sovereign insolvency, abusive lending, and distribution of losses

8/13/2019 Sovereign Insolvency, Abusive Lending, And Distribution of Losses

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Hauser Global Law School Program

ProfessorRichardStewartFacultyDirector

Global Law Working Paper 04/09

Juan Pablo Bohoslavsky

Sovereign Insolvency, Abusive Lending, and Distribution of Losses

NYUSchoolofLawNewYork,NY10012


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Allrightsreserved.Nopartofthispapermaybereproducedinanyform

withoutpermissionoftheauthor.

ISSN 1553-1724

JUANPABLOBOHOSLAVSKYNewYorkUniversitySchoolofLaw

NewYork,NY10012USA


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SovereignInsolvency,AbusiveLending,andDistributionofLosses

JuanPabloBohoslavsky

DirectoroftheLLMinGlobalAdministrativeLaw,UniversidadNacionaldeRioNegro


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Sovereign Insolvency, Abusive Lending, and Distribution of Losses

Juan Pablo Bohoslavsky1

Abstract

This article argues that there are legal and economic justifications for converting the responsibility for granting abusiveloans into a general principle of international law and, as such, that it can and should be applied to matters of sovereigninsolvency. It develops concrete legal and economic reasoning and mechanisms by which the financial losses that any sovereigninsolvency imposes on creditors should be distributed among them. Loans granted to states not following even the mostelemental precautionary guidelines with regard to the analysis of credit risk, and with the intention of diluting or takingunfair advantage at the expense of the other creditors, should be totally or partially subordinated to those not classified asabusive in the case of sovereign bankruptcy.

Key WordsSovereign Insolvency. Lending. Creditors. Abusive. Losses. Finance. Comparative Law.

Introduction

This paper examines some legal aspects of sovereign insolvency, focusing in general on the lack ofrules applied to this realm and, particularly, on the stage at which the financial losses (reduction of thedebt) of sovereign bankruptcy have to be distributed among creditors. It argues that a general principlethat is widely accepted in private lawthe so-called responsibility for granting abusive loansshouldhave an influence on the credit ranking system of sovereign insolvencies, and therefore on the amount ofmoney that each class of creditors collects in these collective procedures.

The first section describes the main flaws of the legal framework of sovereign insolvency. In thiscontext, it describes the poor, insufficient legal rules that govern the credit priority ranking that applies tocreditors when trying to collect from an insolvent state, and how this situation leads to inefficiencies and

abuses on the part of creditors and debtors. It also analyzes the relationship between thepari passuclauseinserted in public bonds and the parity of treatment principle that applies in bankruptcy law. Theinternational financial institutions preferences are critically analyzed.

Exposing actual concrete sovereign insolvency cases, the first section also explains how these legaldeficits have negatively impacted on particular creditors allowing, on the one hand, sovereign debtors toimpose excessively painful haircuts and, on the other hand, abusive creditors to take advantage of this atthe expense of the bona fideones. It also points out how the latest official and nongovernmental proposalsin the field of sovereign insolvency law ignore the collective action problems that are related to theseniority of the credits and to the very behaviour of the creditors.

The second section of the paper begins by introducing the basis of responsibility for grantingabusive loansemphasizing the way that the credit risk was assessed and the dishonesty of the lenderas a new principle to promote fair and efficient allocation of financial losses in the sovereign insolvency

realm. It briefly explains the methodological features of recognizing these general principles in

1Director of the LLM in Global Administrative Law, Universidad Nacional de Rio Negro, Patagonia, Argentina.This paper was produced during the postdoctoral fellowship at New York University School of Law during 2008-09.The author wishes to extend his gratitude to the Hauser programs academic and administrative staff for theirphenomenal support. Special thanks also go to New York University Professors Lee Buchheit, Richard Hulbert,Andreas Lowenfeld, Harvey Miller, Kunibert Raffer and Gerald Rosenfeld for their helpful suggestions and insights,particularly in reshaping early drafts of this paper. I also want to thanks all the participants at the April 1 st, 2009Hauser forum at NYU where this paper was presented and discussed. The views and conclusions reflected in thispaper are solely mine and are in no way intended to reflect the views of the aforementioned people.


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international law before launching into a comparative survey of how the American, Argentinean, Belgian,English, French, German, Italian, and Spanish legal systemsand their case lawstreat this principle ofresponsibility for granting abusive loans. This comparative analysis brings into view a crucial commondenominator: across the board, the bankruptcy laws of the countries studied stipulate that in a bankruptcyprocedure abusive creditors deserve to receive less money than prudent and honest ones.

The final section applies this general principle to the sovereign insolvency field. Abusive loans are

visibleas a representation of a collective action problem that comes with the insolvency of theborrowerwhen lenders grant excessive loans to the already insolvent sovereign trying to get unfairbenefits at the expense of aggravating the borrowers situation and diluting the other creditors. Departingfrom the analysis of the practical difficulties inherent in implementing this idea, the paper then proposes aviable way to introduce the new principle into real sovereign insolvency procedures. It also puts the so-called first-in-time rule next to the legal principle presented in this paper, to articulate the economicrationale of both legal rules in an interactive manner. The application of the principle proposed here tothe position of international financial institutions (IFI) is separately analyzed.

1. Distributing the financial losses of sovereign insolvency among creditors1.1. Institutional and legal framework of the problem

The idea developed in this work addresses one of the collective action problems related to creditorbehaviour in sovereign insolvencies:2 when creditors realize that the debtor will go bankrupt some ofthem try to take unfair advantage at the expense of others, aggravating the borrowers situation anddissipating both its assets and its ability to reorganize.

