Equitable subordination fraudulent transfer, and sovereign debt

Law and Contemporary Problems

Volumn 70, Issue 4, 2007, Pages 171-190

  Feibelman, Adam ^a  

^a UNIVERSITY OF NORTH CAROLINA   (United States)

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EID: 38349078350     PISSN: 00239186     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (224)

1. The literature concerning sovereign indebtedness and general issues of debt relief is vast. See, e.g., DEBT AND THE LESS DEVELOPED COUNTRIES (Joshua D. Aronson ed., 1979);
2. DEBT STABILIZATION, AND DEVELOPMENT (Calvo et al eds., 1986);
3. ANALYTICAL ISSUES IN DEBT (Frenkel et al eds., 1989);
4. DEVELOPING COUNTRY DEBT AND THE WORLD ECONOMY (Jeffrey D. Sachs, ed., 1989);
5. NOURIEL ROUBINI & BRAD SETSER, BAILOUTS OR BAIL-INS? (2004);
6. Jeremy Bulow & Kenneth Rogoff, A Constant Recontracting Model of Sovereign Debt, 97 J. POL. ECON. 155 (1989);
7. Jonathan Eaton & Mark Gersovitz, Debt With Potential, Repudiation: Theoretical and Empirical Analysis, 48 REV. ECON. STUDS. 289 (1981);
8. Jeffrey D. Sachs, A Strategy for Efficient Debt Reduction, 4 J. ECON. PERSP. 19 (1990).
9. The most recent chapter in this literature has focused on the ability of holdout creditors to complicate sovereign-debt restructurings. See, e.g., Patrick Bolton & David A. Skeel, Inside the Black Box: How Should a Sovereign Bankruptcy Framework Be Structured?, 53 EMORY L.J. 763 (2004);
10. William W. Bratton & G. Mitu Gulati, Sovereign Debt Reform and the Best-Interest of Creditors, 57 VAND. L. REV. 1 (2004);
11. Lee C. Buchheit & G. Mitu Gulati, Sovereign Bonds and the Collective Will, 51 EMORY L.J. 1317 (2002);
12. Anna Gelpern & Mitu Gulati, The Political Economy of Altering Standard Form Contracts: A Case Study, 84 WASH. U. L. REV. (forthcoming 2007);
13. Anne Krueger, First Deputy Managing Dir., Int'l Monetary Fund, Address to the Indian Council for Research on International Economic Relations, A New Approach to Sovereign Debt Restructuring (Dec., 20, 2006), available at http://www.imf.org/external/np/speeches/2001/ 122001.html (last visited May 9, 2007).
14. Articles in this volume are part of this growing literature. See also Lee C. Buchheit, G. Mitu Gulati & Robert B. Thompson, The Dilemma of Odious Debts, 56 DUKE L.J. 1201 (2007);
15. Adam Feibelman, Contract, Priority, and Odious Debt, 85 N.C. L. REV. V27 (2007);
16. Anina Gelpern, What Iraq and Argentina Might Learn from Each Other, 6 CHI J. INT'L L. 391 (2005);
17. Christoph G., Paulus, "Odious Debts" vs. Debt Trap: A Realistic Help?, 31 BROOK. J. INT'L. L. 83 (2005);
18. Raghuram Rajan, Odious or Just Malodorous?, FINANCE & DEVELOPMENT, Dec. 2004, at 54;
19. Joseph Stiglitz, Odious Rulers, Odious Debts, ATLANTIC MONTHLY, Nov.,2003, at 42;
20. Patricia Adams, Iraq's Odious Debts, Policy Analysis, No. 526 (Cato Inst. 2004), available at http://www.cato.org/pubs/pas/ pa-526es.html (last visited May 9, 2007);
21. Seema Jayachandran & Michael Kremer, Odious Debt, 96 AM. ECON. REV. 82 (2006);
22. Ashfaq Khalfan et al., Advancing the Odious Debt Doctrine (Center for Int'l Sustainable Development Law, Working Paper No. COM/RES/ESJ, 2003) available at http://www.cisdl.org/pdf/debtentire.pdf. Within the last few years, officials of Iraq, Nigeria,,and Ecuadör have raised the possibility that some debts owed by their countries are odious.
