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Home EJIL Analysis The Global Countdown to October 17: International Responsibility for Foreseeable and Deliberate Sovereign Defaults?

The Global Countdown to October 17: International Responsibility for Foreseeable and Deliberate Sovereign Defaults?

Published on October 8, 2013        Author: 

EJIL Talk Oct 2013The daily political saga of the United States federal government shutdown has the rest of the world riveted – not just for the ratcheting rapid-fire exchanges between President Barack Obama and Republican House Speaker John Boehner (pictured above left, credit) – but more so for the increasing threat that the United States will declare an unprecedented default on a massive portion of its government debt, if, by October 17, the Legislative and Executive branches cannot reach agreement on lifting the United States Treasury’s debt ceiling.  IMF Managing Director Christine Lagarde has said that failure to raise the debt ceiling would be a “far worse threat to the global economy than the current shutdown”.  China and Japan, both holders of significant volumes of US Treasury Bills,  have publicly asked the United States to resolve the impasse and prevent looming damage to their investments.  Fears of a global crisis sparking if the US defaults on October 17 have dominated the opening of the 2013 Asia-Pacific Economic Cooperation (APEC) Forum in Bali, Indonesia, where President Obama’s absence has conspicuously elicited skepticism of the durability of US foreign policy in its ‘pivot’ to the Asia-Pacific, and the United States’ ability to  conclude the negotiations for a Trans-Pacific Partnership agreement (TPP).

Should there be any US default by October 17, it may well be argued that this kind of sovereign default has a peculiar quality of avoidability and foreseeability, where the State had some conceivable measure of control over the default.  Could the United States be internationally responsible to other States (either those suffering the direct result of non-payment of debts, or those affected by a global economic crisis sparking from a US default), if it knew of the global economic impacts of an unprecedented US default and could have avoided it by acting swiftly to lift the debt ceiling, but failed to thus act?

In the first place, one would be hard pressed to locate a specific international obligation that places a concrete duty on the part of sovereign borrowers to avoid a default at all reasonable cost.  After all, no less than the International Covenant on Economic, Social and Cultural Rights provides that the right of self-determination also means that States could “freely pursue their economic, social, and cultural development.”  [Art. 1(1)]  A State’s fiscal and financial decision to service its international debt obligations (including the mode and manner by which it intends to repay monetary obligations) could thus also be contextualized as an exercise of this fundamental sovereign right.

Moreover, there is little by way of international jurisprudence to date that illuminates on the specific duties of sovereign borrowers to avoid causing further economic harms through a deliberate default, although it has been argued that “opportunistic defaults…[constitute] a breach of obligations and, where the creditor is a State, of international law in particular…” (Jorn Axel Kammerer, State Bankruptcy, Max Planck Encyclopedia of International Law, para. 2). As I have discussed in more detail elsewhere, what stands more clearly from the history of international practices and decisions is that economic crises (or any classical interpretation of a state of necessity or emergency) have generally not been accepted as sufficient legal justification for abjuring any payment whatsoever of sovereign debt obligations. The 1912 Russian Indemnities Case decided by the Permanent Court of Arbitration stresses that there is a

“…special responsibility in the matter of delay in the payment of a monetary debt, unless the existence of contrary international custom is established…[there are] no grounds for demanding an exception to this responsibility in the matter of monetary debts by pleading its character of public power and the political and financial consequences of this responsibility…The exception of force majeure cannot, therefore, be accepted.” (para. II.4)

Force majeure was likewise rejected as a defense in the 1929 Brazilian Loans Case decided by the Permanent Court of International Justice, averring that “the economic dislocation caused by the Great War has not, in legal principle, released the Brazilian Government from its obligations.” (para. 58)

The duty of sovereign borrowers to act responsibly and in a timely fashion to avoid deliberate defaults at best, may be seen as a soft norm that has yet to crystallize in the opinio juris of States.  In April 2011, the United Nations Conference on Trade and Development (UNCTAD) released the Draft Principles on Promoting Responsible Sovereign Lending and Borrowing, pointing out that:

“The borrower should avoid opportunistic behaviour and arbitrary discrimination among creditors; and it should respect the voluntary basis of the process and the seniority of debts.  The restructuring should be proportional to the sovereign’s need and all stakeholders (including citizens) should share an equitable burden of adjustment and/or losses.”  (Principle 15, last explanatory paragraph)

The nature of such ‘opportunistic behaviour’ can be understood from an earlier UNCTAD report by Lee C. Buchheit and G. Mitu Gulati, which notes:

 “…circumstances will sometimes arise that will make it unreasonably burdensome for a sovereign to continue normal debt servicing and everyone, borrower or lender should recognize this…but casual or politically-motivated dishonourings of sovereign debt obligations harm both the debtor country and the global system on which so many other countries rely for necessary finance.”  (p. 14.  Italics added.)

In his opus, Sovereign Defaults before International Courts and Tribunals (CUP 2011), Michael Waibel acknowledges that a sovereign borrower does not incur international responsibility from exogenously-caused defaults:

“…mere defaults or temporary suspensions of debt service do not engage the State’s international responsibility.  If financial distress is the result of factors beyond the debtor country’s control (‘exogenous factors’) then the resulting default also does not trigger the debtor country’s responsibility.”

The foregoing work, however, does not categorically declare whether conversely and by implication, a State would always be internationally responsible for defaults arising from ‘endogenous factors’ (or factors within the debtor country’s control).  Could the stalemate between political organs of the United States resulting in a failure to reach agreement on the debt ceiling, for example, amount to an ‘endogenous factor’ or measure of control that would engage the international responsibility of the sovereign?