Even so, this paper does not ignore the problems of so-called debt intolerance; unproductive(inefficient and corrupt) use of loans by the borrowing government; opportunistic default; and therelationship that can exist between the coerciveness of the state as an insolvent borrower and the extentof the reduction of the debt. Since they represent serious problems of sovereign over-indebtedness, theyrequire diverse institutional and economic tools. Institutional changes on the debtor side, as well aschanges in the legal regulatory systems of creditors, are two necessary and supplementary mechanisms tolimit borrowing to a more cautious extent.3

There is some consensus among economic and legal scholars that the international financialarchitecture still needs to perform an important task: namely, to develop a functional sovereign insolvencyprocedure.4This should be one which, while balancing the interests of all parties, fulfils, at least to someextent, the following goals: maximize creditor wealth; solve inter-creditor collective action problemsbefore, during, and after the default of states; discourage opportunistic defaults; protect the debtor; andallow the debtor to fully recover. A balancing approach would thus coordinate debt collection, whileorganizing and rationalizing the decision-making process.5

There have been several academic proposals aimed at tackling these challenges,6 but only few ofthem have received official attention. The Sovereign Debt Restructuring Mechanism (SDRM) elaboratedby the International Monetary Fund (IMF)7and the Collective Action Clauses (CACs) proposed by the

2SACHS, Jeffrey, Do We Need an International Lender of Last Resort?,Frank Graham Lecture, Princeton University,1995, www2.harvard.edu/cidpapers/intllr.pdf; SCHWARCZ, Steven, Sovereign Debt Restructuring: A Bankruptcy ReorganizationApproach,Cornell Law Review, Vol. 85, 1999-2000, pp. 956-7.3REINHART, Carmen, ROGOFF, Kenneth & SAVASTANO, Miguel, Debt Intolerance,Brooking Papers on EconomicActivity, 1, 2003, p. 5.4SCOTT, Hal, A Bankruptcy Procedure for Sovereign Debtors?The International Lawyer, 37, 2003, pp. 103-135.5FLESSNER, Axel, Philosophies of Business Bankruptcy Law: An International Overview, in ZIEGEL, Jacob (ed.), CurrentDevelopments in International and Comparative Corporate Insolvency Law, Oxford, 1994, p. 24; SCHIER, Holger, Towards aReorganization System for Sovereign Debt, Martinus Nijhoff, 2007, pp. 118.6 ROGOFF, Kenneth & ZETTELMEYER,Jeromin, Bankruptcy Procedures for Sovereigns: A History of Ideas, 1976-2001,IMF Staff Papers, 2002.7 KRUEGER,Anne, New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking, April 1 2002,


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U.S. government8are the two main official approaches in the sovereign insolvency debate, representingboth statutory and contractual proposals.

Both models have received harsh criticism9. Regarding the SDRM, the most important obstacle isthat the IMF itself would be the (non)neutral authority which would administer the insolvency procedure,being creditor and judge at the same time. For the contractual approach, problems might arise from themajorities required to approve the modification of the contract terms since even cross- majorities clausesrisk

being exposed to abuse through vote manipulating (buying) by hold-out creditors and bad-faith debtors;furthermore, CACs do not include bank, multilateral or bilateral debt, so debt restructuring would not becomplete.

Surprisingly, both of these approaches fail to address one important aspect of insolvencyprocedures: efficient criterion or criteria to distribute the burden of the reduction of the debt (haircut)among creditors.

1.2. Credit-ranking in sovereign insolvency: an insufficient and difficult-to-enforce rule

In international law there is basically one theoretical guidelinecredit-ranking at the time ofpaymentthat relates to the distribution of financial losses derived from sovereign insolvencies, and itdoes not tackle the collective action problem with which this article is concerned. This deficit in the legalframework of sovereign insolvency also produces a notable void that market forces, sovereign interests,and experts try to fill.

The main rule that governs this field is the principle ofparity of treatmentof creditors in relation tocomparable debt.10This is a rule that comes from the very basis of most domestic bankruptcy laws. 11Because of practical borrower discretion when applying this principlebasically allowing them to decidehow to use their assets to pay their debtscreditors try to enforce this rule through specific clauses suchas the negative pledge, pari passu and sharing clauses,12which minimize (but do not eliminate) ex antetheimpact of the power of the state.13

Reflecting this idea of parity, we can find some informal rules related to credit-ranking if we lookat the practice of the Paris Club, which works on the basis of equitable burden-sharing as follows: eachsovereign creditor has to extend debt relief in proportion to its exposure to the debtor country and thedebtor is expected to seek comparable relief from the private sector.14

http://www.imf.org/external/np/speeches/2002/040102.htm


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The enforcement of this basic legal guidelinewhich rules the ranking of payments that aninsolvent sovereign should followis limited mainly by two factual circumstances. First, given thatsovereigns cannot be subjected to norms like chapter 7 (liquidation) of the US bankruptcy code, andthat they usually do not have assets abroad, they enjoy wide discretion in paying their creditors, oftenviolating informal or customary rules. Second, even these informal criteria applied by insolvent states arenot clear nor unanimously accepted by all the creditors, as they evolve and are constantly challenged.15For example, if the traditionally excluded creditors (from restructurings) form part of a large portion of the

debt stock, it is should be expected that these preferred categories would be subject to question.16The parity of treatment is altered in practice by the use of preferred treatment, given, for example,

to IFI credits, secured debts, trade debts, new credits, collateralized loans, and inter-bank deposit debts,among others. Each is grounded in political and economic reasons that would suggest the recognition ofits seniority. Given the nature of these reasons, this ranking evolves continuously, without paying muchattention to legal principles, as we will see bellow.

1.3. General system of priorities, realpolitik,and disorder

Apart from the weak parity treatment rule we just examined, there are no fixed formal rulesregulating credit preference ranking in cases of sovereign insolvency. Going back in history, if we observethe debt settlements reached during the thirties, there was no uniformity there either. In most cases the

agreements were not grounded in legal principles but in practical solutions to meet immediate needs.17The same phenomenon can be observed in the debt settlements reached in the last two decades.

