Vulture fund is a term commonly used to refer to a private equity or hedge fund that invests in debt considered to be very weak or in imminent default. Investors in the fund profit by buying this debt at a discounted price on a secondary market and then suing the debtor for a larger amount than the purchasing price. Debtors can include companies, countries or individuals. The term is used to criticize the fund for strategically profiting off of debtors that are in financial distress.
The term is a metaphor used to compare the fund to the behavior of vulture birds “preying” on debtors in financial distress by purchasing the now-cheap credit on a secondary market to make a large monetary gain; in many cases, leaving the debtor in a worse state.
Vulture funds have sometimes had success in bringing attachment and recovery actions against sovereign debtor governments, usually settling with them before actually realizing the attachments in forced sales. In one instance involving Peru, such a seizure threatened payments to other creditors of the sovereign obliger. Settlements typically are made at a discount in hard or local currency or in the form of new debt issuance. A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization.
Sovereign debt collection was rare until the 1950s when sovereign immunity of government issuers was restricted. This trend developed due to the long history of sovereign defaulting on commercial creditors with impunity. Accordingly sovereign debt collection actions began in the 1950s. One example was the freezing of Brazil's gold reserves held by the Federal Reserve.
Investment in sovereign debt with the intent to recover was also restricted due to the laws of champerty and maintenance and by the fact that most sovereign debt was syndicated. Under the Doctrines of Champerty, it was illegal in England and the United States to purchase a debt with the sole intent of litigating it. The distinction was made that if the debt was purchased to effect a recovery or facilitate investment, the doctrine was not a bar. Most jurisdictions have now eliminated the doctrine as archaic.
Similarly, sovereign debt owed to commercial creditors in the late 1980s was principally held by bank syndicates. This was the result of the petrodollar crisis of the 1970s when oil earnings were recycled into bank loans. The syndication of debt among banks made recovery impractical as a fund intending to litigate had to buy out the entire syndicate of holders or risk having the proceeds of litigation attached pursuant to sharing clauses in the loan agreements.
As the 1980s progressed, debt rescheduling efforts in Latin America created many new and easily traded instruments such as Brady bonds that brought new players into the market, including banks and hedge funds. The original creditors then wrote down their positions and sold the debt into the secondary market—a market consisting of banks and investment funds focused on buying at discounts to achieve above market returns on their investment.
In this process, much debt was repurchased and converted into local currency by the sovereign country issuers in official debt conversion programs designed to attract investment and in severely indebted countries through World Bank funded buy-backs. The result is that the old syndicates were broken up and many unrestructured syndicate "tails" were available for purchase at discounts exceeding 80% of principal face value. That pricing encouraged funds to invest in recovery actions, which would not otherwise make financial sense due to their length and cost.
In 2009, bipartisan legislation in the US Congress was introduced aimed to prevent vulture funds from profiting on defaulted sovereign debt by capping the amount of profit that a secondary creditor can win through litigation based on those debts. The Stop VULTURE Funds Act was supported by Rep. Maxine Waters (D-CA), Rep. Spencer Bachus (R-AL), Rep. Barney Frank (D-MA) and Rep. Judy Biggert (R-IL). An interfaith poverty alleviation group, Jubilee USA Network, supported the legislation citing the impact that vulture funds have on poor countries. Similar legislation was introduced in the United Kingdom, Belgium, the Jersey Isles, the Isle of Man, Australia, Guernsey and France.
International Financial Institutions
The International Monetary Fund and World Bank noted that vulture funds endanger the gains made by debt relief to poorest countries. "The Bank has already delivered more than $40 billion in debt relief to 30 of these countries...thanks to this, countries like Ghana can provide micro-credit to farmers, build classrooms for their children, and fund water and sanitation projects for the poor," wrote World Bank Vice President Danny Leipziger in 2007. "Yet the activities of vulture funds threaten to undermine such efforts... the strategies adopted by vulture funds divert much needed debt relief away from the poorest countries on earth and into the bank accounts of the wealthy."
The Administration through the Justice Department came out in support of Argentina in the case between NML Capital and Argentina arguing that a ruling against Argentina could make it difficult for countries in financial distress to get crucial debt swaps.[dead link]
In 2002, the British Chancellor (and later Prime Minister) Gordon Brown told the United Nations that it was "morally outrageous" and perverse that the vultures made vast profits by buying up the debts of these poor countries cheaply and then suing for ten or a hundred times what they paid for them.