23. See Feibelman, supra not 2, at nn. 35-36.
24. It will often be debatable whether the extension of any particular funds actually provided a benefit to the sovereign. This is especially true, for example, if the funds supported foolhardy or gratuitous expenditures (say, for example, the building of a vanity palace). This article assumes that there are some uses of funds (say, for example, direct transfer to a government official's private bank account abroad) that can be said to provide no benefit to the sovereign. 'For a more extensive discussion of this question, see Feibelman, supra note 2, at 758-63.
25. Compare, e.g., Rajan, supra note 2 (expressing concerns about the financial consequences sovereigns might face if they repudiate obligations)
26. with Jayachandran & Kremer, supra note 2 (proposing an institutional mechanism that would enable sovereigns to repudiate obligations without foreclosing the opportunity to borrow subsequently).
27. See, e.g., Jayachandran & Kremer, supra note 2.
28. See, also Jubilee Iraq, About Us, http://www.jubileeiraq.org/ aboutus.htm (last visited May 9, 2007) (promoting an arbitration tribunal to repudiate odious debt owed by Iraq after the fall of Saddam Hussein).
29. See infra note 52 and accompanying text.
30. See also NOREENA HERTZ, THE DEBT THREAT 187-94 (2004) ("[D]omestic bankruptcy ... provides us with a good basis on which to design a mechanism for determining which sovereign debts are unpayable or illegitimate, and how debtors and creditors should be treated as a result.");
31. Sfiglitz, supra note 2, at 42 (arguing that a bankruptcy system for sovereigns could provide relief from obligations incurred bf outlaw or odious regimes pursuant to rules established by the United Nations).
32. In theory, creditors and sovereigns could bargain to ensure that sovereigns do not incur odious debt. Sovereigns could promise not to incur such obligations (or risk default of other obligations), and creditors could bargain for the right to designate, by vote, debts as odious. See generally Feibelman, supra note 2.
33. See, e.g., Khalfan et al., supra note 2;
34. Adams, supra note 2.
35. See generally Buchheit et al., supra note 1.
36. Doctrines of fraudulent transfer and equitable subordination are deeply related and, in many circumstances, are interchangeable. See generally Robert Charles Clark, The Duties of the Corporate Debtor to Its Creditors, 90 HARV. L. REV. 505 (1977) (discussing how such doctrines as fraudulent transfer, equitable subordination, and corporate veil-piercing overlap vith each other). See also infra notes 12-51 and accompanying text.
37. Sovereigns may be able to assert these doctrines as well, but this article focuses on the role of creditors.
38. Equitable subordination is a doctrine of lender liability. Lender liability is itself actually a collection of legal claims and defenses that have historically been applied to lenders in different contexts, arising from express or implied contractual duties, tort law, equitable principles, or fiduciary duties. See Adam Feibelman, Commercial Lending and the Sepaittion of Banking and Commerce, 75 U. CIN. L. REV. 943, 971 (20(P). For a classic critique of lender-liability doctrines, see Daniel R. Fischel, The Economics of Lender Liability, 99 YALE L.J. 131 (1989).
39. See, e.g., In re Mobile Steel, 563 F.2d 692 (5th Cir, 1977).
40. See also David Gray Carlson, The Logical Structure of Fraudulent Transfers and Equitable Subordination, 45 WM. & MARY L. REV. 157 (2003);
41. Adam J. Levitin, Rough Justice? The Nature and Limits of Equitable Subordination (Social Science Research Network Working Paper, 2006), available at http://ssrn.com/abstract=900444. For an early important work on the topic, see Aza S. Herzog & Joel B. Zweibel, The Equitable Subordination of Claims in Bankruptcy, 15 VAND. L REV. 83 (1961).
42. See infra note 56 and accompanying text.
43. 11 U.S.C. § 510(c) (2006).