Insolvent sovereigns do a cost-benefit analysis when deciding which debts to exclude fromrestructuring. This is the main reason why, for example, sovereigns try to take care of short-term trade:they are dealing with the countrys ability to participate in the international market.18The same reasoningexplains why some countries, in particular instances (such as Mexico in 1982), decide to exclude capitalmarket instruments from restructuring, because these markets are thought to have very long memories.19

We already saw that the main principle governing the system of priorities is equal treatment ofcreditors. Thus, discriminating among creditors would not only be incompatible with internationalfinancial tradition and justice,20 but also with the so-called pars conditio creditorum rule present in mostdomestic bankruptcy laws,and even in bilateral investment treaties.21

15 When in 1999 Ecuador defaulted its debt, it was logical to assume that the collateralized Brady bonds were goingto have priority over uncollateralized bonds. However, Ecuador opened the restructuring negotiations with theBrady bondholders first, apparently because these bonds gave the country a thirty-day grace period for not being indefault, seeEICHENGREEN, Barry & RUEHL,Christof, The Bail-In Problem: Systematic Goals, Ad Hoc Means, NationalBureau of Economic Research, Working Paper No. W7653, April 2000.16BUCHHEIT,Lee, Of Creditors, Preferred and Otherwise, International Financial Law Review, June 1991, p. 13. Thisprobably can occur with the domestic debt, since countries are now issuing more of this kind of debt, seeGELPERN,Anna, Building a Better Seating Chart for Sovereign Restructuring, Emory Law Journal, Vol. 53, 2004, p. 1136.17 FEILCHENFELD, Ernst, DE MAURY ELRICK, Earle & JUDD, Orrin, Priority Problems in Public Debt Settlements,Columbia Law Review, 30, 1930, pp. 1115.18CLARK,op. cit., pp. 857; ibid., Trade Debt in Sovereign Restructuring,International Financial Law Review, 3, 1984,pp. 33.19BUCHHEIT,op. cit. (1991), p. 12.20FEILCHENFELD, op. cit., p. 215.21For the fair and equitable treatment in foreign investment law seeLOWENFELD,Andreas, International Economic Law,Oxford University Press, 2008, pp. 556; MUCHLINSKI,Peter,Multinational Enterprises & The Law, Oxford UniversityPress, 2007, pp. 635. This field of law is now particularly important in sovereign debt restructuring since thousandsof financial creditors of Argentina sued it through the ICSID in order to collect their bonds. The cases are GiovanniAlemanni and others v. Argentine Republic,ICSID Case No. ARB/07/08 (claiming E 14.3) and Giovanna A. Beccara andothers v. Argentine Republic,ICSID Case No. ARB/07/05 (170.000 bondholders claiming US$ 3.5 billion). Analyzingwhether it is legally possible to use the BIT framework to invoke financial credits, seeWAIBEL, Michael, OpeningPandoras Box: Sovereign Bonds in International Arbitration,American Journal of International Law, 2007, Vol. 101, No.4, pp. 711.


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Despite the defective treatment of this principle by the IMF in its institutional proposal for aSovereign Debt Restructuring Mechanism (SDRM), even this institution appears to recognize theimportance of this rule. The SDRM has explicitly prohibited unjustified discrimination of creditor groupswhen the insolvent sovereign presents the classification of debts in order to negotiate and approve arestructuring.22

The restructuring process involves the allocation of payments over a long period rather than the

liquidation and distribution of a debtors present assets. This is why prioritization (and discrimination) canemerge in the form of at least three different kinds of acts: by paying a certain creditor or creditors first;by reducing their principal and interests less than that of others; and by applying an amortization scheduleproviding for complete liquidation before others.23

These kinds of decisions are taken at the early stages in restructuring procedures when the debtordecides, for example, which debts are going to be restructured and which are not.24This dynamic is not afixed practice, since creditors included in restructuring will try to ensure that even categories of debt thatare formally excluded be subjected to informal roll-over agreements.25In any case, after deciding whichcredits are to be restructured, the debtor, negotiating26 with its creditors, determines the terms of thehaircut.

Looking at different financial crises that have occurred over the past fifteen years, we can easilyconfirm that many sovereign borrowers have used their discretion to discriminate against creditors or

groups of creditors when dealing with the problem of inter-creditor equity.27

The most recent sovereigndefaults show that, within the same restructuring, the extent of the haircut varied greatly among differentclasses of creditors, without following any legal guide when doing so.28

In the current legal and institutional framework, sovereigns can enjoy wide discretionary faculties tonegotiate, reach agreement with their creditors, or just decide the terms of the restructuring and how itaffects each of them in terms of their place in the credit priority ranking. This prerogative is usuallyassociated with not only legal disorder in preference terms but also the idea of sovereignty itself.

