New York State lawmakers are proposing a bill known as the Sovereign Debt Stability Act (Assembly Bill A2970A/Senate Bill S5542A) which aims to fundamentally alter the landscape of sovereign debt restructuring. The practice of sovereign debt restructuring as it currently stands is complex and involves multiple players and processes for various types of debts. Traditionally, sovereign debt restructuring has been governed by a mix of contractual provisions, informal negotiation processes and the involvement of international organizations like the International Monetary Fund (IMF), World Bank, and groups of major creditor states such as the Paris Club and more recently the G20 countries, including under the Common Framework. This new legislative initiative aims to centralize the process for sovereign debt restructurings by introducing a mechanism for the restructuring of sovereign and subnational debt governed by or enforced under New York law. Considering New York law and courts’ important role in emerging market sovereign debt, the enactment of this bill would have a significant impact.

Key provisions of the Sovereign Debt Stability bill

A new restructuring mechanism. The bill proposes a new Article 8 in the New York Banking Law, enabling sovereigns facing financial difficulties to file a petition for debt restructuring with the State of New York. The bill introduces the “independent monitor” as a key player overseeing the process and facilitating a fair and effective agreement between the sovereign debtor and its creditors. The independent monitor is described in the bill as an individual appointed by the New York governor in consultation with the United States Department of the Treasury, and its appointment will require acceptance by both the sovereign debtor and the holders of a majority of the obligations issued under New York law.

Section 223 claims. For the first of two types of claims under the bill — the so called Section 223 claims — the debtor state is required to file a petition for relief, which initiates the restructuring process. This includes notifying creditors, reconciling debt amounts, and submitting a restructuring plan that categorizes different classes of claims. Majority voting principles apply to the amendment of payment terms within each class, effectively allowing for the restructuring terms to be imposed on all creditors once approved. The approval and implementation of a restructuring plan under Section 223 operate both retroactively (except in connection with sub-sovereign debtors) and prospectively and overrides any contractual provisions inconsistent with the provisions of Article 8.

Section 230 claims. Section 230 claims (limited to claims “enforced” under New York law, as opposed to “governed” for Section 223 claims, the distinction being that Section 230 claims seem to require that the New York jurisdiction be available to creditors to enforce their rights under the debt instruments in question regardless of the governing law of the debt instrument itself) pertain to a subset of sovereign debt that the sovereign debtor elects to subject to a limitation on recoveries. This limitation is based on the principle that recoveries on these claims should not exceed what would have been applicable if the claims had been held by the United States itself, and if those claims were the subject of an international debt relief initiative or mechanism (such as the HIPC initiative, the DSSI, the Common Framework and/or the Paris Club). The aim of Section 230 is to align the recoveries on certain sovereign debt claims with the outcomes of international debt relief efforts, ensuring that the burden of debt relief is shared equitably among all creditors. A key feature of Section 230 is the sovereign debtor's ability to elect which claims fall under this category, providing flexibility in tailoring the restructuring to specific needs. The debtor state can also change its election only once before the restructuring plan becomes effective, allowing for an adjustment based on evolving negotiations.

Enhanced seniority for the financing of the restructuring. The proposed bill allows for new financing to be raised with majority creditor approval, granting such new financing higher payment priority over existing claims (with no apparent distinction between secured and unsecured claims).  

Key considerations

Relationship with the IMF's Debt Sustainability Analysis. The Debt Sustainability Analysis (DSA) conducted by the IMF plays a critical role in assessing a country's financial situation and determining the extent of debt relief needed to restore debt sustainability. The bill's process for restructuring could potentially diverge from the IMF's DSA, as it allows sovereign debtors to initiate restructuring plans independently. This raises questions about how these plans will align with the IMF's assessments and whether they could lead to outcomes that do not fully reflect the international community's consensus on a country's debt sustainability need, causing possible disruptions in the negotiation process of Extended Credit Facilities with the IMF at the times when the sovereign has serious balance of payments problems.

Impact on preferred creditor status. Preferred creditor status (PCS) is a principle that exempts certain institutions, like the IMF, World Bank, and other multi-lateral lenders, from taking losses on loans in the event of a debt restructuring. The bill's provisions, especially those related to limiting recoveries (Section 230 claims), do not explicitly account for PCS, potentially affecting the willingness of institutions enjoying PCS to provide financial support to countries in distress. This could also impact the pricing and terms of loans from institutions enjoying PCS, as their exposure to losses in debt restructurings would be higher.

Seniority of new financing. The bill proposes that new financing provided during a restructuring process should be given legal seniority over existing claims (with no apparent distinction between secured and unsecured claims). While the intention is to facilitate the flow of fresh funds into distressed countries, there are concerns about how this seniority will interact with the PCS of traditional multilateral lenders and the overall creditor hierarchy. This could challenge the IMF's lending practices, as the IMF typically requires a senior position to safeguard its resources.

Strategic flexibility. Debtor states are granted the ability to strategically classify their debts as either Section 223 or Section 230 claims, potentially leading to a selective approach that favors certain debts or creditors over others. This could lead to market perceptions of increased risk in lending to sovereigns, especially those with distressed debt profiles. If creditors perceive that their claims could be subject to unfavorable treatment or forced into a restructuring mechanism with uncertain outcomes, they may demand higher yields on sovereign debt or become more hesitant to lend, which could have broader implications for economic development and financial stability in these countries.

Final thoughts

The path to enacting the proposed bill involves a comprehensive legislative process still in early stages. The bill's predecessors did not progress to a full floor vote in either legislative chamber last year, indicating the challenges ahead for this proposal. The legislative landscape, however, may shift significantly later this year as both chambers of the New York State Legislature are up for election on November 5, 2024.

As this is an ongoing development, we will continue to monitor the situation closely and provide updates on significant changes. While the proposed bill seeks to introduce significant reforms to the sovereign debt restructuring process, it is advisable for investors, creditors, and other stakeholders to closely monitor developments and assess the potential impacts on their portfolios and strategies. We recognize the unique challenges and opportunities this bill presents. We are committed to providing you with strategic legal advice and support as you navigate the complexities of managing your sovereign debt in light of these proposed changes.

For further details on the Sovereign Debt Stability Bill and its potential impact on your interests, please do not hesitate to contact us.

Authored by Bruno Ciuffetelli, Evan Koster, Ron Silverman, and Juan Moreno.