Vulture Funds in Latin America
In 2001, Argentina defaulted on roughly $81 billion. NML Capital, LTD., a hedge fund that is a subsidiary of Paul Singer's Elliott Management Corporation, purchased Argentine debt on a secondary market for a price lower than the original amount. 92 percent of creditors restructured in 2005 and 2010 for roughly $.30 on the dollar. NML Capital rejected the proposal and sued Argentina for the full amount in New York State courts.
The main argument that NML Capital has been using in court is a "pari passu" clause that was in the original contractual agreement. Pari passu is Latin for "on equal footing" which means that if Argentina pays back one creditor, they have to pay back all of the creditors, including ones that did not restructure. Since Argentina has already begun to repay the creditors that restructured, Elliot is arguing that they should be paid back.
Pari passu has been used by Elliot to litigate for other country's debt that they bought on secondary markets, another case being Peru. Paul Singer charged in 1995 $ 65 million to Republic of Perú with an inversion of just $ 5 million. Besides, Kenneth B. Dart, who runs the vulture found Dart Management, claims $ 650 million in a lawsuit against Argentina both Dart and Singer, among others, did not accept the Argentine debt restructuring offers in 2005 and 2010 and represent the 7% percent of Bond holders.
Because of this, in the beginning of the case, Argentina asked the court for a declaration that the argument was not legally sound but the court did not make the declaration because Elliot said that they would not use the clause "at any time in the near or distant future."
In June 2012, Elliot Management supported legislation in New York State Senate and Assembly which would have allowed the fund to pursue post-court judgment. Two poverty alleviation organizations, Jubilee USA Network and American Jewish World Service, came out against the legislation citing the negative impacts that vulture funds have on poor countries and mobilized New York State residents to stop the legislation. The legislation did not make it to a vote when the NY State Senate and Assembly ended their session.
On October 2, 2012, NML Capital Ltd., a vulture fund based in the Cayman Islands, which held Argentine debt not included in Argentine debt restructuring, impounded the Libertad, an Argentine Navy training ship in Tema, Ghana. The court in Ghana held that Argentina had waived sovereign immunity when it contracted the sovereign debt being enforced. NML is a subsidiary of Elliott Associates, a hedge fund based in New York City founded by Paul Singer. There is also some doubt that the ship could have been considered an otherwise immune military asset since part of its "good will" visits to Africa included commercial negotiations, which would have negated Argentine claims that the unarmed school-ship was purely military.
Elliot made the pari passu argument and in November 2012, the New York State court ruled in favor of the holdout creditors based on the clause and ordered Argentina to pay $1.3 billion on December 15, the same date they were to pay the creditors that restructured. The appeals court heard oral arguments on February 27.
The Administration through the Justice Department has come out in support of Argentina arguing that a ruling against Argentina could make it difficult for countries in financial distress to get crucial debt swaps.
In 1983, Peru was in economic distress and had large amounts of external debt. In 1996, the nation restructured its debts. Original loans were exchanged for Brady Bonds, tradable bonds issued in the original amount of the loans.
Elliott Associates, a New York-based hedge fund owned by Paul Singer, purchased $20.7 million worth of defaulted loans made to Peru for a discounted price of $11.4 million. Elliott Associates, holding the only portion of Peru's debt remaining outside the restructure, sued Peru and won a $58 million settlement - a 400% return.
Peru, unable to pay the $58 million, continued to repay creditors that held Brady Bonds. Elliot filed an injunction to prevent Peru from paying off its restructured debt without also paying Elliott arguing that Peru violated the "pari passu" clause, which states that no creditor could be given preferential treatment.
Vulture Funds in Africa
In 2007, Donegal International bought Zambian debt from the 1970s for $3 million and sued for $55 million in the British courts. The fund was awarded and ultimately paid $15 million. A series of attempts was then made in Britain and the United States by organizations such as Oxfam and the Jubilee Debt Campaign to change the laws so that vultures would not be able to collect on their awards.