44. See id. See also Carlson, supra note 13, at 199-200 (citing E. Minerals & Chems. Co. v. Mahan, 225 F.3d 330, 338 (3d Cir. 2000);
45. Levitin, supra note 13, at 2.
46. See infra notes 84-85 and accompanying text.
47. 308 U.S. 295 (1939). In Pepper, a controlling shareholder of the debtor caused the debtor to confess liability to a salary claim asserted by the shareholder. Id. at 296-302. The Court found that the shareholder-creditor had engaged in inequitable conduct warranting subordination or disallowance. Id. at 312-13.
48. 306 U.S. 307 (1939). See also Miller v. Borton, 67 F.2d 792 (7th Cir. 1933).
49. See generally Carlson, supra note 13, at 198. The codified rule was initially articulated by.the Fifth Circhit in In re Mobile Steel, 563 F.2d 692 (5th Cir. 1977).
50. See, e.g., Miller, 67 F.2d 792;
51. In re Star Car & Foundry Co., 2 F.2d.53 (4th Cir. 1924);
52. Spencer v. Lowe, 198 F. 961 (8th Cir. 1912);
53. In re Ewald & Brainard, 135 F. 168 (N.D. Iowa 1905).
54. See Andrew DeNatale & Prudence Abram, The Doctrine of Equitable Subordination as Applied to Nonmanagement Creditors, 40 BUS. LAW 417, 419 (1985);
55. Herzog & Zweibel, supra note 13, at 83-85;
56. Rafael Ignacio Pardo, Note, Beyond the Limits of Equity Jurisprudence: No-Fault Equitable Subordination, 75 N.Y.U. L. REV. 1489, 1490 (2000).
57. See also Pepper, 308 U.S. at 307 ("[T]he bahkruptcy court in passing on allowance of claims sits as a court of equity.")... Questions about the jurisdiction of bankruptcy courts have been complicated since the Supreme Court's decision. in N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982). The discussion here does not purport to address any questions of jurisdiction under the 1978 Bapkruptcy Code. Rather, the point here is that equitable subordination originally made its way into bankruptcy law through the substantive content of nonbankruptcy equity jurisprudence, and the bankruptcy doctrine still incorporates basic equitable principles.
58. See In re Mobile Steel, 563 F.2d at 698-99;
59. Local Loan Co. v. Hunt, 292 U.S. 234 (1934).
60. See also Carlson, supra note 13, at 208 & n.158.
61. H.R. REP. No. 95-595, at § 510 (1978) ("[scection 510(c)] is intended to codify case law .... The Bankruptcy court remains a court of equity .... The court's power is broader than the general doctrine of equitable subordination and encompasses subordination on any equitable grounds."); see generally Levitin, supra note 13, at 4-6;
62. Pardo, supra note 21, at 1491.
63. See Carlson, supra note 13, at 198-99 ("Most often insider creditors are the ones punished by equitable subordination.");
64. DeNatale & Abram, supra note 21, at 424 ("Generally, application of equitable subordination has been limited to the claims of management creditors ...." );
65. Herzog & Zweibel, supra note 13, at 101-02.
66. For a very early case in this category,, see Twin-Lick Oil Co. v. Marbury, 91 U.S. 587 (1875) (setting aside claims by directors).
67. For early cases involving parent corporations, see Taylor v. Standard Gas & Elec. Co., 306 U.S. 307 (1939)
68. and Forbush Cb. v. Bartley, 78 F.2d 805 (10th Cir. 1935).
69. More recent cases involving parent corporations include Ansel Props., Inc. v. Nutri/Sys. of Fla. Assocs., 178 B.R. 645 (E.D. Pa. 1995).
70. 11 U.S.C. § 101(31)(B)(iii) (2006);
71. see also Pardo, supra note 21, at n.12.
72. See, e.g., Comstock v. Group of Inst'l Investors, 335 U.S. 211 (1948);
73. In re Process-Manz Press, Inc., 236 F. Supp. 333 (N.D. Ill. 1964).
74. See also DeNafale & Abram, supra note 21, at 432-45; Herzog & Zweibel, supra note 13, at 102-12.
75. See Pardo, supra note 21, at n.12. In fact, the inequitable conduct does not have to relate directly to the creditor's claim.