One can also speculate on the potentially disastrous impact of a US default on its numerous investment treaty obligations.  US Treasury Bills would easily fall within “covered investments” (see Article 1 of the 2012 United States Model Bilateral Investment Treaty), and the failure to repay these forms of government debt could conceivably result in breaches of investment treaty standards of protection owed to foreign investors.  One does not have to reach further than the recent cases of Abaclat and others v. Argentine Republic and Ambiente Ufficio S.p.A. and others v. Argentine Republic to know that sovereign bonds have already been accepted as covered investments, which could be the basis for the initiation of some form of mass claims in an investor-State dispute setting.

Finally, in seeking to assess whether sovereign borrowers have a specific international duty to avoid deliberate defaults, this might be the opportune ‘international moment’ to revisit the doctrine of “abuse of rights” in international law, and its potential applications in sovereign economic decision-making that results in some transboundary harm to the economies of other States. Unlike the prohibitions against causing transboundary harm in international environmental law, there is as yet no counterpart principle in international economic law and public international law that deals with lawful economic acts of States that cause or result in some form of tortious harm to fellow States in the economic system.  Nevertheless, it is a question the conceptual theory of which Hersch Lauterpacht would probably have examined – as he observed in The Function of Law in the International Community (The Lawbook Exchange Ltd., 1933), “…in theory, there is no matter normally falling within the domain of the exclusive jurisdiction of the State which could not be brought within the purview of the operation of the prohibition of abuse of rights.”  (p. 304, para. 22.)

Where the world’s largest economy and sole superpower finds itself on the foreseeable precipice of an unprecedented sovereign default on October 17, one can only wonder if both the White House and the Hill have taken the costs of United States’ potential and future international responsibilities as part of their decision-making calculus.  Certainly a global systemic risk event that the rest of the world is watching.

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4 Responses

  1. Marcin MJ

    Shouldn’t the current situation be considered not as a “measure of control that would engage the international responsibility”, but rather as a situation stemming from domestic law, which cannot be invoked as a justification not to perform one’s treaty duties (VCLT A. 27)and as such cannot be subject to scrutiny by third States according to the principle of non-interference.
    Having said that, the arguably iure gestionis nature of budgetary matters might prevent foreign claims through the veil of sovereign immunity.

  2. Diane Desierto Diane Desierto

    Many thanks Marcin. VCLT Art. 27 prevents a State from invoking domestic law to justify non-performance of treaty obligations – it does not bar third States from asserting treaty-based claims, even if the genesis of these claims may have begun from a State’s good faith implementation of its domestic law.

    Treaty-based claims that might arise would potentially be those from foreign holders of substantial US Treasuries arguing violations of US investment treaty protection standards (e.g. fair and equitable treatment, MFN, national treatment, etc.), resulting in injury to, or deprivation of, their “covered investments” should there be a deliberate default (and any other factual circumstances that an investor would argue violates the standards of protection owed under US international investment agreements). Where an international investment agreement gives investors direct recourse to sue the United States (such as through arbitration at the International Centre for Settlement of Investment Disputes), the defense of sovereign immunity would have been waived ex ante by the States Parties to that investment agreement.

    That said, all these would depend on the factual circumstances as well as the actual content of the United States’ investment treaty obligations. It is particularly critical to observe how the United States government acts over the next few days, and how it ultimately treats its foreign investors should there be a default on October 17. The single act of declaring default, by itself (and especially when the State is amenable to debt restructuring), would most likely not be sufficient to breach investment treaty standards of protection. As the Argentine cases at ICSID have shown, other deprivatory acts and indicia of governmental injury to investors have been shown to engage host State responsibility under investment treaty protection standards.

  3. Marcin MJ

    Thank you for pointing out to my evident mistake in terms of VCLT!

    As for the key question concerning the ‘international responsibility of the United States to other states’ it addresses the problem of responsibility under public international law towards other states (probably owners of T-bonds) and not to the buyers of the obligations emitted under domestic law per se. Although one could consider both international responsibility and liability regimes, the latter – as you’ve admitted – clearly does not apply here.

    In terms of international responsibility for illicit conduct, you’ve indicated two categories of subject affected by such occurring: ‘either those suffering the direct result of non-payment of debts, or those affected by a global economic crisis sparking from a US default’.

    The second group – those who are not creditors of the U.S. – has no legal recourse. Even taking into account the Lauterpacht’s doctrine of abuse of rights, suggesting other solution would entail international responsibility for national economic policies. The only soft law norms I could think of are declarations of the G20 leaders concerning common duty of safeguarding stability of the international financial system, which could not constitute grounds for initiating any proceedings.

    As for the first group of States-owners of American bonds, in light of recent rulings concerning Argentine’s default the argument that the State issuing bonds automatically renounces its immunity from jurisdiction and execution does not appear evident. However, even if the did in fact U.S. renounce its immunities explicitly, this relates to private law claims stemming from a breach of a contractual obligation towards investors and not from a violation of a substantive norm of public international law, even if investors could have a legal remedy based on international investment treaty establishing internationalised procedural framework.

    Thus the remaining field is the one of claims by third States-owners of American bonds not related to the contractual obligations of the U.S. here, however, they do not substantially differ from the category indicated in the proceeding paragraph.

    Lastly, while drawing distinction between international responsibility for violations of public international law and claims stemming from a contractual relationship under domestic law, it might be useful to note that the 1912 Russian Indemnities Case was based on the peace Treaty of January 27/February 8, 1879 and so Turkish obligations towards Russian citizens were based upon international and not domestic law.

  4. John Snow

    Just a real-time countdown to US Default http://countdowntodefault.com/