“The majority of the debts that Iraq has inherited from the regime of Saddam Hussein, I believe, are odious in law, and thus not legally enforceable.”International conference on Iraq and debt relief in Berlin, Germany
March 16, 2004

Thank you. It is my honour to be here with you to discuss this very important subject.

I have been asked to discuss the legal doctrine known as the Doctrine of Odious Debts and how it relates to Iraq after Saddam. I will get right to the point. The majority of the debts that Iraq has inherited from the regime of Saddam Hussein, I believe, are odious in law, and thus not legally enforceable.

What are odious debts?

In 1927, a Russian professor of law named Alexander Sack, teaching in Paris, published the most extensive and the most important works on the treatment of state debts. Professor Sack was no radical. He had been a minister in the Tsarist regime and had seen the Bolshevik repudiation of the Tsarist debt. He believed that government debts should be repaid when a new government came to power. Otherwise, he said, chaos would reign in relations between nations and international trade and finance would break down.

But he also believed there was one exception to this rule. Sack believed that debts not created in the interests of the state should not be bound to this general rule.

Some debts, he said, are odious.

And he defined an odious debt this way:

“If a despotic power incurs a debt not for the needs or in the interest of the State, but to strengthen its despotic regime, to repress the population that fights against it, etc., this debt is odious for the population of all the State.”

In this case, Professor Sack said, “the creditors have committed a hostile act” against the people. They can’t therefore expect that a nation freed from a despotic power will assume the ‘odious’ debts, which Professor Sack called “a personal debt of the power that has incurred it.” When this power falls, he said, the debt “consequently . . . falls with the fall of this power.

Though he was writing 80 years ago, Professor Sack could have been talking about modern day Iraq. Today, there is a widespread recognition that the debts created by Saddam Hussein’s regime were used to finance weapons, palaces, and instruments of repression against the Iraqi people.

Saddam’s debts are classic “odious debts.”

How do we know? Well, we don’t know for sure. In fact, no one knows for sure exactly what the money was spent on. Official government statistics weren’t systematically kept; those that do exist aren’t precise and don’t add up; some documents have been looted, some bombed; and the creditors, by and large, aren’t talking. The World Bank and IMF haven’t been in the country since the 1980’s, hence the World Bank’s table on external debt leaves the line for Iraq completely blank. The IMF is carrying out a “debt sustainability analysis” and has contacted some 50 countries, requesting information about any outstanding debt and arrears owed to them by Iraq. But, the IMF admits, its “staff has no way of verifying this information.”

On the other hand, evidence is beginning to come in to indicate that since Saddam assumed the presidency of Iraq, he accumulated some $40 billion in overseas private assets, the country’s GDP was cut in half, and Iraq went from having no debt to being the most indebted nation in the world.

We are all familiar with the estimates of what Iraq owes: Debt claims against Iraq are thought to total approximately $120 billion. Of that, $42 billion is owed to the governments that form the Paris Club, $60-$65 billion is owed to non-Paris Club sovereign creditors, and the balance – $3 billion to commercial banks and $12 billion to corporations – is owed to the private sector. What is so striking about Iraq’s creditors, is that they are mostly governments. Iraq’s debt crisis was caused by governments – the German government, the French government, the Russian government, the American government – that lent money according to political criteria, not market criteria. As one prominent American commentator put it in the Wall Street Journal, “All of it had to do with politics, in one way or another.”

What is Iraq to do?

I believe Iraq should resolve its debt crisis, not by pleading for mercy from its creditors, but through arbitration according to the rule of law. The new Iraqi administration should not agree to repay any debt incurred by Saddam’s regime until creditors submit proof of the legitimacy of the debts.

In requiring this proof, the Iraqi people do not need, nor should they feel compelled to seek, approval from those governments or from international bodies such as the U.N., the Paris Club, the World Bank or the IMF. Because they are supported by the rules of natural justice for minimum standards of fair decision-making: The Iraqi people are entitled to be informed about the claims against them, in detail, not just in aggregate; they are entitled to a fair hearing in which they can make legal representation; and they are entitled to a unbiased adjudication of claims in which no adjudicator has an interest – pecuniary or proprietary – in the outcome.

This would rule out the Paris Club.

In the world of international finance, bad public sector loans are negotiated at the Paris Club, a group of major creditor governments coordinated by the French finance ministry. The Paris Club operates in secret and informally, avoiding embarrassment to lenders and borrowers alike. Government creditors bring their claims to the Paris Club table, but only in aggregate form, not on a loan by loan basis. These creditors would prefer to write-off Saddam’s debts in this closed environment to avoid the alternative – an embarrassing public challenge. The Paris Club would cover-up the West’s odious loans to Saddam, and Paris Club members would bury their politically-motivated mistakes under the guise of “an orderly restructuring process” based on what they decide is Iraq’s ability to pay, rather than on the rightness of Iraq having to do so.

The Paris Club machinery is well in motion for Iraq, with some discussion of up to 80% of Saddam’s debts being written off. But Iraqis should beware of conciliatory creditors enticing them to the Paris Club. This club would treat the debts of Saddam Hussein’s regime as debts of the Iraqi people, legitimizing them in the process.

Instead of accepting a backroom political deal in which the creditors are the judges and Iraqis have to plead for mercy, the new Iraqi government should follow the rule of law to determine the validity of the claims against their people. It should do this by launching an arbitration process that determines just who financed the regime of Saddam Hussein and exactly where the billions upon billions of dollars went.

Here is how it could do it.

First, in order to establish the extent of legitimate debts – i.e. those that were used in the interest of the state – Iraq should conduct a fact-finding. The new Iraqi government could do this by inviting creditors – the only party that has documentation – to make claims, through a public forum such as an Internet site. This satisfies the first rule of natural justice.

