TWN Info Service on Finance and Development (Jul19/05) 
17 July 2019
Third World Network

Vulture funds gain at expense of human rights
Published in SUNS #8943 dated 10 July 2019

Geneva, 9 Jul (Kanaga Raja) - Vulture funds are inherently exploitative, and they deploy predatory financial strategies to obtain disproportionate and exorbitant gains at the expense of the realization of human rights, particularly economic, social and cultural rights, and the right to development.

This is one of the main conclusions highlighted by the Human Rights Council Advisory Committee in its final report on the activities of vulture funds and their impact on human rights.

The Human Rights Council Advisory Committee, composed of 18 independent experts, functions as a think-tank for the Council and works at its direction.

The report by the Advisory Committee is before the ongoing forty-first session of the UN Human Rights Council (24 June-12 July 2019).

"Seeking the repayment in full of a sovereign debt from a State that has defaulted, or is close to default, is an illegitimate purpose. In a debt crisis, more than financial obligations are at stake," said the Advisory Committee.

Excessive claims awarded to vulture funds have allowed them to reap profits at the expense of the welfare and sustainable development of the poorest countries, without taking due account of the negative consequences of such actions on the capacity of a State to fulfil its human rights obligations.

The duty to observe due diligence to prevent a negative impact on and potential violations of economic, social and cultural rights applies to all States and stakeholders, including the management of vulture funds.

The impact of their activities on the enjoyment of economic, social and cultural rights should therefore be systematically assessed, said the Advisory Committee.

According to the report by the Advisory Committee, there is no international legal regime governing cases of State insolvency or bankruptcy.

When a State defaults on its sovereign debt, it must initiate a process for restructuring the debt in order to obtain a reduction in the debt or an extension of the repayment terms.

That implies undertaking complex and protracted negotiations with a very diverse range of creditors.

Participation in such restructuring processes is voluntary and therefore even a small percentage of creditors may well decide to hold out with a view to obtaining a higher level of repayment in future.

It is at this point that vulture funds come into play. These commercial entities are not lenders, but private hedge funds that purchase on the secondary market (or collect from other bondholders) distressed debt at discounted prices and then sue the debtor for a much higher amount.


They are popularly called "vultures" because of their modus operandi, whereby they:

* Target States with distressed economies and a weak capacity for legal defence. According to the African Development Bank, 20 of the 36 poorest developing countries have been threatened or targeted by aggressive litigation by vulture funds since 1999.

The World Bank estimates that more than one third of the countries that qualified for its debt relief initiative have been targeted by lawsuits by at least 38 litigating creditors, with judgments totalling $1 billion in 26 of those cases.

* Operate and take advantage of the lack of regulation of the secondary market. To obtain significant discounts, vulture funds acquire sovereign bonds when the indebted country is either close to default or has already defaulted on its debt. In the secondary market, they can operate with great secrecy in terms of both ownership and operations.

Sovereign bonds are thus traded between investors without the debtor State concerned necessarily being aware or informed of such operations.

* Refuse systematically to participate in orderly debt restructuring processes. Once the State starts negotiations with private bondholders to restructure the sovereign debt, vulture funds exercise their "right" to hold out and/or start collecting and purchasing sovereign distressed bonds; they then wait until the country's financial situation has improved to start negotiations for a better deal.

In addition to difficulties in gaining access to the international capital markets again, the debtor State is under the threat of being subjected to a long and costly process with a particularly aggressive litigator.

The additional pressure may easily prompt some Governments to accept highly disadvantageous deals.

* Sue the country for reimbursement of the full value of the bond, plus interest and procedural costs. If the debtor State does not surrender to the claims of the vulture funds, then the next step in the strategy is to file legal claims seeking reimbursement of an amount much higher than the price they paid in the secondary market (usually the face value of the bonds), increased with interest, delay penalties and legal expenses.

To ensure that they get a favourable court decision, they make sure that "creditor-friendly" jurisdictions are involved in the resolution of the dispute. The courts of debtor countries may increasingly become an option, as weaker legal systems are easily overwhelmed by the level of technical detail involved in this kind of litigation.

Procedures are particularly protracted (on average six years), costly and burdensome (with annualized returns ranging from 50 per cent to 333 per cent).

As a consequence, the financial and reserve management capacities of the debtor State remain compromised for a long period.

* "Chase" the country to enforce the judgment. Once vulture funds have obtained a favourable judgment, they seek its enforcement before different courts through "forum shopping" practices, until they secure the enforcement action they desire.