Even respecting the very core of this notion of sovereignty, it is desirable for each party to developa minimal set of rules to govern the credit ranking process in a sovereign insolvency. There are severalnegative consequences of not having a clear and enforceable priority system.29First, some creditors maygamble on subordinating other creditors. Lenders may attempt to obtain de factopriorities by issuing debtsthat involve a very high credit risk through short maturities and dispersed bondholders, provoking highercosts for the borrower, higher risk of default, and higher transaction costs in the event of restructuring.Second, because creditors do not know whether they are going to be involuntarily subordinated, they cancharge this risk to the price of loans. Third, the borrower itself, trying to delay default, may be tempted totake excessive new debts and dilute earlier creditors. Fourth, a creditor may try to lend, but only backedby collateral. Fifth, because priorities and even collateral are difficult to enforce, creditors can try toshelter themselves with faster repayment schedules, provoking a roll-over crisis. Sixth, once financialdistress emerges, creditors will compete to catch the cash flows of the debtor, complicating and delaying

22 IMF, The Design of the Sovereign Debt Restructuring Mechanism Further Considerations, 2002, available athttp://www.imf.org/external/np/pdr/sdrm/2002/112702.pdf .23FEILCHENFELD, DE MAURY ELRICK, & JUDD,op. cit., p. 1144.24BRATTON, William, Pari passu and a Distressed Sovereigns Rational Choices,Emory Law Journal, 53, 2004, ps. 843-4;BUCCHEIT, op. cit., (2002), pp. 74.25BUCHHEIT, op. cit., (1991), p. 12.26To read about the aggressive style of the Argentinean government in negotiating the terms of its last default, seePORZECANSKI,Arturo, From Rogue Creditors to Rogue Debtors: Implications of Argentinas Default, Chicago Journal ofInternational Law, Vol. 6 No. 1, 2005, pp. 311.27GELPERN, op. cit., p. 1116.28ROGOFF & ZETTELMEYER,op. cit., pp. 792.29 BOLTON, Patrick & SKEEL, David, Inside the Black Box: How Should a Sovereign Bankruptcy Framework beRestructured?,Emory Law Journal, 53, 2004, pp. 788; GELPERN, op. cit., pp. 1116,1140; ZETTELMEYER,Jeromin,The Case for an Explicit Seniority Structure in Sovereign Debt,IMF, Research Department, Working paper, September29, 2003.


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the restructuring and, thus, the borrowers recovery. Finally, it has been pointed out that violatingabsolute priority in bankruptcy increases the bias of equity holders and managers in favour of riskierinvestments, because they know they will receive the benefits while creditors will bear the negativeoutcomes of this business.30

1.4. Equivalent treatment of creditors and thepari passuclause battle

Creditors have tried to limit the arbitrarinessor at least the impactof sovereign borrowers whenjeopardizing the payment of principal or interest. To this end (which fits in with others, such asdiscouraging rogue creditors) they have developed different contractual devices.31 The first one is thesharing-of-payment clause that ensures that if a lender receives a payment disproportional in comparisonwith the amount that other lenders receive from the common borrower, the latter can ask to have theexcess payment shared with them. The second clause is the so-called negative pledge that prohibits thelender from pledging its assets in favour of other creditors, precluding the preferential allocation ofassets.32

The third contractual device is the pari passuclause, which has provoked broad discussion in bothscholarly and judicial realms over the past few years, in terms of the extent of its interpretation. On theone hand, a narrow reading of this clause supports the idea that it is basically a promise that the financialobligation will always rank equally in preference of payment with all the other unsubordinated debts of

the borrower.33The borrower cannot modify (worsen) the legal status of the creditor in terms of ranking.This narrow reading of thepari passuclause has a historical explanation. The clause as we know it todayoriginated in the early seventies, when lenders were first becoming aware of the fact that the Spanish,Philippine, and Argentine legal systems explicitly permitted actions that had the effect of formallysubordinating existing debt to other debtor obligations. This would support this restrictiveinterpretation.34

On the other hand, some judicial cases have broadened this reading, holding that this clause alsocompels equal treatment. The most famous case among them is Elliot (2000),35 in which the courtrecognized the ratable payment criterion as implicit in thepari passuclause, implying that creditors cannot bediscriminated against by the debtor through paying some but not others who enjoy the same status. Thisis precisely what happened in Elliot: a creditor opposed the payment that the debtor wanted to make toother creditors without paying him at the same time.

If one admits that sovereign borrowers are not allowed to formally subordinate debts but can doso in practice (paying A but not B), it seems that the pari passu clause does not tackleand cannoteffectively respond tothe challenge of protecting creditors from arbitrariness in the framework ofcollective action problems and abuse of debtors or even other creditors. We have to bear in mind that incorporate bankruptcy procedure legal priorities affect the status of debts (U.S.C. Section 1129.b) longbefore any money crosses the table, whereas in sovereign bankruptcy the priorities only take effect at thefinal step, that is, when it comes to payment.36

Even when a broad reading of the clause could aggravate coordination problemssince hold-outcreditors could oppose any payment that the borrower intended to make to other creditors, thus

30 BEBCHUK, Lucian, Ex Ante Costs of Violating Absolute Priority in Bankruptcy, National Bureau of EconomicResearch, Working Paper 8388, July 2001.31HYDE, op.cit., pp. 531-2.32BUCCHEIT, Lee, How to Negotiate Eurocurrency Loan Agreements,International Financial Law Review, London, 2006,pp. 86.33BUCCHEIT, Lee & PAM, Jeremiah, The Pari Passu Clause in Sovereign Debt Instruments, Emory Law Journal, 53, 2004,pp. 869.34See BUCCHEIT & PAM, op. cit., pp. 871, 903.35Elliot Associates, L.P., General Docket No. 2000/QR/92,Court of Appeals of Brussels, 8thChamber, 26 September2000.36BRATTON, op. cit., p. 846.


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complicating the restructuring problem37 the arbitrary discrimination of payments to creditors, notgrounded in legal reasons would not be accepted.