76. See In re Enron, 333 B.R. 205 (Bankr. S.D.N.Y. 2005).
77. See, e.g., DeNatale & Abram, supra note 21, at 446-47 (citing In re Carolee's Combine, Inc., 3 Bankr. 324 (Bankr. N.D. Ga. 1980)).
78. See Carlson, supra note 13, at 199;
79. DeNatale & Abram, supra note 21, at 419, 429-47 (discussing, cases in which courts have subordinated the claims of nonmanagement creditors who engaged in fraud, exercised a degree of control over their debtors, or engaged in other inequitable conduct such as violating the automatic stay of bankruptcy law).
80. See also Enron, 333, B.R. 205 (subordinating claims by creditors without suggesting that they were insiders).
81. See, e.g., L & M Realty Corp. v. Leo, 249 F.2d 688 (4th Cir. 1957).
82. See generally Herzog & Zweibel, supra note 13, at 99.
83. 67 F.2d 792 (7th Cir. 1933).
84. See, e.g., Columbia Gas & Elec. Corp. v. United States, 151 F.2d 461 (6th Cir. 1945);
85. In re Sayman's, Inc., 15 Bankr. 229 (Bankr. N.D. Ga. 1981).
86. See generally Herzog & Zweibel, supra note 13, at 101.
87. See Pardo, supra note 21, at n.12.
88. See Carlson, supra note 13, at 199;
89. William L. Medford, Debt-to-Equity Recharacterization: Is It More Than Equitable Subordination's Evil Twin? 23 AM. BANKR. INST. J. 26 (Nov. 2004).
90. See Carlson, supra note 13; Clark, supra note 10.
91. See 11 U.S.C. § 548(a) (2006).
92. See also 11 U.S.C. § 544(b)(1) (2006) (providing that a trustee may avoid certain transfers that are voidable under state fraudulent transfer laws).
93. See Carlson, supra note 13, at 167.
94. Unif. Fraudulent Transfer Act § 4(a) (1984).
95. Id § 7(a)(1);
96. Carlson, supra note 13, at 167-68.
97. See, e.g., In re Saylor, 178 B.R. 209 (B.A.P. 9th Cir. 1995).
98. See Carlson, supra note 13, at 166-67 (distinguishing between fraudulent transfer cases involving "exchanges" and "donations");
99. Douglas G. Baird & Thomas H. Jackson, Fraudulent Conveyance Law and Its Proper Domain, 38 VAND. L. REV. 829, 829-36 (1985) (noting that the doctrine has its roots in the Statute of Elizabeth, adopted by England in the sixteenth century).
100. See Barry L. Zaretsky, Fraudulent Transfer Law as the Arbiter of Unreasonable Risk, 46 S.C.L. REV. 1165, 1165-67 (1995);
101. Unif. Fraudulent Transfer Act § 4(a)(2) (1984).
102. Unif. Fraudulent Transfer Act § 4(a)(2) (1984).
103. Zaretsky, supra note 42, at 1166.
104. See id. at 1166 & n.23.
105. See id. at 1166 (noting that bonafide transferees who give value for an exchange are generally protected from liability).
106. See id. at 1178-92;
107. Baird & Jackson, supra note 41, at 850-54.
108. See Bruce A. Markell, Following Zaretsky: Fraudulent Transfers and Unfair Risk, 75 AM. BANKR. L.J. 317, 327 (2001).
109. See Zaretsky, supra note 42, at 1181-92.
110. Zaretsky, supra note 42, at 1173.
111. See also Markell, supra note 48 (discussing Zaretsky's approach and applying it to evaluate absolute priority);
112. R. Stephan Painter, Jr., Subprime Lending, Suboptimal Bankruptcy: A Proposal to Amend §§ 522(F)(1)(B) and 548(A)(1)(B) of the Bankruptcy Code to Protect Subprime Mortgage Borrowers and Their Unsecured Creditors, 38 LOY. U. CHI. L.J. 81, 125-26 (2006) (discussing Zaretsky's approach).
113. See supra notes 12 (equitable subordination) and 39 (fraudulent transfer) and accompanying text. David Carlson has argued that equitable subordination is properly understood as a remedy for fraudulent transfers. Carlson, supra note 13, at 200 ("[E]quitable subordination is simply a fraudulent transfer remedy.").
