Can Venezuela’s creditors grab Venezuelan assets in a default?

 If PDVSA defaults on its debts, then yes. It would be a standard commercial dispute. Once a court made its final ruling, U.S. officials would seize Citgo shares, sell them, and give the proceeds to the creditors after deducting expenses and taxes.

But if the Bolivarian Republic defaults, not PDVSA, then it gets harder. Let’s say I own shares in a company and I default on my debts. Creditors can go after my shares in the company, but they cannot go after the company’s assets. This is true even if I am the only shareholder in the company. (Limited liability goes both ways.)

This principle applies to companies owned by foreign states. An official House of Representatives report (see footnote 185 on page 196) bluntly stated: “Section 1610(b) [of the Foreign Sovereign Immunities Act of 1976] will not permit execution against the property of one agency or instrumentality to satisfy a judgment against another, unrelated agency or instrumentality. There are compelling reasons for this. If U.S. law did not respect the separate juridical identities of different agencies or instrumentalities, it might encourage foreign jurisdictions to disregard the juridical divisions between different U.S. corporations or between a U.S. corporation and its independent subsidiary.” 

So far, so clear. Citgo is safe from creditors of the Venezuelan government. 

But here’s the thing: I can’t hide from creditors by creating a separate me-controlled firm and transferring my assets to it. In the words of the Supreme Court, “where a corporate entity is so extensively controlled by its owner that a relationship of principal and agent is created, we have held that one may be held liable for the actions of the other.” Morever, there is a “broader equitable principle that the doctrine of corporate entity, recognized generally and for most purposes, will not be regarded when to do so would work fraud or injustice.” 

In 1983, the Supreme Court specifically extended that principle to foreign state-owned entities in First National City Bank v. Banco para el Comercio Exterior de Cuba (Bancec).

Here’s the backstory. In 1960, Bancec arranged to sell some Cuban sugar to a Canadian company. Citibank issued a letter of credit to Bancec for the sugar. Bancec handed it to the Cuban central bank  (the Banco Nacional) for collection. On September 15, 1960, the Banco Nacional presented the letter to Citibank. The next day, the Cuban government nationalized all Citibank branches. (This was remarkably poor timing.) Citibank, not surprisingly, did not pay Bancec. Bancec sued in the Southern District of New York. The Cubans let the claim sit around until 1975. When they picked it again, they argued that Bancec was an independent state-owned company; why should it be liable the Cuban government’s actions?  

The case went all the way up to the Supreme Court. The Supreme Court upheld the lower court ruling: “Bancec is not a mere private corporation, the stock of which is owned by the Cuban government, but an agency of the Cuban government in the conduct of the sort of matters which even in a country characterized by private capitalism, tend to be supervised and managed by government. Where the equities are so strong in favor of the counter-claiming defendants, as they are in this case, the Court should recognize the practicalities of the transactions. . . . The Court concludes that Bancec is an alter ego of the Cuban government.”

Alright, then. Easy! It might be impossible to seize Citgo assets because Citgo is clearly not an agent of Caracas, but it might be possible to take Citgo shares away from PDVSA. After all, it would not be hard to argue that PDVSA has not been an independent commercial entity since 2002. 

So I ran this past a lawyer friend of mine who works on this stuff.

And ... oh boy ... PDVSA does not own Citgo directly. It owns it through PDV America Inc which is in turn a subsidiary of PDV Holding Inc, both incorporated in Delaware. And those two companies are not legally beholden to PDVSA. 

So now you have to show that PDVSA has no independence and that PDV Holding Inc and  PDV America Inc have no independence. That ain’t so easy. In short, Lex is too sanguine about the prospects for seizing Citgo. It could happen, and my lawyer friends think it will happen ... but only after a long delay.

But there’s another problem! Venezuela has ICSID judgments against it. Unless Venezuela pays them, then ExxonMobil and ConocoPhillips will be sniffing around those assets. Their claims rank higher than claims by bondholders, since uncompensated expropriation, unlike default, involves a clear denial of justice. 

In short, you have a mess. Sure, the fact that Citgo is there will make the Bolivarian Republic think six times about defaulting. But the economic mismanagement in that country is of such a scale (sorry, Shah8 ☺) that Caracas no longer really has any other options.  

Now, creditors have another recourse.

The creditors could go after Venezuelan oil exports directly. There is a recent history of this. In 2007, Texas courts ordered American companies to turn over not only royalties but also physical oil due the Congolese Republic. (See here and here; the decision itself is here.) Now the legal approach used in Texas did not have legs. But to be fair, the suits were quite different than the suits that might happen regarding Venezuela. 

