When a country appears poised to default on its national debt, a certain class of hedge funds spies opportunity. These so-called “vulture funds” have relied on a tried-and-true playbook to extract wealth from defaulting countries, the likes of which include Puerto Rico and Argentina.
The basic strategy is intransigence. Despite only owning a slice of a defaulting country’s debt, vulture funds can disrupt the entire restructuring process by refusing to negotiate alongside other creditors. Those non-vulture creditors typically have other interests that incentivize them to cut a deal for a debt restructuring, but vultures can and do gum up the works and hold out for maximum possible repayment, which may end up requiring economically ruinous tax increases or cuts to other programs.
However, there’s a legal wrinkle here: The reason why vultures like Elliott Management, Aurelius Capital Management, Contrarian Capital Management, and GMO Trust have been able hold all parties at the negotiating table hostage boils down to a loophole in New York state law, which itself is grounded in a centuries-old doctrine known as “champerty.”
Champerty traces its origins to the Anglo-French term champêtre, and the Latin phrase campi pars, meaning “part of the field.” In a contemporary legal context, champerty essentially bars investors from buying debt for the primary purpose of bringing a lawsuit to recover it. In the past, defaulted nations could use this as protection against financiers buying up their debt for pennies on the dollar and using it as leverage to squeeze them dry.
But a 2004 amendment to New York state law, which governs 52 percent of sovereign debt contracts globally, defanged the champerty defense by shielding large-scale commercial debt acquisitions from being invalidated under it. That amendment has since served vulture funds well, as indebted countries in default can be sued in New York for claims exceeding $500,000.
Vulture funds will disrupt the resolution process for their own maximum short-term interest.
Naturally, commercial acquisitions of sovereign debt below $500,000 are few and far between, so the limit is largely pretextual. Even tiny countries always borrow much more than this. “That’s the point,” Assemblymember Jessica González-Rojas (D) told the Prospect. She said that for vulture funds, the goal was to “carve a loophole to be able to continue to exploit and extract as much wealth from struggling nations as possible.”
González-Rojas has set out to change that. She is once again the sponsor of the Assembly version of a bill introduced by New York state Sen. Liz Krueger (D) to close the loophole and once again make it illegal to buy any quantity of debt for the sole purpose of extracting repayment, seriously undermining the vulture fund business model. Although the Senate has passed Krueger’s legislation twice before, the companion bill has never made it onto the Assembly floor. On Tuesday morning, González-Rojas delivered remarks in Albany in support of the bill. She was joined by community members, fellow electeds, and members of the Debt Justice Alliance.
“This bill is critical for our communities and diaspora, who know that global economic instability impacts families here in New York and around the world,” said González-Rojas. “The entire world is watching, and New York has an opportunity to lead in a way that truly matters.”
It remains unclear whether the companion bill will be considered on the Assembly floor during the current legislative session, in large part because the state budget is already over three weeks late. González-Rojas is “a little nervous about how long this will drag out,” but remains hopeful that the legislation will pass this year, pointing to “the support and the engagement of the market itself, and the changes we made over the years.”
Institutional investors like pension funds tend to invest in sovereign debt indirectly through asset managers. Investing in the debt of developing countries can offer higher yields than that of developed nations, but the prospect of above-average returns does not come without a proportional level of risk.
Pension funds have long-term investment horizons, so if they have bond exposure to a developing country that defaults on its debt, restructuring that debt is almost always the preferred outcome. Like domestic lenders, they tend to want the country back on its feet and growing as soon as possible. But that’s not how vulture funds do things—they will disrupt the resolution process for their own maximum short-term interest. It’s toxic for everyone else including the other creditors. When vulture funds hold out, it becomes increasingly likely that good-faith creditors end up recovering less than they otherwise would at the conclusion of an orderly restructuring process. Meanwhile, the defaulting country is effectively shut out of capital markets until the restructuring is resolved.
“There are many good actors that are operating in good faith, and actually they find that the vulture funds … cause chaos in any restructuring negotiation,” González-Rojas told the Prospect. “We’re really targeting those bad actors that are specifically seeking to purchase the sovereign debt for the sole purpose of litigation and profiteering off these vulnerable nations.”
According to Rob Solano, executive director and co-founder of Churches United for Fair Housing (CUFFH), a founding member of the Debt Justice Alliance, the ball is largely in Assembly Speaker Carl Heastie’s court.
“I think Carl has really seen more than ever the need to push this forward after the budget is passed,” Solano said in an interview. “We look forward to standing side by side with our Speaker.”
THE DEBT JUSTICE ALLIANCE was born out of disaster relief recovery efforts following Hurricane Maria in 2017. At the time, CUFFH, New York Communities for Change (NYCC), and the Center for Popular Democracy “started to peel back this onion of why … [our communities] are coming to America,” Solano told the Prospect. “That’s what really sparked it.”
And so began a yearslong campaign to restore champerty to its former glory under New York state law. Advocates within and adjacent to the coalition deployed a host of tactics to sound the alarm on vulture funds, including direct pressure, education, and engagement with state lawmakers.
“When we help destroy other countries’ economies, preventing them from providing education, infrastructure, clean water, electricity, and healthcare to their people, not only do the people of that country suffer, but we suffer the ripple effects of that destabilization,” Krueger said in a statement. “I’m hopeful New York will be able to catch the rising tide and move this bill this year.”
For González-Rojas, the scourge of vulture funds is an issue that hits close to home.
“My mom’s Puerto Rican,” she said. “A lot of this was inspired [by] what happened and continues to happen in Puerto Rico.”
Puerto Rico has been ravaged by vulture funds, which advocates contend are to blame for the island nation’s illegal, odious debt. This debt has since been reduced through a federally administered restructuring process, but austerity measures have left Puerto Rico’s social safety net and broader economy in tatters.
Given the impact vulture funds continue to have on developing countries around the world, the coalition and its legislative allies believe that now, more than ever, is the time to restore champerty under New York state law.
“There’s a sense of urgency because of the [state of] the economy in the world in general,” José González, senior director at NYCC, told the Prospect. “Countries that are in debt will feel those shocks more acutely.”
Both the coalition and state lawmakers seem to have made inroads with the investor community. That could be a tailwind for the legislation. Moreover, the International Monetary Fund has been supportive of bringing order to sovereign debt restructurings for years.
“All of these ingredients were not necessarily present in the past,” González said.
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