It is true that rogue creditors can undermine restructuring procedures through their claims againstthe debtor. However, this is not primarily provoked by the interpretation of the pari passu clause but,rather, by the lack of an institutional framework that allows supermajorities to impose their agreement ondissident creditors. In fact, the Elliotcase was the formal trigger for the IMF to develop and propose

the SDRM.38

Good proof that this clause would not be the main cause of holdout creditor problems isthat these creditors can oppose agreements even when approved by overwhelming majorities of creditors,whether or not apari passuclause exists, as shown by re Alliedin 1985.39

In any case, the current judicial struggle brought about by the pari passuclause highlights not onlythe abuse of some hold-out, hyper-speculative creditors and the frustration of bondholders discriminatedagainst by sovereign debtors, but also the insufficiency of such contractual devices in preventing abusesby these same debtors. However, the judicial evolution of this clause shows it to be an unpredictable andinadequate tool for enforcing inter-creditor equity.40

The underlying legal issue in this problem is the way in which the financial losses of a sovereignhave to be ordered in the event of insolvency. As explained above, there is a general principle in domesticbankruptcy law that supports equal treatment of creditors (including payments) except for those legally orcontractually subordinated or preferred. Although there are several political variables that a government

considers when deciding how to distribute the losses that a haircut necessary implies among creditors,theoretically they must be paid equally, except if legal reasons exist to do otherwiseas claimed by theprinciple proposed in this paper.

Some scholars question why so many creditors use share clauses (which indeed embrace a broadreading of the pari passuclause), when supposedly41pari passu clauses already contemplate this rule.42Atthe same time, one might also ask why many creditors, even without enjoying the protection of shareclauses, successfully challenge the borrowers decisions for violating one of the cardinal principles ofbankruptcy law: pars conditio creditorum. Perhaps the answer is that the principle of equal treatmentastantamount to prorated paymentshas its legal roots not only in contractual sources but also,particularly, in general legal principles.

In any case, thepars conditio creditorum, as a manifestation of distributive justice, is complementary to,rather than mutually exclusive of the incentive upon which the principle builds and the responsibility forgranting abusive loans. The equal treatment principlewhich assures that all creditors have the samerightis limited by legal or contractual preferences for some creditors and also by certain moralizingrules that, through subordinating credits, penalize abusive and fraudulent conducts.

1.4. IFI preferences

In practice, one of the factors that affects the way in which creditors suffer the haircut is manifestedin the preference of IFIs, although reality shows that it is not an absolute preference since, for example, insome cases the IMF will roll over its loans when the sovereign is unable or unwilling to pay. Far frombeing strictly theoretical, with the onset and evolution of the current financial crisis and the renewed roleof the IMF in international sovereign finance, this issue is crucial to sovereign insolvency law.

37Ibid., pp. 823, 836.38KRUEGER, op. cit.39Allied Bank International v. Banco Credito Agricola de Cartago,1985, 757 F.2d 516 (2d cir. 1985).40GELPERN, op. cit., p. 1136.41It has been explained, in any event, that both clauses have different extents and goals, seeBRATTON, op. cit., pp.857-8.42 OLIVARES-CAMINAL, Rodrigo, Rethinking Sovereign Debt Restructuring: Lessons From the Argentine Case, doctoralthesis, Queen Mary University of London, August 2007, p. 74.


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There is serious doubt on whether this preference has legal grounding. Some scholars haveargued that this preference is only de facto.43For example, when we survey the statutes of the World Bank(WB) and the IMF, we do not find any rule that explicitly or implicitly states a preferential status.

The IMF has itself recognized that no legal seniority status exists but this forbearance is exercised bycreditors for policy reasons and creditors have not legally subordinated their claimsto those of the Fund.44This preferencewould also be important in order to avoid arrears and efficiency troubles in this cooperative IFI.45

Going even further, the IMF argues that preferred creditor status has been recognized as benefiting not justFund members but official and private creditors alike by allowing the Fund to assist member countries in regaining asustainable financial path and helping to promote orderly resolutions to debt problems, when needed () The concept of theFunds preferred creditor status is confirmed by the Paris Club, where official bilateral creditors exclude the multilateralfinancial organizations from the rescheduling process.46

It is problematic to state that there is a legal preference grounded in this confirmationby the ParisClub, or in borrowers practices when paying the IFIs more generously than other creditors. As the IMFitself explains, these behaviours correspond to matters of economic convenience rather than to anyconviction that they should behave in such a manner because of a legal obligation.

Even so, there is no consensus among economists about the financial effects of IFI loans and,consequently, the need for preferential status of their credits. Indeed, it has been said that if one acceptsthat some of the loans and bail-outs implemented particularly by the IMF were not economically sound,

the suggestion would indeed be to treat its credits as junior in order to discourage multilateral foundsfrom just subsidizing private creditors and deferring reforms when sovereign borrowers have very seriousfinancial troubles.47

It seems clear that the arguments for supporting this preferential status work in the economicfield and are related to the special role that these institutions play in the global system. In any case, theSDRM proposes that this preference be formally incorporated into international law, which might meanthat this status does not have enough grounding in the current legal framework. We will retirn back againto the matter of IFI seniority once we have incorporated the main principles being proposed in this paperinto our analysis.

1.5. What the latest defaults have taught us

Beyond the basic rules described above, since the thirtieswhich were characterized by tensionamong private sectors and huge financial losses48there have not been major official efforts to developlegal guidelines to promote an efficient, fair allocation of financial losses in sovereign insolvencies. Oneprobable, yet partial, explanation for this is the fact is that with only a few exceptionsnamely, the LatinAmerican debt reduction that took place between the two World Wars;49the London Agreement in 1953,which implemented a meaningful reduction of the German debt; and the a similar agreement reached

43 RAFFER, Kunibert, Preferred or Not Preferred: Thoughts on Priority Structures of Creditors, paper prepared fordiscussions at the 2nd Meeting of the ILA Soverign Insolvency Study Group, 16 October 2009, IMF; RUTSELSILVESTRE, J. Martha, Preferred Creditor Status under International Law: The Case of the International Monetary Fund,International and Comparative Law Quarterly, Vol. 39, N 4, 1990, pp. 813-4.44 IMF, Financial Risk in the Fund and the Level of Precautionary Balances, prepared by the Finance Department,approved by Eduard Brau, February 3, 2004.45See Communiqu of the Interim Committee of the Board of Governors of the IMF,Press Releases N 88/33 (September 261988) and N 89/83 (April 4 1989).46Ibid.47SCOTT, op. cit.48SeeFEILCHENFELD, DE MAURY ELRICK & JUDD, op. cit., pp. 1115-44; QUINDRY, Silvester, Bonds & Bondholders.Rights & Remedies, With Forms, Burdette Smith Co, Vernon Law Book, 1934, Chicago & Kansas City.49The haircut obtained by these countries ranged from 15% - 48% of effective debt reduction, see JORGENSEN,Erika & SACHS, Jeffrey, Default and Renegotiation of Latin American Foreign Bonds in the Interwar Period, inEICHENGREEN & LINDERT, The International Debt Crisis in Historical Perspective, Mit Press Cambridge, 1989, pp. 57.