The Venezuelans could sell their oil at the point of embarkation and try to hide it, but that opens up foreign refineries to lawsuits. With the world awash in oil, many will be behooved to avoid going anywhere near the Venezuelan stuff. 

So here is the upshot: a default will cause much pain in Venezuela but it will not make creditors whole. Having Citgo as a target does not cancel out all the problems with legal enforcement of sovereign debt because even if the creditors win it will take forever and a day to collect. But because of the legal challenges to oil sales, default be a big enough disaster for Venezuela that the country will likely make an offer that 75% of its creditors will accept. They will then abandon any attempts to go after Citgo. 

Given what Venezuelan bonds are yielding, I’m tempted to buy them. How bad could the restructuring be?

Comments

[J.H.]

Interesting stuff. What will a Venezuelan default mean for Caracas' support for Caribbean, Central American and some South American countries via PetroCaribe and ALBA?

[shah8]

Since you're gunna call me out...

1) I've yet to be all that convinced that Venezuelan mismanagement, relative to assets and geopolitical position, and also relative to the neighboring countries is especially outrageous. People and countries are as corrupt as they can manage to be in their positions.

2)I haven't really kept up in the current economic struggles, but superficially, in merely keeping in hemispherean politics/economy, most countries are suffering from a dollar shortage. It's not as if Colombia isn't scrambling for cash to pay for it post-secondary system, for example.

3)Venezuela's import/export of goods structure makes it really difficult politically to allow the bolivar to float. I'm always amused at Palmerstinian-type liberals that think that it's possible to politically finangle this. Yeah, you *could* simply neglect everyone outside of the urban elite/middle class and do a lot of repression when you let the real wage fall outside of the protected classes. My sense is that Venezuela has more centers of power, with more material disagreements among them, than most of the other SA countries. Moreover, Venezuelan politics is centered along Chavism and traditional macho SA nationalism, in my opinion. Your choices are between Maduro, perhaps some other wily insider, or a straight-up caudillo. Insane US foreign policy that pretends that Machado and Leopoldo Lopez and the people they stand for aren't dead ducks, politically, just isn't going to work.

Mebbe I need to repeat this: No stabilization policy that does not also protect wage purchasing power (to some degree) is viable. It just isn't. Even if there isn't a serious political response, sober-minded economists have got to, for once, seriously fear and take seriously demand destruction deflation. And I think that if you do, the number of viable plans other than idiotic neoliberal nostrums are small, and require considerable finesse in their design and public salesmanship. Sure, there are a number of "stop shooting yourself in the foot" things Venezuelan policymakers can do--but my impression is that relative to the hole, it's small potatoes and longer time horizons than presently available.

4) How defaults are handled depends on the individual countries involved and their geopolitical positioning, as well as their economic positioning. Russia 1998 was handled differently than Ecuador. One was too big to be very aggressive in recovery. The other had every opportunity to pick the best time to default, and did so. MENA countries (thinking mostly of Egypt and Turkey) has backing from the GCC for geopolitical reasons, and never considered default. Next, I'm not entirely sure (like you) that Citgo is a better idea than restructured bonds. Why fight to forcibly take some external assets, with all of the legal/other costs that might entail, when you can make a simple bet, effectively on how long you were prepared to wait for oil to rebound in price?
---

And yes, I'm fully aware of your expertise and respectfully so, given that I read this blog.

It's not as if I *really* like trying to filter anything real from Moon of Alabama, Zero Hedge, and the like...

[shah8]

I have been thinking about this a lot.

Venezuela essentially needs the IMF. Venezuela's neighbors needs Venezuela to admit that they need the IMF (disordered deval destructive to them, too). There has to be a managed, carefully buffered devaluation, with whatever restructurings that can survive political contest done. There needs to be a public campaign to explain what's going on and why, and a reassurance that bad times will be kept short. In short, an overtly neutral political orientation by the IMF is mandatory, no matter how anyone feels about Chavism or its consequences. I am beginning to believe that the institutional players in USFP that control the Southern Cone portfolio are increasingly entering very dangerous territory with their continued obsession with resuscitating Copei.

[NA]

Some notable ICSID awards

Gold Reserve vs Venezuela- on Sep 22, 2014, ICSID awarded GRZ $740 mm

Exxon/Mobil vs Venezuela – on Oct 9, 2014, ICSID awarded Exxon $2.1 bil

Owens Illinois vs Venezuela – on March 12, ICSID awarded OI $455 mm

Tidewater vs Venezuela – on March 13, ICSID awarded Tidewater $61 mm

Conoco vs Venezuela . . .