JURIST Associate Editor Yuriy Vilner is a member of the University of Pittsburgh School of Law Class of 2013 and an LL.M. Candidate at the Católica Global School of Law, a Lisbon-based faculty of the Catholic University of Portugal. In the final entry of a four-part series on the realities and priorities of Portuguese sovereign debt management, Vilner argues that Portugal’s decision makers should account for the possibility of investor-state arbitration as a bondholder response to a restructuring program…

In the wake of Greece’s momentous debt deal, Lisbon policymakers are examining debt management proposals in a comparatively similar setting. As in Greece, risks of an essentially legal nature are likely to be undervalued, given Portugal’s more imminent constraints: a vulnerable national economy, increasingly restless society, and reduced influence over the EU and global political processes. Legal risk analysis is further likely to be confined to domestic law, which governs more than 90 percent of the value of Portuguese bonds. A risk assessment of this type is necessarily incomplete and potentially ruinous given Abaclat [PDF], a recent International Centre for Settlement of Investment Disputes (ICSID) tribunal’s decision to affirm jurisdiction over a mass investor claim in response to Argentina’s public debt restructuring. Having signed 45 bilateral investment treaties (BITs), Portugal should not take its treaty obligations lightly.

In the event of restructuring, most bondholders are better positioned to seek recourse under the ICSID, a global and disinterested dispute settlement body, than to litigate against the Portuguese state in its own court. To preview the bondholders’ substantive claims, one could look to, for example, the Germany-Portugal BIT [PDF], which contains several actionable provisions featured in most of Portugal’s other investment agreements. Throughout a restructuring, the Portuguese state would be duty-bound to, inter alia, treat German investors no less favorably than their domestic counterparts, under Article 3 of the agreement, refrain from expropriating a German investment unless done for a public purpose with fair compensation rendered, under Article 4.2, and to ensure that investment transfers are carried out without undue delay, under Article 7.1.

First, Article 3 acquires relevance if Portuguese investors receive more favorable post-restructuring terms and conditions than their German counterparts, irrespective of Portugal’s economic, political or social justifications, compelling as those may be. Second, an imposed “haircut” on a debt instrument is probably tantamount to an expropriation for purposes of Article 4 of the Germany-Portugal BIT. Lastly, a protracted restructuring process is very likely to delay a German investor’s ability to manipulate an investment transfer. Rather than prepare potential defenses to each of these claims, Portuguese policymakers must first focus on the preliminary question of ICSID jurisdiction.

A private bondholder claim to recover post-haircut losses raises several types of jurisdictional roadblocks, though Abaclat clarified that these are not insurmountable. Abaclat involved an unprecedented mass investor proceeding initiated by 180,000 Italian bondholders against Argentina for breaches of the Italy-Argentina BIT [PDF]. In 2001, Argentina had defaulted on over 100 billion USD of bond debt and, in 2005, began to restructure by offering to its creditors reduced principal or lower yield bonds in place of their original investments. These terms were accepted by 75 percent of Argentina’s creditors, but a group of over 180,000 Italian investors held out and initiated ICSID proceedings. To be sure, the Italy-Argentina BIT contains language and investor protections very similar to those found in most Portuguese BITs. Thus under the ICSID route, potential claimants may look to Abaclat’s resolution of several main jurisdictional questions:

1. Did Portugal consent to ICSID arbitration for claims related to its sovereign debt instruments? And, if so, did it consent to a collective proceeding to resolve those claims?
2. Do Portuguese BITs cover bonds as “investments” subject to treaty protections?
3. Are holders of Portuguese debt “investors” from a state with which Portugal has concluded a BIT?

First, one precondition to ICSID jurisdiction over our hypothetical bondholder action is Portugal’s consent to investor-state arbitration. Consent involves a lot of gray area, since over 90 percent of Portuguese bond contracts are governed by local law, and elect a Portuguese choice of forum. However, parties to a BIT consent to ICSID jurisdiction where the alleged breach is of a treaty obligation. In other words, whether there is a breach of contract or a violation of constitutional rights at domestic law is of no direct relevance to ICSID jurisdiction. A corollary applicable to the post-restructuring context is that there is no relevant distinction between a holdout investor and her counterpart who “voluntarily” accepted a haircut on an investment. Since neither has gotten paid, both have had their rights violated under an applicable BIT.