114. As sovereign-dept restructuring has grown more commonplace and arguably more important, there has been growing interest in developing a sovereign-bankruptcy-type scheme. A number of observers believe that sovereigns could borrow money at better rates if they had the benefits of a bankruptcy or insolvency law. See NOREENA HERTZ, THE DEBT THREAT 187-94 (2004);
115. Steven Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, 85 CORNELL L. REV. 956 (2000);
116. Stiglitz, supra note 2, at 42.
117. A bankruptcy or debt-restructuring scheme could reduce the power of holdout creditors, enable sovereigns to create priorities, and give sovereigns some protection from their creditors. See Bolton & Skeel, supra note 1.
118. The IMF recently proposed a sovereign-debt-restructuring mechanism. Bratton & Gulati, supra note 1, at 26-43;
119. Gelpern, supra note 2, 398-99.
120. Krueger, supra note 1. The IMF proposal attracted some significant opposition and appears to be off the table for now. It is important to note, however, that any sovereign-bankruptcy or debt-restructuring scheme could include a provision for avoidance of fraudulent transfer or for subordination of claims and interests on equitable grounds.
121. See supra notes 18-23 and accompanying text.
122. See also Carlson, supra note 13, at 208, 212-13 (suggesting that the Pepper Court acknowledged that equitable subordination was available under state law at the time).
123. See Nerox Power Sys. v. M-B Contracting Co., 54 P.3d 791, 794-95 (Alaska 2002) ("The Alaska Supreme Court has recognized that the doctrine of equitable sdbordination, whereby the court may 'undo or offset any inequity in the claim position of a creditor that would produce injustice or unfairness to other creditors in terms of bankruptcy results,' can exist outside of the standard bankruptcy coptext.") (quoting White v. State ex rel Block, 597 P.2d, 172, 176 n.13 (Alaska 1979));
124. Haydu v. Wellner, 1994 Conn. Super. Lexis 1105 (Conn. Super. Ct. 1994) (considering but refusing to apply equitable subordination in a foreclosure action);
125. Shultis v. Woodstock. Land Dev. Assocs., 594 N.Y.S.2d 890 (App. Div. 1993) (subordinating the amount of senior liens that were obtained without necessary consent of junior lienholders);
126. Carlson, supra note 13, at 218-19 (discussing cases in which equitable subordination was applied outside of bankruptcy);
127. Levitin, supra note 13, at 2 ("Equitable subordination is not exclusively a bankruptcy action...."). Carlson argues that equitable subordination is actually best thought of as part of fraudulent-transfer law, and "the equation of fraudulent transfer and equitable subordination proves that equitable subordination is a remedy that can be instituted under state law when appropriate."
128. Carlson, supra note 13, at 200.
129. See also Gaff v. FDIC, 919 F.2d 384, 393 (6th Cir. 1990) (finding that equitable subordination is exclusive to bankruptcy law but drawing analogies from the doctrine to determine the content of federal common law);
130. City of Parkersburg v. Carpenter, 507 S.E.2d 120, 123 (W.Va. 1998) (noting that equitable subordination is "applied 'almost exclusively' in bankruptcy proceedings," and declining to apply the doctrine in the case at hand).
131. Nerox, 54 P.3d at 794-95.
132. See HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995) (finding that equitable subordination is exclusively a feature of federal bankruptcy law and thus not part of New York law);
133. Paul H. Schwendener, Inc. v. Jupiter Elec. Co., 829 N.E.2d 818, 826 (Ill. App. Ct. 2005) ("Because the principle of equitable subordination is particular to bankruptcy law, it is an issue 'which can only be decided in a bankruptcy setting.") (quoting In re Poughkeepsie Hotel Associates Joint Venture, 132 B.R. 287, 292 (Bankr. S.D.N.Y. 1991));
134. PCL/Calumet v. Entercitement, L.L.C., 760 N.E.2d 633 (Ind. Ct. App. 2001);
135. Hilo Crane Serv. v. Ho, 693 P.2d 412 (Haw. Ct. App. 1984).
136. See also Levitin, supra note 13, at 2, n.5 (noting that some states limit equitable subordination to receivership or liquidation contexts).
