Zambia: Let the looters pay the vultures

Odious Debts Online
February 28, 2007

A recent British high court ruling that permits a so-called “vulture fund” to pursue an enormous profit on its purchase of Third World debt from Zambia has provoked a backlash from global debt campaigners. However, U.S. law professor Larry Cata Backer argues that, within an odious debts context, the fund ought to be able to seek repayment but not from the people of Zambia.

The case and the moral outrage

Debt campaigners have denounced a London high court ruling that permits Donegal International, a so-called “vulture fund,” to enforce its claim to payment from Zambia for sovereign debt Donegal had bought more than a decade ago on the secondary debt market.

Vulture funds are companies that buy up the debt of poor countries cheaply, often at a time when they are negotiating unpayable debts, and then later try to reclaim the debt for its full value plus interest, sometimes by suing the country.

The claim against the government of Zambia arises from a $30 million debt it incurred with the Romanian government in 1979 for the supply of argricultural machinery. Zambia reneged on the repayments and eventually the outstanding debt was renegotiated to some $3 million. That’s when Donegal International stepped in and purchased the bad debt for under $4 million from Romania. Donegal then persuaded Zambia to agree to repay $15 million, an amount Donegal says has since been inflated by legal costs and interest to a whopping $55 million.

In the wake of the Zambian decision, debt activists have mounted campaigns to stop vulture funds like Donegal, which they say “swoop in on the worlds’ poorest countries in order to make a cynical buck out of their debts.” Campaigners argue that the high court ruling will also undermine Zambia’s poverty reduction efforts – the country received $4 billion of debt relief [PDF] from the Group of Eight rich nations in 2005 under an international debt relief scheme. That relief was supposed to enable Zambia – one of the world’s poorest countries – to use funds that would have gone to debt servicing to boost the country’s health and education infrastructure.

“Profiteering doesn’t get any more cynical than this,” said Caroline Pearce [PDF] of the Jubilee Debt campaign, who added that vulture funds make a mockery of the work done by governments to write off the debts of the world’s poorest.

Martin Kalunga-Banda [PDF] , a Zambian presidential adviser and consultant to the international development charity Oxfam International, said the amount of money Donegal could extract from Zambia was equal to all the debt relief the country had received last year.

“It means 30,000 children who would have benefited from going to school free will not be able to do so,” he said. “It also means the treatment, the Medicare, the medicines that would have been available to in excess of 100,000 people in the country will not be available.”

High Court Justice Andrew Smith, who ruled on the case, conceded that although the proceedings aroused “strong feelings” because “Zambia is a poor country and sees itself as being vulnerable to vulture funds,” his concern [PDF] was bound to “the legal questions . . . raised by the applications before me and not with questions of morality or humanity.”

It has also been alleged that the debt bought by Donegal has been “tainted by corruption and was purchased by Donegal from “behind the back of the [Zambian] government.”

Justice Smith found that international witnesses called by Donegal had been dishonest and unreliable. Mr. Smith described [PDF] Michael Sheehan, the American financier who owns Donegal, as “not merely careless but cavalier” in the presentation of his evidence and said that delays to the trial were to “put at its kindest” a result of some of Donegal’s witnesses being “less than candid.”

A BBC “Newsnight” investigative report claimed Mr. Sheehan offered to make a $2 million payment to Zambia’s then president Frederick Chiluba’s favourite charity at the time of the debt purchase, a payment Mr. Sheehan described as a “charitable initiative,” which Zambia’s lawyers have characterized as a “bribe.” White House officials have taken a particular interest in this aspect of the case.

After viewing the BBC “Newsnight” report, Washington’s powerful congressional judiciary committee chairman, Congressman John Conyers, brought the matter to the attention of President Bush. Although Mr. Sheehan, a U.S. resident, denies the payment was a bribe, it could still mean that Donegal falls foul of the U.S. Foreign Corrupt Practices Act.