And what of the possibility of another Abaclat-style mass proceeding, this time following a Portuguese restructuring? The mass proceedings in Abaclat were initiated as aggregate proceedings; that is, each original claimant was aware of and consented to ICSID arbitration. And since ICSID jurisdiction would apply to each claimant in the event of disaggregation, Argentina consented to the collective proceeding. It was further mentioned that the collective nature of the proceeding resulted naturally from a sovereign bond’s availability to a high number of investors. Hence, the Abaclat tribunal’s unprecedented jurisdiction over a mass proceeding was justified by its discretionary power under Article 44 of the ICSID Convention, and the claims would be entertained insofar as they were otherwise admissible. Indeed, there does not appear to be a BIT that precludes the possibility of a mass proceeding. Needless to say, Portugal would have to think twice before prioritizing its institutional creditors over its minor investors.

Second, to what extent are sovereign issued bonds covered as “investments” by an applicable BIT treaty? It appears that the vast majority of Portuguese BITs define investment broadly enough to include sovereign bonds, aligning with Article 1.1 of the Italy-Argentina BIT, which Abaclat interpreted to “cover an extremely wide range of investments,” and as not espousing a “restrictive approach” to the term’s scope. Indeed, bonds were considered “obligations” under the Italy-Argentina BIT, and would thus likely qualify as “benefits of economic value” (“prestaçoes com valor econômico“) under the Germany-Portugal BIT or “obligations with economic value” (“obrigaçoes com valor econômico“) under the Portugal-Brazil BIT [PDF]. In at least one case, however, “payment obligations from either Contracting party” (thus, sovereign bonds) are specifically excluded as covered investments (Art. 1 of Portugal-Mexico). Thus, unless a BIT contains language specifically excluding sovereign bonds as investments, Portugal would have a difficult time proving otherwise.

Lastly, which bondholders may claim a breach under a Portugal signed BIT? As previously hinted, both institutional and retail investors enjoy BIT protections. To reconsider the potentially significant Portugal-Germany BIT: any German natural person and any German juridical person conceived under German law may bring a treaty claim against Portugal. Annex 1(b) of that treaty adds that any German passport holder is considered a “national” for treaty purposes. But there is nothing to preclude, for instance, a US institutional investor from filing as a German juridical person on the basis of a subsidiary or other corporate form. Thus, even a Mexican institutional holder of Portuguese debt is not precluded from pursuing an ICSID claim if its corporate links elsewhere grant it other nationalities. There are plenty of policy arguments against blatant “treaty shopping” of this kind, but whether it would be disallowed remains to be seen.

The above commentary is an incomplete summary of the jurisdictional challenges of an ICSID claim against Portugal for non-payment on its sovereign bonds. Even if a claimant or group prevails at the jurisdictional phase, the task of proving breach under a substantive BIT treaty provision requires additional time and resources. Nevertheless, the possibility of ICSID arbitration represents a strong bargaining tool for Portugal’s creditors. Portugal should not wait to observe the substantive phase of Abaclat and the unforeseen legal fallout of Greece’s restructuring. Judging by recent trends, the Abaclat decision on jurisdiction and Portugal’s various BITs ought to be required reading materials for anybody involved in the country’s debt management process.

Yuriy Vilner holds a B.A. (Hons.) in Political Science from McGill University, in Montreal, Canada. Vilner currently is working as an intern at CARDIGOS, a Lisbon-based corporate law firm, and has prior internship experience with the US State Department.

Suggested citation: Yuriy Vilner, Realities and Priorities of Portugal’s Debt Management, Pt. IV, JURIST – Dateline, Apr. 12, 2012, http://jurist.org/dateline/2012/04/yuriy-vilner-portugal-debt.php.