137. See supra note 52 and accompanying text.
138. See supra note 54.
139. This article does not consider whether or to what extent the doctrines of equitable subordination or fraudulent transfer might be fruitful in other cases involving sovereign obligatiops that would not be considered odious.
140. For a discussion of this point, see Feibelman, supra note 2, at 768-69.
141. It is arguable that subsequent creditors would not be harmed because they presumably knew of the odious claim. The interest rate those creditors demanded should reflect the sovereign's balance of obligations, resources, and assets at the time of their transaction with the sovereign.
142. See supra note 14 and accompanying text.
143. Financial distress or insolvency in the sovereign context is generally described in terms of unsustainability. See Feibelman, supra note 2, at 3-4.
144. See also Robert K. Rasmussen, Integrating a Theory of the State into Sovereign Debt Restructuring, 53 EMORY L.J. 1159 (2004 ).
145. See G. Mitu Gulati & George G. Triantis, Contracts Without Law: Sovereign Versus Corporate Debt, 75 U. CIN. L REV. 977, 977-78 (2007) (proposing that, although banks may have previously monitored sovereign borrowers, creditors currently appear to delegate monitoring and governance functions to the IMF).
146. See Anna Gelpern, Odious, Not Debt, 70 LAW & CONTEMP. PROBS. 81, 98 (Summer 2007) ("For governments financing other governments, policy influence is a central objective, regardless of the form the transfer takes.").
147. See supra notes 27-28 and accompanying text.
148. Cases decided under § 510(c) would be persuasive authority, however, and they could lend support to any argument that a particular odious debt should or should not be subordinated.
149. See Baird & Jackson, supra note 41, at 851 (noting that a leverage buyout technically "hinders" a target firm's creditors because it "leaves them with fewer assets" with which they might satisfy their claims).
150. For a similar argument, see Painter, supra note 56, at 123-28. Painter proposes to amend the Bankruptcy Code to allow trustees to avoid certain predatory consumer loans as constructively fraudulent transfers pursuant to § 548(A)(1)(B). According to Painter, loans designed to erode home equity without providing benefit to the borrower should be avoidable in part because they harm the borrower's other unsecured creditors.
151. See supra note 16 and accompanying text.
152. See supra note 39 and accompanying text.
153. See generally Carlson, supra note 13;
154. Fischel, supra note 12;
155. Levitin, supra note 13.
156. Imagine that the harmed creditor might, for example, have decided to lend money to the common debtor based on-a misrepresentation of fact by the "bad" creditor. The other creditors, loaned money knowing the fact that had been misrepresented. This example is based on Allstate Life Ins. Co. v. Linter Group Ltd., 994 F.2d 996 (2d Cir. 1993), which is discussed at some length in Carlson, supra note 13, at 159.
157. See Carlson, supra note 13, at 199-200;
158. Levitin, supra note 13, at 31 (noting that this practice is due "in part. [to] the difficulties in quantifying the exact harm").
159. This is what Carlson calls a "demotion" approach to equitable subordination. Carison, supra note 13, at 199-202.
160. See id. at 200-02.
161. See Levitin, supra note 13, at 8-11.
162. See id. at 8-9.
163. See id. at 9.
164. See id.
165. See id. at 7 (citing Herzog & Zweibel, supra note 13, at 86). Levitin criticizes this view and argues that equitable subordination should be considered a penal remedy.
166. See Levitin, supra note 13, at 33-34.
167. See, e.g., Omri Ben-Shahar & Mitu Gulati, Partially Odious Debts? 71 LAW & CONTEMP. PROBS. 47 (Autumn 2007) (describing an approach to identify partially odious debts).
168. Carlson describes this form of remedy as a kind of assignment; the amount of the claim is effectively assigned to the harmed creditor. Carlson, supra note 13, at 202. Taking this approach can often be quite difficult, especially if the harmed creditors enjoy different priority and if other creditors in the same classes as these creditors are not harmed.
