit consents; (7) who will be the administrator; and (8) anti-manipulation provisions. This is just a sample of some of the specific legal issues within collective action clauses that must be addressed. The list above does not cover where the collective action clause actually goes (e.g. trust deed or “master” fiscal agency agreement) which is a key decision for the drafting of the agreement.
The practical implications of these clauses only come into effect when there is the need to amend the debt issuance. So the sovereign must balance the need to conclude the financing agreement against the importance of these provisions in the case of distress during negotiations.