Figures show that attachment of a country's assets abroad has become a particularly common legal strategy in past years. Despite many unsuccessful attempts, such pressures have often helped vulture funds to achieve a favourable out-of-court settlement.

* Obtain exorbitant profits. Vulture funds have achieved, on average, recovery rates of some 3 to 20 times their investment, equivalent to returns of 300-2,000 per cent.

In some cases, the claims of vulture funds constitute a significant portion (12-13 per cent) of a country's gross domestic product (GDP).

* Operate in jurisdictions where bank secrecy rules apply. Most vulture funds are incorporated in tax havens, where there is no obligation to disclose information on benefits or ownership and it is feasible to hide gains to avoid or evade taxation.

Such jurisdictions facilitate the secretive manner in which vulture funds operate and the flight of much-needed capital, particularly from developing countries.

According to the Advisory Committee, the predatory practices of vulture funds in relation to developing countries, particularly heavily indebted poor countries, have a long history.

The countries most commonly targeted have unsustainable debt burdens and lack both the capacity and the resources needed to face such complex and protracted judicial processes.

In recent years, vulture funds have aimed their profit expectations at middle-income countries, particularly Argentina.

With more than 50 lawsuits filed by commercial investors after the default of 2001, the country accounts for a third of the total number of lawsuits brought by vulture funds.


The Advisory Committee analysed a number of case studies to highlight the human rights impact deriving from the activities of vulture funds including Donegal International Ltd. v. Zambia; FG Hemisphere v. Democratic Republic of the Congo; and NML Capital Ltd. v. Argentina.

In NML Capital Ltd. v. Argentina, in the context of the deteriorating economic, financial and social situation that led Argentina to a catastrophic collapse in 2001, the Government, soon after defaulting, recognized the need to restructure roughly $81 billion of debt.

In two successive exchanges of offers, in 2005 and 2010, Argentina succeeded in reaching an agreement with more than 92 per cent of its creditors, which agreed to take an approximately 70 per cent "haircut" on their bond holdings.

A group representing 1.6 per cent of bondholders, led by NML Capital Ltd. (a hedge fund based in the Cayman Islands), refused to restructure and decided to sue the country in the New York State courts for the full amount.

Some of the defaulted bonds had been bought on the secondary market just before the country's default in 2001, but most were purchased afterwards, at bargain prices.

The vulture funds allegedly paid about $48.7 million for more than $220 million in defaulted bonds soon after the default; others were purchased even after the bond exchanges of 2005 and 2010.

In November 2012, a New York district court judge ordered Argentina to pay NML Capital and other "hold-outs" in full (about $1.3 billion), an amount that may represent a profit of about 1,600 per cent.

The court ruling was first confirmed by a decision of the United States Court of Appeals for the Second Circuit and subsequently endorsed by the Supreme Court, which stated that the country could not pay the creditors that had accepted the exchange offers until the "hold-out" creditors had been paid in full.

In February 2016, with a newly elected Government in office in Argentina, the United States court set a number of conditions for effectively lifting the injunction and allowing Argentina to service its restructured debts.

Events accelerated from then on and in April 2016, ceding to massive financial pressure, Argentina abruptly reversed its previous policy regarding the claims and agreed in an out-of-court settlement to pay $6.5 billion to the "hold-outs".

According to the Advisory Committee, that settlement represented a further setback in the process aimed at setting up an international sovereign debt restructuring mechanism based on the equal treatment of creditors.

"Paying vulture funds much more than was paid to cooperative creditors in previous debt restructuring is a disturbing outcome. Rewarding those who refuse to participate in debt restructuring efforts sends the wrong message," it said.

The case of Argentina is not an exception, but forms part of a more general trend, it added.

Increasingly, non-cooperative creditors are reaping extraordinary profits owing to settlements reached or judgments obtained after disruptive litigation.

Not only do investors' expectations of obtaining high returns by suing countries asphyxiated by onerous financial terms benefit from the lack of a global mechanism on debt restructuring, but they may also be at the origin of this state of affairs.

In fact, statistics show that lawsuits and attempted attachments are increasingly becoming a common way of solving sovereign debt disputes, entailing costly and protracted judicial processes for the defaulting State.

In the period from 1976 to 2010, there were about 158 lawsuits against 34 defaulting countries in the United States and the United Kingdom alone.

The high success rate (72 per cent) certainly encourages this worrying tendency. Since the 1990s, the percentage of debt crises involving litigation has grown from 10 per cent to almost 50 per cent.

Africa has been by far the most harassed region, with an average of eight cases filed every year. Not for nothing African countries have the lowest rate of winning cases and have disbursed more than 70 per cent of the nearly $1 billion awarded to vulture funds as a result of lawsuits.

