THE ROLE OF THE LAWYER IN EXTERNAL DEBT MANAGEMENT
by Mr. Lee C. Buchheit
(Article Reference: Document No.5, October 1995)

II. The Usefulness of Lawyers

Once the client overcomes any inhibitions about using its lawyers, it is likely to find that legal advice is helpful throughout all stages of an external debt management program.

Borrowing Guidelines
Many governments like to establish borrowing guidelines that set out the approval procedure for incurring external indebtedness by the state (acting in its own name) and by public sector entities. In some cases, these guidelines may also apply to private sector borrowers[2]. Borrowing guidelines can be used to regulate the timing of external borrowings, the ceiling amounts, minimum tenor/grace periods, maximum interest margins and fees payable to the lenders and any other matters that the government feels are important[3]. The jurisdictional basis for promulgating borrowing guidelines can often be found in the government's authority to give foreign exchange remittance approvals for external borrowings, or in the government's authority to tax and regulate inward investment.

Borrowing guidelines applicable to public sector borrowers may also set out policies regarding standard legal/documentation issues that arise in external borrowings. For example, the government may instruct that any cross-default clauses in credit agreements for public sector borrowers not pick up obligations of entities (such as the state itself or other public sector obligors) that are not a party to the loan in question. This is done to avoid the risk that all public sector indebtedness may be placed in jeopardy of acceleration should one public sector borrower fall out of compliance with one loan agreement. The guidelines may establish policies on matters such as negative pledge exceptions, acceptable grace periods on payment and covenant defaults, the scope of waivers of immunities and so forth. The important point for the government to bear in mind when establishing borrowing guidelines that address documentation issues is that the announced policies should not be so out of line with market practice that lenders refuse to do business in the country altogether[4]. The notion of "market practice", however, encompasses a fairly wide range of alternatives on most issues.

There is no doubt that borrowers sometimes regard guidelines of this kind as paternalistic and, for obvious reasons, they are not popular with lenders. The justification for such guidelines is that both the business and legal terms of cross-border financing transactions can be highly infectious. If a public sector borrower agrees to pay a facility fee of 3% or accepts a sweeping negative pledge clause in one loan agreement with one lender, for example, those precedents will almost certainly become the benchmark for all of its subsequent deals[5]. Moreover, all public sector borrowers in the country may have a direct interest in what each of their sister entities is prepared to accept by way of credit terms and documentation. If even one public sector borrower - out of laziness, inexperience or an unwillingness to consult competent counsel - agrees to a lender's first draft of a credit agreement, this will significantly increase the pressure on all of the country's other public sector borrowers to accept equivalent terms and similarly-worded clauses in their own external borrowings. Lenders in subsequent transactions for other entities will seize upon the most favourable precedents and purport to see in them standard market practice for deals involving Ruritanian public sector borrowers. This is a very hard argument for a borrower to resist when one of its sister entities has just accepted the clause in another deal.

The infectious nature of these precedents justifies, in the minds of some governments, the promulgation of borrowing guidelines whose purpose is to standardize documentation practices throughout the public sector on important business and legal issues that arise in cross-border financing transactions. Some countries monitor these issues by requiring credit documents to be submitted to the central bank or the ministry of finance for review after negotiation by the parties but prior to signature. It is obviously more efficient, however, for the government to signal in advance what its policies are in this area and allow the parties to negotiate within the prescribed policies rather than wait to be told that their agreed deal trespasses upon some undisclosed government guideline.

---

[2] The history of the sovereign debt reschedulings in the 1980s and early 1990s demonstrates that no government can afford to ignore the borrowing practices of its private sector. Even though many private sector loans during the 1970s were originally incurred without the benefit of any type of government guarantee, the lenders were usually successful once the debt crisis started in forcing the governments to guarantee the rescheduled obligations or to assume the indebtedness entirely upon the payment to the government of the local currency equivalent (sometimes at a subsidized exchange rate) of the amounts originally due. The lenders' theoretical argument in support of this request focused on the common practice of forcing all foreign exchange in the country to be sold to the central bank following the on-set of the debt crisis. If the government wanted to centralize ownership of foreign exchange at the level of the central bank, the lenders argued, then the government must also assume liability for repaying the private sector's foreign currency obligations. The lenders' practical argument lacked subtlety: if the government wanted the lenders' cooperation in restructuring public sector debt, then the government must satisfy those same lenders regarding the treatment of their private sector exposure in the country. See Walker and Buchheit, Legal Issues in the Restructuring of Commercial Bank Loans to Sovereign Borrowers, in M. Gruson, R. Reisner (eds), Sovereign Lending: Managing Legal Risk, 139,141-42 (1984).

[3] See Wessel, "IMF Urges Developing Nations to Study Controls on Inflows of Foreign Capital", Wall St. /., Aug. 22,1995 at A2, col. 2.

[4] A case in point was the policy of certain Latin American countries during the 1970s not to accept foreign law or submission to foreign courts in their external debt contracts. The reaction of many financial institutions was to cease lending to those countries until the policies were changed. See Shapiro, "Who Has Jurisdiction If a Government Is Sued?", Institutional Investor, April 1977 at 56.

[5] It is no use asking, by the way, how subsequent lenders always seem to know about a borrower's prior agreements. The international financial community is a surprisingly small village in which information and documents rarely stay confidential for very long.


>> Next:The Usefulness of Lawyers (continued) | Previous Page | back to Table of Contents