United States: Enforcement Case Of The Month: Hamilton Reserve Bank v. Sri Lanka – Even Better For Sovereigns Than An International Bankruptcy Regime?

One of the significant risks that creditors weigh when deciding whether to lend money is bankruptcy risk: can the borrower use the bankruptcy laws to discharge the debt or compel the creditor to accept less than it bargained for? In the sovereign debt market, it has been an article of faith for creditors that states cannot file for bankruptcy and obtain such relief. But a recent ruling from the U.S. District Court for the Southern District of New York—Hamilton Reserve Bank v. Sri Lanka—may cause creditors to question that faith, with uncertain consequences for sovereign creditors and borrowers alike.

States, like private companies and individuals, need to borrow money to finance investments. Without a private market for sovereign bonds, many countries would be unable to raise money to build the roads, bridges, canals, airports, and power plants needed to improve their populations' standard of living. In this sense, sovereign debt makes the world go around.

But sovereign bonds differ in important ways from the debt issued by private companies. Sovereign debts are unusually difficult to collect through the usual legal channels, because of sovereign immunity doctrines in most jurisdictions. Yet unlike private companies and individuals, sovereigns can't file for bankruptcy and have their debts discharged or forcibly written down.

As a result, when sovereigns do not pay their private debts, a peculiar dynamic ensues: creditors want to maximize their recovery, but have few tools to do so, while sovereigns are reasonably safe from seizure of their most important assets, but lack the tools of bankruptcy to eliminate the liability entirely. Caught between these book-end principles, sovereigns and their creditors maneuver for leverage in restructuring negotiations, which ordinarily include not just private creditors, but also public creditors (i.e., other sovereigns) and multilateral institutions, like the IMF or World Bank.

This article focuses on a recent case that could disturb the balance in these negotiations. Indeed, the decision in Hamilton Reserve Bank v. Sri Lanka, rendered the U.S. District Court for the Southern District of New York—a key forum for sovereign debt disputes—may weaken one of the few tools creditors have to create leverage, putting a thumb on the scale of sovereigns in restructuring negotiations.

How so? The decision in Hamilton Bank may come to grant sovereigns one of the key benefits of bankruptcy—a stay of enforcement actions from creditors—without imposing any of its obligations. If this precedent becomes a trend, it could alter the characteristics of sovereign debt, with unknown consequences for a large market.

The saga of Hamilton Bank begins in 2012, when Sri Lanka issued $1 billion of bonds maturing in 2022. Over the last few years, Sri Lanka's debt rose to unsustainable levels, and, on April 12, 2022, its ministry of finance announced a moratorium on foreign debt repayments.

On March 20, 2023, the IMF approved $2.9 billion in assistance for Sri Lanka. The IMF program requires Sri Lanka to restructure its debts with both private creditors and "official" creditors—sovereigns that have traditionally negotiated restructurings through the Paris Club, an informal group of 22 countries, including the U.S. One of the key principles of the Paris Club is that the debtor must seek "comparability of treatment" between official and private creditors.

Hamilton began to buy Sri Lanka's debt in August 2021, ultimately acquiring more than $240 million of these bonds. After Sri Lanka declared a moratorium on repayments, Hamilton filed suit in the Southern District of New York seeking more than $250 million in principal and accrued interest.

On July 17, 2023, Sri Lanka requested a six-month stay to allow it to conclude restructuring negotiations with official and private creditors. France and the United Kingdom filed an amicus brief on September 6 supporting Sri Lanka's request for a stay. And the U.S. filed a statement of interest on October 2 similarly supporting the request—a position in some tension with prior practice in other cases. ¹

On November 1, 2023, the Court granted Sri Lanka's request and stayed the litigation for six months. There is a more-than-passing resemblance between the stay granted in Hamilton Bank and the automatic stay in a bankruptcy. Both give a debtor "time and space to conduct a restructuring"² by stopping creditors in their tracks. But the U.S. bankruptcy regime imposes obligations in exchange for that "time and space"—notably the requirement to disclose a debtor's financial condition, assets, and liabilities, as well as increased scrutiny on the disposition or sale of assets for a bankrupt entity. Sri Lanka has obtained a de facto bankruptcy stay as to its bondholders without assuming any of these obligations.

Of course, the stay in Hamilton Bank is (for now at least) limited to only six months' duration. It remains to be seen whether Sri Lanka will claim six months hence that negotiations remain ongoing. It also remains to be seen whether the Court would credit that assertion a second time. Nevertheless, the prospect that bondholders could be prevented from reducing their claims to judgment while a sovereign negotiates with other creditors has the potential to alter the dynamics of restructuring involving debt with a New York forum clause.

Beyond this macro concern, there are also several discrete conclusions in the Hamilton Bank decision that could prove problematic for sovereign debt holders wishing to enforce their rights.

For one, while the Court recognized "that a stay will prejudice the plaintiff's ability to obtain a prompt judgment,"³ it reasoned that this prejudice is "limited" by the fact that "if Hamilton prevails on its claim at some future date, any judgment will be subject to pre-judgment interest."⁴ But this assumes the conclusion that a judgment debtor will pay the judgment debt and prejudgment interest. Unfortunately for creditors, that assumption is not a safe one—particularly where, as here, the debtor has a history of not paying its debts, and limited mechanisms exist to compel it to do so, because it is a sovereign.

Second, the Court found that a stay was merited to avoid a "'rush-to-the-courthouse' by private creditors" attempting "to secure priority."⁵But having resort to the courthouse—and the limited enforcement mechanisms available from U.S. courts—is a benefit of the bargain that creditors obtain when lending money. Depriving creditors of the ability to reduce their claims to judgment (a right that sovereigns expressly grant to holders of their bonds) forces creditors to play with one hand tied behind their backs.

Finally, while the Court emphasized that the stay did not render Sri Lanka's debt "unenforceable" and "does nothing to vitiate Hamilton's pre-existing contractual rights,"⁶ that distinction is likely to be of little comfort to creditors. Creditors' "pre-existing contractual rights" are of scant value unless there is a remedy available to vindicate them. Justice delayed is justice denied, and eliminating any timely remedy plainly diminishes the attendant right.

In sum, the precedent set in Hamilton Bank—providing sovereigns with a de facto bankruptcy stay in restructuring scenarios—may create ripples in in sovereign restructurings and, as a result, in the sovereign debt markets themselves. This impact would be compounded if Sri Lanka obtains a further stay if restructuring negotiations are not concluded within the six-month window set by the Court. Unfortunately, orders granting a stay are not ordinarily appealable unless the stay is so extended as a constitute a de facto dismissal of the claim, and so the Second Circuit will not have an opportunity to weigh in—unless other, further stays are granted. Creditors with claims against sovereigns would be wise to watch with interest whether the decision in Hamilton Bank becomes a trend that complicates their efforts to enforce their rights in the future.

Footnotes

1 See, e.g., Pravin Banker Assocs. v. Banco Popular Del Peru, 109 F.3d 850, 855 (S.D.N.Y. 1997).

2 Hamilton Reserve Bank Ltd. v. Democratic Socialist Repub. of Sri Lanka, No. 22 Civ. 5199 (DLC) (S.D.N.Y. Nov. 1, 2023), ECF No. 77 at p. 14.

3 Id. at 10.

4 Id.

5 Id.

6 Id. at 13-14.

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