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between Indonesia and its largest creditors in 1970-7150and except for the Highly Indebted PoorCountries Initiative of the IMF (which did not mainly affect private creditors), there has been nosignificant sovereign debt restructuring that involving major losses for private creditors.

Historically, except for the aforementioned cases, most restructuring procedures have not entailedoverly painful haircuts for creditors, while the Brady plan, multilateral bail-outs, and restructuring plansstill significantly reduced the extent of the negative effects of sovereign defaults. It is therefore

understandable that the criteria according to which losses are shared did not receive much attentionamong creditors.

This inertia was challenged by the Argentinean case of 2001-2005, when a haircut that exceeded75% of the face value of the bonds was accepted by more than 76% of its creditors. Although theArgentinean haircut was the harshest, the most recent defaults (Russia, Ukraine, Pakistan, and Ecuador)led to restructuring agreements that implied haircuts clustered in a range of from 25% to 60%.51If thecurrent sovereign insolvency framework allowed a debtor to implement such radical haircuts,52then it ispossible that other debtors would consider taking similar steps.

As the Argentinean case shows, when the haircut is substantial (and painful), creditors are morewilling to discuss loss distribution. Leaving aside internal and social debt issues,53financial creditors havefought fiercely to reduce their own losses in many ways: the full repayment Argentina made to the IMFwas criticized by other creditors;54holdout creditors are still trying to benefit from Argentinas improved

economic situation55

(which is partially a consequence of the sacrifice that the majority of the creditorsmade when accepting the restructuring plan);56 Italian and German bondholders sued the banks whichhad sold them the so-called tango bonds;57 Italian bondholders demanded and received some compensationfrom the Italian government58 for not supervising those banks;59 German bondholders argued that theGerman representative on the IMF board did not fulfil his duties to the German people, but ratherprioritized international financial interests and that this justified compensation; and the Paris Club is still

50 PAZARTZIS, Photini, La rengociation des dettes: les exemples allemand (1953) et indonsien (1970), in CARREAU,Dominique & SHAW, Malcom N. (eds.), La dette extrieure The external debt, The Hague Academy of InternationalLaw, Martinus Nijhoss Publishers, 1995, pp. 57-77; MORALES, Rafael, The German Debt Settlement of 1953: SomeGuidelines for the Current Debt Crisis,ibid., pp. 79-107.51 STURZENEGGER, Federico & ZETTELMEYER, Jeromin, Haircuts : Estimating Investor Losses in Sovereign DebtRestructurings, 1998-2005,Journal of International Money and Finance, 27, 2008, pp. 780.52

The pending judicial and arbitrated claims against Argentina are related to holdout creditors, not to the majority ofcreditors that in fact accepted the restructuring agreement.53MICHALOWSKI,Sabine, Sovereign Debt and Social Rights Legal Reflections on a Difficult Relationship, Human Rights LawReview, 2008, 8, 1, pp. 35-68.54EM Ltd. V. Republic of Argentina,473 F.3d 463 (2d Cir 2007). At this time the Report on the Evaluation of the Role ofthe IMFin Argentina, 19912001,made by the Independent Evaluation Office about the co-responsibility of the IMF in thecollapse of Argentina, had been released (June 30 2004).http://www.imf.org/EXTERNAL/NP/IEO/2004/ARG/ENG/INDEX.HTM55For more about the litigation of creditors against Argentina in German and American courts, seeLOWENFELD,op.cit., pp. 740.56This argument was recently used by an Argentinean court to dismiss a claim filed by a creditor (Juzgado Nacionalen lo Contencioso Administrativo Federal N 1, October 12 2006). For comments about this sentence seeMICHALOWSKI, Sabine, El estado de necesidad como defensa contra el pago de la deuda externa,Jurisprudencia Argentina,2007, IV, Fasc. IX, November 28 2007, pp. 3.57 SEB-Bank wegen falscher Beratung zu Argentinien-Anleihen verurteilt, Sddeutsche Zeitung, November 72003 (Frankurts Court, 2003); En Alemania, un fallo judicial apunta a un banco por los bonos, Clarn, October 29 2003(Mnsters Regional Court, 2003);Deuda: otro fallo contra un banco,Clarn, November 8 2003 (Mnsters Regional Court,2003); Banca, Borsa e Titoli di Credito, 2004, II (Mantovas Court, 2004); Sezione II, I Contratti, N 1, 2005(Venezias Court, 2004); Judge Angelo Pezzuti, March 21 2005 and May 31 2005 (mimeo, Firenzes Court, 2005).58Act 266 December 23 2005, sections 343 to 345, GU N 302 December 29 2005, Suppl. Ordinario N 211.59SeeFRANZONI, Massimo, La responsabilit civile delle authorities per omissione di vigilanza,in GALGANO& VISINTINI,Mercato finanziario e tutela del risparmio, CEDAM, Padova, 2006, pp. 267-279; SCOGNAMIGLIO, Giuliana, Laresponsabilit civille della CONSOB,ibid., pp. 281-311.