In other countries particularly hit by the financial crisis, such as Ireland or Spain, vulture funds are developing speculative strategies in relation to non-performing private loans.

In that context, their strategy is quite similar: they acquire distressed real estate assets, taking advantage of the difficulties people are having to repay their loans to the banks and wait until the mortgage is in default.

In such a way, vulture funds progressively get a dominant position in the housing market that ends by allowing them to influence rents and house prices. Speculation drives up property costs and makes housing unaffordable for low-income households.

The report by the Advisory Committee noted that at present, only three countries, Belgium, France and the United Kingdom, have enacted some sort of legal framework to discourage disruptive litigation initiated by vulture funds.

Attempts to enact similar initiatives in the United States have failed so far.

While these national laws have played an important deterrent role, it is evident that concerns raised by the activities of vulture funds can only be effectively tackled if more countries pass national laws to limit their claims.

To avoid "forum shopping" strategies, regulation is particularly needed in those jurisdictions preferred by vulture funds for starting litigation or enforcing attachments, said the Advisory Committee.

National legislators may resort to useful guidelines deriving from existing domestic laws and experience of implementation, namely:

(a) protection should be extended to any debt-distressed country and not only to heavily indebted poor countries;

(b) procedures should allow for the identification of debts that are protected from the claims of vulture funds, on the basis of objective criteria;

(c) concerns about the socioeconomic situation of the debtor State and the well-being of its population should be adequately incorporated and addressed by the legislator; and

(d) issues regarding the lack of transparency in the secondary debt market and the operation of vulture funds in tax havens should be also tackled.

The Advisory Committee noted that a growing consensus on the need to curb the activities of vulture funds has emerged over the past 10 years.

A number of States have expressed in several forums their support for undertaking common actions aimed at protecting heavily indebted poor countries from vulture funds and, more generally, at the establishment of an international mechanism for orderly debt restructuring.

Responding to the increasing demand for international action, in September 2014, the UN General Assembly adopted its landmark resolution 68/304 entitled "Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes", in which it called for a legal framework aimed at facilitating the orderly restructuring of sovereign debts and capable of deterring creditors from disruptive litigation.

One year later, the Assembly endorsed a set of principles that should guide the establishment of an international orderly sovereign debt-restructuring workout.

In view of the efforts and the progress made over the past years, it is difficult to understand the reasons behind the current political deadlock in the process aimed at setting up a debt-workout institution, building on General Assembly resolution 69/319 on Basic Principles on Sovereign Debt Restructuring Processes, said the Advisory Committee.

It noted that in April 2018, the European Parliament insisted on the need to set up an international debt-workout mechanism capable of solving debt crises in a fair, speedy and sustainable manner.

According to the resolution adopted by the EU Parliament, the road map on sovereign debt workout developed by the United Nations Conference on Trade and Development (UNCTAD) and the proposal to establish an international debt-restructuring court should be at the heart of the new mechanism.

Meanwhile, vulture funds make the most of the absence of an international regulatory framework by exploring new ways to enforce the terms of their sovereign bonds, particularly through the international investment arbitration system.

Despite the fact that the system is not designed to hear disputes over financial assets, it seems that arbitrators have opened the door to speculative claims, said the Advisory Committee.

The report by the Advisory Committee highlighted the following impacts of the activities of vulture funds on human rights: hindering the capacity of a State to fulfil economic, social and cultural rights; jeopardizing international poverty reduction initiatives; contributing to increased debt service; and undermining the realization of the Sustainable Development Goals.

The Advisory Committee recommended that the Human Rights Council maintain the issue of vulture funds and human rights on its agenda in order to assess the impact of their activities on economic, social and cultural rights and the right to development, and support further initiatives aimed at identifying and curtailing illegitimate activities by vulture funds.

The Advisory Committee further recommended that the Human Rights Council adopt a new resolution, following the examination of the present report, entrusting the Advisory Committee with the follow-up to this issue, with a view to making concrete recommendations to States and relevant stakeholders.

A further study reviewing relevant national legislation and case law, as well as good practices, would help States in the process of establishing an adequate legal framework, it said.

The Advisory Committee also recommended that Member States enact legislation aimed at curtailing the predatory activities of vulture funds within their jurisdictions.

Domestic laws should not be limited to heavily indebted poor countries but should cover a broader group of countries and apply to commercial creditors that refuse to negotiate any restructuring of a debt.

Claims that are manifestly disproportionate to the amount initially paid to purchase a sovereign debt should not be considered, it said.