169. See Levitin, supra note 13, at 10. In that case, priority rules conflict with targeted subordination.
170. See id. at 10-11. Levitin proposes that equitable subordination should be viewed as a quasi-punitive claim.
171. See id. at 30-36. In addition, Levitin argues that behavior justifying equitable subordination also generally gives rise to direct causes of action between creditors.
172. Id. at 24. In those cases, there should be distribution of a debtor's assets without subordination and injured creditors can then pursue the inequitable ones.
173. Id. at 25. Meanwhile, the amounts recovered from the debtor by the inequitable creditors should be kept in a constructive trust for the benefit of the injured creditors.
174. Id. at 25, n.103.
175. See supra note 17 and accompanying text.
176. See Levitin, supra note 13, at 8. Under § 510(c) of the Bankruptcy Code, for example, a claim or interest can be subordinated to some claims and not others.
177. Pepper v. Litton, 308 U.S. 295, 311 (1939).
178. See supra note 64 and accompanying text.
179. See Levitin, supra note 13, at 25, n.103 (noting the possible use of constructive trusts).
180. For a good summary of this history, see William W. Bratton, Pari Passu and a Distressed Sovereign's Rational Choices, 53 EMORY L.J. 823 (2004);
181. Lee C, Buchheit & Jeremiah S. Pam, The Pari Passu Clauses in Sovereign Debt Instruments, 53 EMORY L.J. 869 (2004).
182. See generally Bratton, supra note 88. Consider this example of such a clause: "The obligations of the Guarantor hereunder do rank and will rank at least pan passu in priority of payment with all other External Indebtedness of the Guarantor, and interest thereon."
183. Id. at 824.
184. G. Mitu Gulati & Kenneth N. Klee, Sovereign Piracy, 56 BUS. LAW. 635, 636 (2001).
185. See also Buchheit & Pam, supra note 88, at 880-82 (discussing recent cases in which sovereigns' creditors have relied on the pari passu clause).
186. 194 F.3d 363 (2d Cir. 1999).
187. See Buchheit & Pam, supra note 88, at 912-17.
188. See also Bratton, supra note 88, at 10;
189. Debra J. Schnebel, Intercreditor and Subordination Agreements - A Practical Guide, 118 BANKING L. J. 48, 49 (2001).
190. See, e.g., Fischel, supra note 12, at 133 ("Lender liability cases have led to the creation of an area of commercial law that has not been accompanied by the development of a coherent theoretical framework establishing the rights of lenders and their duties...").
191. See, e.g., Gelpem, supra note 64, at 15 & n.42 (rioting that creditors respond to risks of subordination and default by lending less to sovereigns than they otherwise would).
192. The risks that lenders must take into account when they extend credit include the risk of exogenous events and the risk that their debtor will behave in ways that reduce the expected chances of recovery. See Fischel, supra note 12, at 133-34.
193. See also Buchheit et al., supra note 2. Creditors price these risks to the extent that they are able to do so; to the extent that they cannot precisely predict the effects of these risks, they will raise prices enough to ensure that they will not face a net loss in making their investment.
194. See Fischel, supra note 12, at 135-36. In this environment, if a creditor can find a way to reduce or more precisely price risk, it should enjoy a competitive advantage. Similarly, if a borrower can find ways to credibly commit to avoid opportunistic behavior, it can reduce its borrowing costs.
195. See Feibelman, supra note 12, at 949
196. (citing Fischel, supra note 12;
197. Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. FIN. ECON. 305 (1976)).
198. One significant way for creditors to reduce risk is to reduce the ability of borrowers to behave in ways that increase the risk of default. They can do so by monitoring and controlling the actions of debtors. See Fischel, supra note 12;
199. George G. Triantis & Ronald J. Daniels, The Role of Debt in Interactive Corporate Governance, 83 CAL. L. REV. 1073 (1995). Thus, creditors who lend to commercial firms engage in various forms of corporate governance, that is, direct as well as indirect control mechanisms.
200. See Feibelman, supra note 12, at 946-53. Not only do these control mechanisms arguably reduce the amount that any particular creditor will charge for credit, they appear to increase their debtors' value by reducing inefficient behavior by managers.