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claiming that it should not suffer any reduction of its credits.60

This case shows several things very clearly: that the impact of the haircut among creditors can be azero sum game;61 that there is not a stable and predictable priority credit ranking; that creditors do notenjoy an institutional framework within which to have an orderly discussion about how to allocatefinancial losses among them, which delays and complicates the restructuring process;62 and, that if theborrower feels that it has enough room to expand its discretionary (and arbitrary) power, it will do so. 63

Thus, there is a need for a more orderly and efficient process for distributing financial losses amongcreditor groups. This implies that some minimum ex ante and enforceable ex post guidelines regardingcredit ranking should exist in the realm of sovereign insolvency.

1.6. Seniority ranking in sovereign insolvency proposals (SDRM, CAC, and FATP)

The SDRM formalizes the continuity of the status quoin this particular issue. IFIs have absolutepriority and are therefore excluded from the restructuring process, resulting in the fact that only theprivate sector is asked to make sacrifices. Regarding the status of bilateral debt, this official proposal isnot yet clear. The latest version suggests that these debts should form a different class of credits in orderfor the agreement to be approved. Domestic debt (trade debt, claims against the central bank, and so on)are in principle excluded, given that it is the debtor who has to decide whether to include them in theagreement.64Since it is necessary to obtain acceptance by at least 75% of the creditors to approve priorityfinancing, creditor votes would be difficult to obtain in a timely fashion.

In terms of the CACs, they only involve bondholders, which leaves aside the rest of the creditorsthat also need to be qualified as senior or junior. It has no provisions capable of solving the debt dilutionproblem either.65The priority of new lending is not the main concern of this contractual approach66andthe only possibility for bondholders is to agree to the subordination of their own credits, but there is noguarantee that this decision will be affirmative.

The social movement Jubilee 200067 developed and presented a proposal of Fair and TransparentArbitration Procedure (FTAP),68 which would provide (regarding the seniority ranking) that all unsecuredcreditors would have to receive symmetrical treatment in terms of bearing losses. IFIs and Paris Clubdebts are qualified as unsecured.

60On September 2, 2008 the Argentinean government announced its intention of fully repaying these loans, but theextent and execution itself of these payments were delayed due to the onset of the current financial crisis.61 BUCHHEIT,op. cit. (2002), p. 74.62Recent empirical studies have shown that creditor coordination problems, political shocks, and governmentalbehaviour of the borrower lead to messy restructurings, TREBESCH, Christoph, Delays in Sovereign Debt Restructurings.Should we Really Blame the Creditors,Free University of Berlin and Hertie School of Governance, 2008 (mimeo).63Since 1987, the coerciveness of the average sovereign borrower has increased, due basically to changes in creditorcomposition and the international legal environment, cfr. ENDERLEIN, Henrik, MULLER, Laura & TREBESCH,Christoph, Debt Disputes. Measuring Government Coerciveness in Sovereign Debt Crises,paper presented at the AnnualConference of the International Studies Association, San Francisco, CA, March 26-28 2008.64 IMF,op. cit. (2002).65 BOLTON, Patrick & SKEEL, David Redesigning the International Lender of Last Resort, Chicago Journal ofInternational Law, Vol. 6 No. 1, 20005-6,pp. 182.66 KRUEGER, Anne & HAGAN, Sean, Sovereign Workouts: An IMF Perspective,Chicago Journal of InternationalLaw, 2005, 6, pp. 214.67PETTIFOR, Ann, "Arbitration, Insolvency and Limited Liability: Their Relevance to Debtor Nations, 2001,http://www.jubileeplus.org/analysis/analysis.htm; ibid., Resolving international debt crises the Jubilee Framework forinternational insolvency, 2002, http://www.jubilee2000uk.org/analysis/reports/jubilee_framework.html; ibid., Captulo 9-11para resolver las crisis de la deuda internacional: la Jubilee Framework, estructura para la insolvencia internacional, NewEconomics Foundation report, 2002, http://www.jubileeplus.org/analysis/reports/jubilee_framework_sp.pdf.68AMBROSE, Soren, Social Movements and the Politics of Debt Cancellation,Chicago Journal of International Law, 2005,6, pp. 272.


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None of these three proposals establishes seniority rules relating directly to the creditorbehaviour and the collective action problem with which this paper tries to deal, such as responsibility forgranting abusive loans. Even instituting a perfect symmetry among all creditorsor setting up creditorcategories that completely ignore the actual behaviour of the lenders and the situation of the sovereignwhen borrowing moneyimpedes creating efficient ex ante incentives to promote prudence in futureloans.

2. Responsibility for granting abusive loans

2.1. A sound guide for distributing losses among creditors: Looking at the lendersbehaviour and its consequences

We now turn to the problem of how financial insolvency losses should be distributed among asovereigns creditors, and here we must pay closer attention to domestic bankruptcy laws. Although equaltreatment of creditors is the main rule, it is limited from two sides: priority credit ranking and thesubordination of certain credits. We will focus on one specific category of this last type of credits.

Most legal systems establish that if creditor A engages in some kind of fraudulent lending practiceand grants excessive loans, it does not deserve the same treatment as creditor B which has not violated

pars conditio creditorum, has carefully evaluated its credit risk, and has acted according to the economicsituation of the debtor. This rule has a clear economic rationale: it provides incentives for creditors to beprudent and diligent in assessing risk, encourages efficient allocation of financial resources, helps creditorsact in good faith, prevents collective action problems in insolvency contexts, and helps to prevent theaggravation of the situation of the debtor and, thus, of the creditors as a whole.

