Bondfriendliness and Globalization

Default has always been a painful and unpleasant aspect of the credit space and not just because it means a loss of capital. There are differences in legal procedure in dealing with restructuring and bankruptcy across countries. This makes things messy.

Globalization has implied an increase level of legal transplantation—the wholesale adoption of chapters of commercial law from one jurisdiction to another. This works to mitigate the differences in settlemtn of default because the bankruptcy procedures become harmonized not in name, but certainly in effect. Yet a preference for English law to bind international debts, like Ukrainian sovereign bonds, or Russian oils company bonds prevails. It is very common for bonds to be issued by one country, denominated in the currency of another country, and be adjudicated under the laws of yet another country. When it comes to creditors, USD is the preferred currency and English law the desired code. Globalization is the interplay of efficiency and complexity.

The United States commercial code has one of the most debtor friendly laws around, with courts that are typically set on rehabilitating and preserving the owners of a concern. There are two basic decision points. The first is an evaluation of whether the insolvent debtor can be, with restructuring, converted into a going concern. If not, then the debtor assets are sold, with the proceeds going to cover liabilities and creditors. The second is whether the debtors and creditors can agree to such a restructuring plan. If not, then either the judge will force agreement through cram-down or the debtor assets will be sold, with the proceeds going to cover liabilities and creditors. It is clear that Japan has the same basic decision points, though cram-down is not directly comparable in the two countries. Restructuring in Japan is performed by a court-appointed receiver while the restructuring is done jointly by creditor and debtor, so there is a different wrinkle there.

Have a look at the restructuring/BK procedure in the United States compared to Japan.

What is different is how the United States and Japan go about selling debtor assets and dividing the proceeds among liabilities. In short, the capital structure is different. Japan is clearly more bond-friendly in liquidation than the United States. In debtor friendly US, debtor in possession (DIP) lenders, lawyers and the government are at the top, followed by wage arrears and accounts payable. Only after these are settled do creditors get a crack at sharing the pie. In Japan, the arrears on book are settled first. Then the lawyers and DIP and government claims are settled. Then the capital structure settles the same as the United States.

English law is quite different from both. Set alongside the US and Japanese law, it is clear why bondholders overwhelmingly prefer English law binding debt issuance: Secured claims with fixed charge are at the top of the capital structure and unsecured claim and sub debt holders are at the bottom. The implication is that only due to cross-holding of debt will these parties necessarily sit at the same table in negotiations with debtors.

There are other reasons why English law is preferred like how English law fosters outside-of-the-court resolution or “wind-up” (what they call BK liquidation). When the court tone is non-involvement, cooperation becomes a core value needed to get things done.

Of course the acid test of globalization success is the extent to which it empowers the individual over the tribal, especially single initiative over regulation and control. Yes, dear reader, you see where I am going now. It is not a cram-down that makes for optimal outcomes. It is voluntary agreement and associated freedom of contract to wind-down that makes the best of a messy situation.

The signal for this globalization is seeing a deeper harmonization of the capital structure and/or legal transplantation of law because natural selection works to secure the freedom of the individual and the certainty of his or her rights. This includes putting their capital to use where they please and contracting with even less uncertainty. This is how you favorably resolve the interplay of complexity and efficiency.


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