EMTA SPECIAL SEMINAR: THE PERU LAND REFORM BOND CASE
Thursday, June 2, 2016
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York City
Following the resolution of the Argentine legal case, this Special Seminar will discuss another legal case which may be of great interest to EM investors.
Peru’s Land Reform Bonds have been in default for over 20 years. The Seminar will provide background, analysis and commentary by leading legal and academic experts on the case, including a review of a key court decision issued by Peru’s highest court and the prospects for future arbitration claims.
Issues to be addressed on the panel will include:
3:15 p.m. Registration
3:30 p.m. – 5:00 p.m. Panel Discussion
Arturo Porzecanski (American University) – Moderator
Mark Cymrot (BakerHostetler)
Charles Blitzer (Blitzer Consulting)
John Coffee (Columbia University Law School)
Mark Friedman (Debevoise & Plimpton)
Cocktails 5:00 p.m.
Support Provided by BakerHostetler.
Registration fee for EMTA Members: US$95 / US$695 for non-members
This Special Seminar is part of a continuing series of panels and presentations that EMTA is pleased to sponsor on various topics of interest to Emerging Markets investors and other market participants, and is part of EMTA’s Legal & Compliance Seminars*.
*CLE credit will be available for NY attorneys. This Seminar is non-transitional and appropriate for experienced attorneys only. Please click here for details on EMTA’s Financial Hardship Policy.
Peru Land Reform Bond Case Debated at EMTA Seminar
EMTA hosted a Special Seminar, “The Peru Land Reform Bond Case”, on June 2, 2016 at its NYC offices, with support from BakerHostetler. Arturo Porzecanski (American University) moderated the panel, with the following panelists: Mark Cymrot (BakerHostetler), Charles Blitzer (Blitzer Consulting), John Coffee (Columbia University Law School) and Mark Friedman (Debevoise & Plimpton). Relevant documents addressed during the panel discussion can be accessed by Clicking Here, including a brief statement by Peru.
Peru’s Land Reform Bonds have been in default for over 20 years. The Seminar provided background, analysis and commentary by leading legal and academic experts on the case, including a review of a key court decision issued by Peru’s highest court and the prospects for future arbitration claims.
Arturo Porzecanski provided some background on the arbitration case being brought by Gramercy against Peru by referring to his article “Peru’s Selective Default: A Stain on Its Creditworthiness”: /media/vcxd2jzk/d412ef8e-c0c4-4806-b1d6-ff47937291d3.pdf.
“In the 1970s…one-third of Peru’s total agricultural acreage…were expropriated…The compensation provided to landowners was miserly…[and] about 85 [%] of total recognized land values were settled…with long-term Agrarian Debt Bonds, which committed future governments to honor fixed coupons on obligations maturing in 20 to 30 years. These bonds became worthless during the 1980s, however, because hyperinflation raged and the Peruvian currency lost most of its value. In the wake of the filing of hundreds of lawsuits seeking judicial redress, in 2001 the country’s Constitutional Tribunal ruled that the government should resume payment of the land-reform debt after updating its nominal value on an actuarial basis. And yet, successive administrations did not act on this ruling, despite the fact that since the mid-1990s Peru has exhibited vigorous economic growth, significantly strengthened public finances, and substantially improved creditworthiness, such that governments have had more than the necessary ample fiscal resources to redeem the land-reform bonds at their full, original value. It was not until July 2013 that the Constitutional Tribunal reaffirmed the government’s obligation to pay the current value of the agrarian debt and gave it six months to issue a decree-law regulating the procedure for payments on the land-reform bonds. The current (Ollanta Humala) government complied, but it put forth an adjustment formula which does not revalue the bonds correctly and leaves them nearly worthless, thus adding insult to long-standing injury. Evidently, we are now in the presence of a case of blatant unwillingness to pay, one which undermines Peru’s claim to be a nation that is creditworthy, investor-friendly, and respectful of the rule of law”.
Porzecanski also drew the audience’s attention to the Gramercy Press Release and Financial Times article “Big Rating Agencies Steer Clear of Peru’s Defaulted Debt”, both published that morning.
Responding to “what is the appropriate disclosure of Peru’s default in SEC filings”, John Coffee provided the “bikini method of law teaching – covering key points, but just barely” – by explaining that Peru has repeatedly filed registration statements, but has not disclosed its default relating to the payment on the land reform bonds, which can be viewed as a material omission that may be actionable. While the default may not threaten the solvency of the nation, it is a default on a large amount of debt (possibly $4-5 billion, based on the Consumer Price Index (CPI)). Peru’s stance is that the bonds were issued under local law, so the materiality requirement is not triggered and there is, in fact, no dispute. Coffee posited that that makes it even more material for Peru to so selectively default, discriminate against foreign investors and secondary market purchasers, and “is a bad sign” for its future bond issuances in the US generally. He also reported that Peru deems the non-payment as an “administrative resolution”, with a supreme decree that adjusted the methodology for valuation of the payments on the bonds at a 99% discount from its original value. This default was seemingly made as a political choice, rather than based on insolvency or other reasons typically given by other nations. In addition, the integrity and authority of the judiciary has been brought into question by allegations that a recent decision by the Peruvian Supreme Court was altered through “whiting out” of one of the judge’s opinions. This suggests to investors that the Executive has authority over the courts and can influence their outcomes, thus making enforcement of creditors’ rights tenuous.