In 2009 a British court awarded $20 million to vulture funds suing Liberia. Before the vultures could collect their money a Debt Relief (Developing Countries) Act 2010 was passed in the UK parliament in 2010 after the Liberian President and 2011 Nobel Peace Prize Winner Ellen Johnson Sirleaf appealed on the BBC Newsnight programme for the vultures to "have a conscience and give this country a break".
That act caps what the vultures can collect—they had to settle with Liberia for just over $1 million—and effectively prevents them suing for exorbitant amounts of money in UK courts. Nick Dearden of the Jubilee Debt Campaign said of the change: "It will mean the poorest countries in the world can no longer be attacked by these reprehensible investment funds who grow fat from the misery of others." The law was made permanent in 2011 but there are still havens for this activity, such as Channel Islands and The British Virgin Isles. Another vulture fund, FG Hemisphere of Brooklyn, sued Democratic Republic of Congo for a debt from Yugoslavia in the 1970s which it had picked up for just over $3 million.
FG sued in Hong Kong, Australia, and Jersey which was not covered by the UK law against vultures. The Chinese government blocked the attempt to sue in Hong Kong but the Jersey court awarded $100 million to FG. FG's owner Peter Grossman was doorstepped by freelance reporter Greg Palast and asked whether he thought it was fair to take $100 million for a debt he had paid $3 million for. He said "Yeah I do actually…I'm not beating up the Congo I'm collecting on a legitimate claim". A series of attempts was then made in Britain and the United States by organizations such as Jubilee USA Network, Oxfam and the Jubilee Debt Campaign to change the laws so that vultures would not be able to collect on their awards. The Jubilee Debt Coalition is now calling on the Jersey government to ban vultures collecting there too and Jersey is consulting on making that change. Jubilee's Tim Jones went to Jersey in November 2011 to ask the government to ban vulture funds there too. He told The Guardian that the Democratic Republic of Congo "desperately needs to be able to use its rich resources to alleviate poverty, not squander them on paying unjust debts".
Vulture Fund FG Hemisphere run by financier Peter Grossman is attempting to enforce an ICC arbitration award for $116 million owed by the Democratic Republic of Congo. The award was originally issued by an arbitral panel of the International Chamber of Commerce (ICC) in favor of Energoinvest DD of Bosnia in the amount of $39 million and then sold to FG Hemisphere. The award was issued by the ICC in respect of unpaid construction contracts pursuant to which Energoinvest supervised construction of high-tension power lines for transmission of power from the Inga–Shaba dam in Congo; the power lines are still in service. Sales of assets by Energoinvest have been criticized by opposition parties in Bosnia as having been "an abuse of power" by the management who defend themselves on the basis that the company had to sell assets in order to pay salaries after it was impoverished and broken up in the break up of the former Yugoslavia.
Since acquiring the arbitration award, FGH has been engaged in a world wide campaign to enforce it by registering it as a judgment in jurisdictions in which it identifies assets of the Congo DRC. FGH has also been in settlement negotiations with Congo DRC for ten years offering discounts of as much as sixty percent of the award. Exasperated at its inability to settle the debt, FGH has resorted to enforcing its judgment rights, including in the courts of the United States, Hong Kong and now Jersey.
Although the World Bank and the development community used to favor debt for development conversions to resolve outstanding debts, they changed their policy on the issue in the 1990s when the World Bank's international development association arm decided to fund buy-backs with bilateral development assistance loans. In order to depress the price of the debtor country debts concerned, they strongly recommended to debtor governments that they refuse offers for inward conversion into local currency.
This policy of discouraging compromise on external debts owed by severely indebted lower income countries grew into the cancel the debt campaign championed by Oxfam and Jubilee. Accordingly, the collection of the Energo debt has been condemned by a broad range of NGOs. It has also been condemned by UNICEF, a UN agency that pioneered debt for development swaps with the World Wildlife Fund in the 1990s.
Grossman and other distressed debt investors have recently been targeted by the development community and the liberal press, including the BBC and Guardian news organizations with "name and shame campaigns" in order to try to influence the vote of the government of Jersey in considering anti-vulture legislation.
The anti-debt movement is now advocating that the debt of middle-income countries should also be forgiven. This is an argument which is not likely to be well received by European governments which are concerned by the prospect of a default by Greece on its external bonds.
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