The government could then make arrangements to pay those debts it finds legitimate and invite an arbitration for those it considers “odious.”

There are well-established arbitral procedures for the resolution of international disagreements that could be used, including the United Nations Commission on International Trade Law. Under such rules, Iraq and its creditors would choose arbitrators to constitute a tribunal and agree on the set of legal standards. In whatever arbitral process is chosen, the doctrine of odious debts would be just one principle used. Other legal and equitable principles relating to representative capacity, fraud, corruption, unjust enrichment, as well as general principles of private law, would guide the arbitrators in their decision-making.

In order to establish its legitimacy and thus the legitimacy of its decisions, the Tribunal’s proceedings must be conducted in public.

Iraq could also, to demonstrate its good faith, place a portion of the debt money into an escrow account for payment of arbitral awards.

Creditors who didn’t like this course of action by Iraq could sue for repayment in the jurisdictions specified in each contract. But they would by no means be assured of success in court. For one thing, if the debts were odious, the associated contracts may well have been odious too, allowing Iraq to challenge the jurisdiction specified in the contracts. Those creditors who could demonstrate that their loans were used in the interest of the state would have nothing to fear.

Knowing that the Iraqis would demand proof of how the money was spent, and that details of the loans would be available in a public forum, many creditors – particularly the public lenders that provided Saddam’s regime with most of its funds – might simply not submit their claims at all.

Conceivably, the great majority of debts could be found to be illegitimate, leaving Iraq with a manageable debt load that it could refinance without aid of Paris Club “relief.” If it does need relief, the relief should be for legitimate, not illegitimate debt.

This process, as recommended by Alexander Sack, would not allow an arbitrary or unilateral repudiation of debts, but rather one that was subject to due process of law.

Some creditors have issued dire warnings of financial doom for Iraq if it pursues an odious debt arbitration. This is nonsense. Others will cry foul and threaten a financial boycott of Iraq should it pursue odious debt arbitration. The new Iraqi government should ignore them.

Mark Medish, former deputy assistant secretary of the U.S. Treasury, and now a lawyer in private practice representing some of Iraq’s creditors, called an odious debt arbitration “misguided.” It would be bad for Iraq, he argues, and “would set a damaging precedent for the international financial system. . . . For Iraq to normalize its external financial relations, it must respect one of the first principles of the rule of law: contracts should be honored. Without this presumption, markets cannot work,” he said, and chaos would ensue.

Quite the opposite would happen.

Because the corollary to Mr. Medish’s first principle of law, that “contracts should be honored,” is the principle that “illegitimate contracts need not be honored.” In order for creditors to claim this first principle of law, they have a prior duty to establish the legitimacy of a contract.

Rather than undermining respect for the rule of law, an odious debt arbitration would employ the rule of law.

The process would give creditors the chance to produce evidence that the proceeds of their loans were used for legitimate public purposes. This “due diligence” is neither unusual nor onerous. Indeed, in much lending and project financing today, the lenders know the purpose of the loan and an elaborate set of representations and warranties binds the borrower. Funds are disbursed periodically as conditions are fulfilled. When conditions are not fulfilled, the loan is canceled and the debt becomes due immediately. The legitimacy or illegitimacy of such loans can readily be determined. Under an Iraqi debt arbitration, if creditors could establish this due diligence, then their claims would be upheld as legitimate. If they couldn’t, then their claims must fail.

International finance would be well-served by this precedent.

An arbitral process for Iraq’s debts would demonstrate to lenders that the legitimacy of a borrower matters. It matters if the borrower is a Saddam Hussein, because extraordinary diligence is required to create binding financial obligations. So, too, does the use to which funds are put matter. Lenders need to beware. They would learn that, if their funds were used to buy weapons, palaces, and instruments of repression, under the doctrine of odious debts, their claims would be legally unenforceable.

The doctrine of odious debts would promote creditor scrutiny of loans of an allegedly public nature. It would discourage reckless lending, and it would provide diligent creditors with security vis-à-vis future loans.

Today, most lenders to distasteful governments assume that, no matter how heinous the governments’ nature and expenditures, these countries will force their citizens to repay debts. This expectation has created moral hazard in sovereign borrowing, leading to risky loans and chronic loan defaults. In contrast, the doctrine of odious debts would help eliminate that moral hazard by distinguishing between debts that are tied to a regime and thus fall with the regime, and debts that would survive the regime. By clarifying the responsibilities of creditors or borrowers, and thus their rights to repayment or repudiation, an odious debt arbitration would help eliminate the moral hazard that has destabilized international finance for the past 60 years.

As for Iraq, the critics are wrong to predict that Iraq would be hurt if it resorts to due process and the rule of law to settle claims against its people. Rather, the stability and predictability created by the rule of law would attract international capital and promote diversified and healthy market activity. And international capital markets will figure out quickly enough that future loans and bonds can easily be made “odious debt-proof” with due diligence.

Meanwhile, the Paris Club alternative to a public arbitral process – closed door negotiations by creditors who decide on Iraq’s ability to pay – would spawn conspiracy theories, breed cynicism, and, I predict, be deeply resented by Iraqis. The Paris Club alternative would appear to be no more than an international fix in which Iraq’s resources were pawns of the creditors, including Russia, Japan, France, Germany, and the U.S.

More profoundly, by giving creditors an incentive to lend only for purposes which are transparent and of public benefit, future Saddams will lose the ability to finance their armies and their foreign bank accounts. And that would be profoundly good for future generations in Iraq and elsewhere.

Thank you.