201. See Nishant Dass & Massimo Massa, Bank-Based Governance: A Tradeoff Between Lower Risk And Greater Information Asymmetry 8 (Fed. Reserve Bank of N.Y., Working Paper, 2006), available at http://www.newyorkfed.org/research/conference/2006/fin_intermed/ Massa_INSEAD_August18.pdf.
202. See generally Mitchell Berlin & Loretta Mester, Optimal Financial Contracts for Large Investors: The Role of Lender Liability (Fed. Reserve Bank of Philadelphia, Working Paper No. 00-1, 2000), available at http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=213815.
203. See supra discussion on page 173.
204. For discussions of optimal definitions or optimal liability in the context of odious debt, see, for example, Feibelman, supra note 2, at 758-63;
205. Ben-Shahar & Gulati, supra note 81.
206. See supra note 63.
207. But see Gelpern, supra note 64 and accompanying text.
208. See Fischel, supra note 12, at 138-40.
209. See id.
210. See Gulati & Triantis, supra note 64.
211. Under the leadership of Paul Wolfowitz, the World Bank has apparently increased its efforts to monitor sovereign regimes for corruption. See Jai Damle, The Odious Debt Doctrine After Iraq, 70 LAW & CONTEMP. PROBS. 139 (Autumn 2007) (discussing Wolfowitz's plan to make assistance from the Bank conditional on anticorruption policies).
212. See Jill E. Fisch & Caroline M. Gentile, Vultures or Vanguards?: The Role of Litigation in Sovereign Debt Restructuring, 53 EMORY L.J. 1043 (2004);
213. Defaulted Sovereign Debt? Litigate Itl, N.Y. L.J., Feb. 22, 2005, available at http://www.law.com/jsp/nylj/ PubArticleNY.jsp?id=1108992913591 (last visited Feb. 25, 2007).
214. Prominent examples include Elliott Associates, the pari passu case noted above. See supra note 91 and accompanying text.
215. The Argentinean debt crisis has generated a significant amount of litigation. See, e.g., H.W. Urban GmbH v. Republic of Argentina, No. 02 Civ. 5699, 2004 WL 307293 (S.D.N.Y. Feb. 17, 2004) (certifying a class of creditors suing the sovereign);
216. Lightwater Corp., Ltd. v. Republic of Argentina, No. 02 Civ. 3804, 2003 WL 1878420 (S.D.N.Y. April 14, 2003) (rejecting the sovereign's request for a stay of litigation to negotiate with creditors). Other recent cases include Af-Cap, Inc. v. Republic of Congo, 383 F.3d 361 (5th Cir. 2004) (defining tax revenue and royalties received by the sovereign as "commercial activity" and subject to attachment because it was transferred to another creditor);
217. Turkmani v. Republic of Bolivia, 193 F. Supp. 2d 165 (D.D.C. 2002);
218. Hirshon v. Republic of Bolivia, 979 F. Supp. 908 (D.D.C. 1997).
219. Most recently, Donegal International successfully sued Zambia to recover on $55 million in Zambian obligations that Donegal had purchased at a steep discount from Romania in 1999. See Zambia Pays 'Vulture Fund' $15m, BBC NEWS, Apr. 24, 2007, http://news.bbc.co.uk/1/hi/business/6589287.stm.
220. See supra notes 90-91 and accompanying text.
221. No. 03602569 (N.Y. Sup. Ct., Jan. 24, 2005) (unpublished opinion, on file with author).
222. See Kensington, Int'l, Ltd. v. Société Nationale Des Pétroles Du Congo, No. 05 Civ. 5101 (LAP) 2006 WL 846351 (S.D.N.Y. Mar. 31, 2006) (denying defendants' motions to dismiss).
223. See Fischel, supra note 12, at 140 ("Whether the increased risk of lender misbehavior created by loan covenants imposes costs that outweigh the benefits from limiting debtor misbehavior cannot be resolved at the theoretical level. The answer will vary depending on the situation and particular covenant involved.").
224. See Berlin & Mester, supra note 96, at 1.