In response to Porzecanski’s question on why the SEC has been fairly passive about Peru’s registration statements’ omissions and/or misstatements, Coffee explained that, for large issuances, the SEC policy is to permit shelf registrations, which are not reviewed carefully until registration goes effective (thus focusing their resources on smaller issues and IPOs, which have expected problems with creditworthiness and volatility). In addition, the SEC’s enforcement division likely reviewed the potential investor base, which it probably deemed sophisticated types who can fend for themselves and pursue any claims through private arbitration, so there was no priority to particularly review these Peruvian bond non-disclosures. Moreover, the SEC may have received some friendly advice from the State Department or Treasury not to push too broadly on a friendly state such as Peru. Nevertheless, all the above does not mean that the SEC will not act in the future. What’s material should relate to what investors really care about – does the rule of law apply or not?
Mark Cymrot posited that the SEC does not view the lack of registration statement disclosure as a violation because this 50 year old debt was a local political issue and should continue to be handled as such, and does not belong in an international forum. As Peru’s economy shriveled up, the bonds became worthless in the 1980s and, thus, the resolution of their future continues to be a local matter.
In response to how the ratings agencies should incorporate the default into their credit analysis, Charles Blitzer explained that the general view was not to put countries on selective default for these types of matters since the agencies don’t look at every single potential default. “It all hinges on what’s material”; whereas this topic was “not on [the rating agencies’] radar, that may begin to change with the announcement of the Gramercy arbitration. The agencies may continue to view this as a contingent liability. Blitzer thinks Peru should settle this matter privately and that it is not a material event. While the underwriters’ lawyers should have probably disclosed this topic in the prospectuses, any litigant under such non-disclosure may be “hard-pressed to show damages” (and the statute of limitations may also be applicable).
Porzecanski pointed out that markets are now commingled, with foreign investors buying local debt and vice versa, so this topic is not just a local matter. For valuation, Peru has committed in the past to use the traditional CPI approach of Colombia and Chile (as opposed to the informal indexing to the exchange rate of $ as Argentina, Brazil and Uruguay have used). Blitzer’s view was that CPI was vague, needing weights, with the calculation of which goods would be included in the consumer basket inherently hard to pin down. Therefore, the end result of this matter (including valuation) will likely be brought about by negotiation. Porzecanski countered that CPI changes from time to time in countries with a history of indexation, but monthly mortgage payments and salaries are clearly indexed.
Mark Friedman summarized the events leading up to the $1.6 billion claim by Gramercy related to the arbitration filed that morning. With the Constitutional Tribunal’s early 2000 decision that the bonds be paid at the “current value” at the rate they would have been when issued, with Peru’s heretofore accepted tradition of using the CPI and with the country’s own evaluation of $5 billion+ 1-1/2 years ago (and $7.9 to $10.5 billion from expert Professor Edwards from UCLA), it is highly unlikely that the number for valuation purposes should be a nominal or 99% discounted amount or effectively zero (as Peru has recently claimed).
Friedman explained that the Gramercy arbitration was brought under an investment treaty between the US and Peru, and claimed violations of international law obligations related to rights against expropriation without due process, fairness and equitable treatment. The neutral remedy is not governed by local law since the rights arise under international law. When Gramercy purchased the bonds from 2006-2008, there was an expectation that the bonds were lawful and valuable until the 2013 Constitutional Tribunal opinion (which, as previously described, is subject to criminal allegations brought by the Peruvians themselves on the 11th hour majority opinion reversal) based on “false premises of Peru’s inability to pay these bonds and the economic impact on its population”. The administrative process of valuation is a “total sham…pretending payment at full value and then paying zero is problematic”. Gramercy wants an amicable solution and has tried to engage in substantive, good faith negotiations with Peru, touting a restructuring that would benefit all bondholders, but thus far Peru has not responded to scheduling a meeting. Friedman reported that Peru did claim that it may not pay at all if doing so adversely affects the Peruvian economy, or it may pay differing valuation amounts depending on who the creditor is, and Gramercy in any case would get paid last. In addition, any creditor that wants to get paid must submit to Peru’s internal process and waive all rights and other remedies. However, Friedman states that proper enforcement of creditors’ rights is crucial.
Cymrot echoed his earlier comments that this was a political (not international judicial) issue related to the Peruvian economy and how best to handle those that had their land expropriated. The political considerations included the losses by those whose property was expropriated in 1969, but also the damage done to many poor landowners when US banks panicked in the 1980s, as well as many other considerations. In the 1980s, US banks were permitted by their regulators to carry defaulted sovereign debt obligations at full value (not mark to market) for fear of a market collapse. Nobody suggested that the US banks were engaged in securities fraud, which suggests that Coffee is looking at the issue of Peru’s current disclosures too narrowly. The impact of a 50-year old default on Peru’s current financial condition is unlikely to be material to current buyers of Peruvian bonds.
Coffee countered that these bond obligations were validated by the country’s own Supreme Court, thus rendering them not a political issue. Moreover, the bonds traded in the secondary market, which also made the topic less political. Cymrot believed that Peru did not market the so-called bonds to the public, they were internal sovereign obligations; hence, they were understood to be subject to a political process, not an international arbitration one. He believed that Gramercy was attempting to “boot-strap” the 2013 judicial decision and “back into events that happened over 50 years ago” to buttress its argument for payment. Blitzer raised the example of revolutionary bonds given to soldiers as furthering the pari passu argument, where each holder should be treated similarly regardless of his nationality, as well as the international law precedents of the Italian bondholder suit in ICSID and Russian domestic law treasury bonds.
Blitzer predicted that the arbitration will “peter out”, the tribunal decree will be thrown out and negotiations with the new government will result in a settlement of the case. He recommended that a creditors’ committee be formed on day one of the new administration so that the negotiations can more easily be accomplished. Friedman predicted that either candidate will be more likely to take this topic more seriously than their predecessor. Porzecanski concurred and reminded the audience that Argentina matter was finally successfully settled by the new administration, not by the court system.