“It’s our position that the Foreign Corrupt Practices Act and the comity doctrine brought from our constitution allows the president to require the courts defer in individual suits against foreign nations. And so, we’re conducting a couple of things,” said Mr. Conyers. “First of all, we want to know where these practices are going on at the present time, and, two, how we can get this information to President Bush so that he can, as he indicated to us, stop it immediately.”

Mr. Bush has the power to block the collection of debts by vulture funds, either individual ones or all of them, if he considers it to be at odds with U.S. foreign policy, in this case debt relief for poor countries.

U.S. law professor Larry Cata Backer, meanwhile, has brought an interesting legal perspective to the issue: the Zambian case, he says, highlights the clash when multiple systems of law and legal norms – one private and economic (to protect the integrity of capital markets for secondary debt) and the other public and political (to forgive certain debts in order to free up funds for development) – function simultaneously on different aspects of a complicated transaction.

The political community – debt campaigners, NGO activists, as well as Gordon Brown (the likely successor to British Prime Minister Tony Blair as leader of the Labour Party) – have characterized public debt speculators in secondary capital markets as “perverse and immoral [PDF] ” and suggest that such entities ought to have some sort of obligation to act in the interests of the state.

“We particularly condemn the perversity where vulture funds purchase debt at a reduced price and make a profit from suing the debtor country to recover the full amount owed – a morally outrageous outcome,” said Mr. Brown, in a 2002 address to the United Nations.

But, says Professor Backer, “this makes little sense.” The U.K., he says, “would hardly argue that Donegal International ought to act in the interests of stakeholders other than those with an interest in the entity. Donegal International is not a state actor.” Rather than browbeat Donegal for seeking a return on behalf of its investors, Backer suggests that if the debt is odious, “let the great insights of modern odious debt doctrine” take their course.

Let the doctrine do its job

In Odious Debts and Vulture Funds: Making a Case for Repudiation of Sovereign Debt [PDF] ,” Backer argues that Donegal ought to be able to seek repayment for its purchase of Zambian debt from the public officials who incurred the debt on behalf of the citizens of Zambia, but not for their benefit.

Backer says he has written how the doctrine “would distinguish between legitimate and illegitimate state debt on the basis of the purpose for which it was incurred. Debt incurred for the benefit of the nation, whether or not well used, would remain the obligation of the state. Debt incurred for the benefit of the agents of a state, whether as a consequence of corruption or for some other illegitimate purpose, would be deemed to be the personal debt of the agent, against whom the creditors could proceed. Creditors making loans to a state would have the obligation of satisfying themselves of the legitimacy of the loan before it is incurred.

“As a consequence,” continues Backer, “the application of the odious debt doctrine in this way can continue to support the integrity of the secondary capital markets – the Zambian debt can still be collected. But it also furthers international public economic policy – the Zambian state is relieved of the obligation for the debt, repayment falls to the party actually responsible for its incurrence, that is the officials who acting for their own interests purported to incur a debt for Zambia. Donegal International ought to be able to seek repayment of the debt – but only from the agents of the state for whose benefit the loans were made, and not against the Zambian state itself. In the future, Donegal International will assess the value of secondary market transactions with this in mind.”

In other words, Donegal International, and other vulture funds, would learn to beware: if the loans were to crooks, it is the crooks they must chase payment from.

“To the extent that issues of legitimacy and corruption play a greater role in the validity of debt contracts and to the extent that courts take seriously the separability of a state from its officials (and thus apply more vigorously an ultra vires rule) courts will begin to apply some of the great insights of modern odious debt doctrine. And that is a step in the right direction,” Backer added.

A further court hearing on the Zambian case is scheduled for March 9 to ascertain legal liability and cost. It is thought that the court will not allow Donegal to claim full repayment from Zambia and will likely set the amount closer to the agreed upon price at the time of purchase.

The case is being heard in the English courts because the purported settlement agreement stated that in the event of a dispute, the parties should submit to the English jurisdiction.

Read the High Court judgment in full

Further Reading:

The vultures that prey on the poorest: Britain is, at last, clipping the wings of the hedge funds that pick the bones of the world’s weakest countries. [PDF ver here] (The Independent, July 26, 2009)

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