Patricia Adams
North Carolina International Law and Commercial Regulation, Volume XXXII, 5/10/2007
November 2, 2007

This is Jeff King’s second major work on the doctrine of odious debts, the first being the landmark study he produced with Ashfaq Khalfan and Bryan Thomas on behalf of the Centre for International Sustainable Development Law at McGill University in 2001 (and finalized in 2003). Like the first, this one is full of important legal history and arguments that odious debt advocates will want to know.

Here are some of my favorites. Critics of the doctrine often argue that since so many countries have repaid debts that might be classed as odious – for example, South Africa after apartheid and the Philippines’ repayment of the Bataan nuclear reactor – that this “state practice” in effect has established a rule of international customary law that debts must be repaid. Not true, says King. “At all times in the history of sovereign debt, there has been a set of overpowering incentives and threats associated with payment of sovereign debt to creditors in a position to punish defaulting sovereigns,” King says, including political recognition, institutional membership, access to military aid, trade markets, and drawing rights at the International Monetary Fund and World Bank, or fear of ostracization in capital markets. The fact that a debtor repays a debt for these reasons is not sufficient to establish a binding legal rule: it must be shown that they feel legally obliged to do so. Indeed, the absence of an established undermines the argument that the repayment of such debts was accepted as law. Critics also argue that the absence of an “odious debt” claim is evidence that the concept will not hold legal water. Again, King doesn’t buy it. States have not, nor need they declare that they are applying the odious debt doctrine when they use various sources of law to prove that the disputed debts were contracted in the absence of benefit, consent and with creditor awareness. “The term odious debt is merely a label provided by Sack” to identify such loans. King goes on to list examples of state practice where nations have refused to repay debts they considered odious without actually referring to them as “odious debt,” including the non-apportionment of Spanish debts relating to the repression of an independence struggle on the island of Cuba (1898), the Soviet repudiation of Tsarist debts (1918), and the non-apportionment of Prussian debts relating to the colonization of Poland (1919), among others.”

Odious debts critics love to say that it is nearly impossible to define the doctrine of odious debts’ “absence of benefit” criteria. Not so, says King, “The law is rife with judicial interpretation of vague terms” (such as “reasonableness” in tort law, the “rationality” standard in English administrative law, and so on). Notions of “public purpose” and “public benefit,” he says, already play a role in public law and courts engage in review of them. “American public law, for instance, has recognized that the raising of taxes must be for public purposes, and that by extension, any public debt that will be financed out of public tax money must itself be for public purposes” – and has been litigated in various states, he adds. (This notion – that taxes must be used for public purposes – seems so obvious that one wonders how the development experts at the World Bank missed this fundamental rule of good governance when they let the estimated $100 billion of their loans – in effect deferred taxes – “leak” to corruption.)

King then explains that judiciaries usually defer on the definition of public benefit in cases where the decision-maker is democratically accountable. On the flip side, however, judiciaries may well expect a higher standard of due diligence by lenders considering loans to undemocratically accountable decision-makers.

As for stopping future odious debts, King pulls apart the most talked about proposal in circulation by Michael Kremer, Seema Jayachandran and Jonathan Shafter and proposes a different way for lenders to “odious debt proof” their loans.

The Kremer-Jayachandran-Shafter proposal would create an international institution to designate certain regimes as odious in order to stop future egregious odious debts and to provide stability in international financial markets. This would thereby put lenders on high alert that, in the absence of super due diligence, they might lose their claim to repayment. Bad idea, says King. Such an institution, consisting of states acting in their own self-interest and never on the basis of impartial assessments (much as the World Bank and IMF now does), would designate very few regimes as odious. Secondly, King says, declaring a regime, rather than a set of actions, to be “odious” would be “a rather ‘nuclear’ type of option and … unlikely to be deployed until the regime reaches pariah status.” Thirdly, and here King makes a point long argued by Probe International, if a regime is not designated “odious,” a creditor can rely on this when lending to it and justify their actions as “due diligence” when, in fact, “it would eliminate the need for any diligence at all.” (Probe International has gone further and argued that receiving the Good Housekeeping Seal of approval from the proposed odious regime designator would protect creditors from odious debt actions by aggrieved citizens and encourage moral hazard on the part of lenders – perpetuating, and even entrenching, the current situation.)

Instead, King proposes a three-step, predictable, and cost-effective procedure for lenders to odious debt proof their loans.

Firstly, leaders should ensure consent of the borrowing public by establishing whether governments were elected by free and fair elections – for example, by reviewing evaluations of specially appointed UN monitors, U.S. Department of State human rights reports, international media coverage, the Economist Intelligence Unit, etc.

Secondly, when dealing with non-democratic regimes, lenders should stay away from loans for general, unspecified purposes, military purchases, or loans that can in any way be linked to forms of subjugation. Meanwhile, lend to purposes that are part of an integrated development plan. (I would add a note of caution here that apparently worthy projects in integrated development programs, such as roads, bridges and dams, are often chosen, not because they are the best investment for development, but because of the corruption opportunities they provide the public decision-makers: Chinese citizens have captured the essence of this problem in their reference to “silver roads, golden bridges, and diamond dams.”) To this King suggests a solution in the form of an accountability regime that segregates funds and audits them regularly.

Thirdly, and here is where King’s experience in Wall Street corporate law helps: lenders should conduct bona fide pre-negotiations assessment of the borrower, demonstrate good faith in determining the purpose of the loan by explicitly identifying the use of funds and incorporating into the agreement any needed representations and warranties about not applying funds towards dubious circumstances, and record such commitments in minutes. “None of this is beyond the powers or competency of any corporate law firm now involved in sovereign lending. The added costs would be marginal.”

“It must be recalled,” King says, “that these additional requirements arise where creditors deal with non-democratic regimes. Is this too high a transaction cost when lending money to dictators? Hardly.”

Given the extraordinarily high costs of repudiation, King says, “and the relatively easy procedural scheme presented here, there is no reason to think that creditors could not take this step and increase the security of their credit arrangements without prompting any greater market instability.” Most banks or domestic corporate lenders conduct much the same type of diligence in day-to-day lending, he says, as do private companies doing business in foreign countries where there are significant investment risks. “In short, it makes business sense,” King adds. “More importantly, perhaps, creditors may well live up to a moral responsibility that no one publicly doubts: to ensure that they do not lend support to non-democratic regimes that are harming or defrauding their own populations.” Case closed.

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