Even when responsibility for granting abusive loans is broader in domestic law, we will see that from aninternational perspective reckless conduct alone is not enough to create liability and subsequently lead tobeing subordinated in a sovereign bankruptcy procedure. This general principle, as this section aims toverify, requires the establishment of fraudulent intent, which differentiates this rule from the so-calleddeepening insolvencydoctrine.

When a lender tries to obtain extra (unfair) advantages at the expense of other creditors in thecontext of insolvency, it can do so by attempting to grant loans which assume an excessive risk that can

only be understood if we integrate the extra advantages to the cost-benefit analysis conducted by thelender. This is the way that excessive risk assumed by an abusive lender and unfair advantage can gohand-in-hand

Regarding the factual consequences of abusive loans, it is important to mention, first, that they canimpede the debtors asymptomatic insolvency from revealing itself, precisely because the new credits keepthe debtor afloat and functioning in the market for more time, concealing the real (insolvent) situation ofthe debtor.69

Second, during the extra time in the borrowers commercial life its debt usually increasesconsiderably dueon the one handto the moral risk problems that appear in the administrators andshareholders behaviour during the final period of the company andon the other handto thegradually worsening conditions in which the company is dealing with other economic players. The assetsof the debtor are also dramatically reduced during this period because of the same moral risk problems

and the claims that other creditors are starting to make against the debtor, that erode its wealth.Finally, the disguising of the debtors situation can inhibit creditors from using their contractual and

legal self-protection tools in order to collect their credits and defend the borrowers wealth.

All these types of equity deterioration affect the guarantee of the creditors: they will receive less thanthey could have collected if the debtor had filed a restructuring procedure earlier. Since the economic

69DI MARZIO,Abuso nella concessione del credito, Edizioni Scientifiche Italiane, Napoli, 2004, pp. 39, 170-1, 186-9, 220.


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situation of a debtor that leads a loan to be qualified as abusive is characterized by irreversible distress (norational financial aid would avoid the collapse), this kind of loan does not eliminate insolvency, but ratherhides it and possibly aggravates it, prolonging the interval between asymptomatic and symptomaticinsolvency.

For all the reasons mentioned above, domestic bankruptcy laws have tried to discourage abusiveloans by allowing these creditors to collect less money in insolvency procedures than those who are not

abusive. This is effected through the principle of responsibility for granting abusive loans.

2.2. A general legal principle

The insufficiency of legal guidance regulating, in general, the problems that sovereign insolvencycomes with and, in particular, the consequences of abusive loans, cannot be an excuse non liquetfor thelegal questions that this economic, social, and political phenomenon raises. If we were to ask which legalnorms apply to the behaviour of speculative creditors, at first glance international law does not provideclear responses. International finance needs answers and this gap can be filled by general principles oflaw.70

Art. 38 of the Statute of the International Court of Justice (ICJ) recognizes general principles as alegal source of international law. Therefore, when necessary, it is worth resorting to legal principles inorder to solve disputes and make the legal framework more predictable. Particularly in sovereigninsolvency law, domestic principles have been doing a very important job, as the official proposals ofSRDM and CACs actually show.

There are basically two methods for identifying general principles: the quantitativeand the qualitative.The first one is ponderous, too mathematical, and does not reflect the view of the aforementioned Art.38, since it alludes to general principles recognized by (the colonialist expression) civilized nationsnotallthecivilized nations.71

Havingdiscarded thequantitative method, the problem requiring solution must be individualised.An analytical approach has to be implemented, taking into account the rationale behind the way domesticlaw responds to a particular problem. This requires an intrinsic evaluation of the principles founded indomestic systems that provide the best solution for the case, rather than a mechanical or statistical searchof predominant rules.72 Using this telos-oriented approachwhich has been openly adopted by the EuropeanCourt of Justice73it is apparent that a synthesis of domestic rules and concepts is necessary.

The selection of the relevant system is largely dependent on the purpose of the comparativeanalysis.74As an example, the Iran-U.S. arbitral claim tribunal focused on what Iranian and American lawestablished to determine whether general principles could be applied to this procedure. For the case thispaper addresses, it is useful to focus on creditor and debtor legal systems.

Apart from the similarities between private and state insolvencies,75 there is a growing andbroadening tendency to systematize principles distilled from domestic legal systems (especially takingChapters 9 and 11 of the U.S. Bankruptcy Code as models) in order to build a new sovereign insolvencyarchitecture. The notable similarities in domestic bankruptcy laws facilitated the work to create the SDRMproposed by the IMF, since, for instance, the standstill and approval of the reorganization plan are

70 BASSIOUNI, M.Cherif, A Functional Approach to General Principles of International Law, Michigan Journal ofInternational Law, 11, 1990, p. 776; OLUFEMI, Elias & CHIM, Lim General Principles of Law, Soft Law and the

Identification of International Law,Netherlands Yearbook of International Law, 28, 1997, p. 4.71FORD,Christopher, Judicial Discretion in International Jurisprudence: Art. 38 (1) (c) and General Principles of Law, DukeJournal of Comparative & International Law, 1994, 5, p. 76.72TRIDIMAS,Takis, The General Principles of EU Law, Oxford Univ. Press, Oxford, 1999, p. 38.73SCHIER,op. cit., pp. 105.74Ibid., pp. 94.75CARREAU, Dominique, Bilan de recherches de la Section de langue franaise du Centre dtude et de Recherche de lAcadmie,in La dette extrieure. The external debt, Centre dtude et de Recherche de Droit International et de RelationsInternationales, Acadmie de Droit International de La Haye, Martinus Nijhoff Publishers, 1992, pp. 20.


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deeply-rooted institutions in domestic law. In other cases, the distilling of general principles in order todevelop a new institutional design for sovereign insolvencies has been even more explicit.76The idea issimple: legal lacunae cannot be a valid argument for not applying the rule of law to the sovereign insolvencyproblem, and the general principles coming from domestic bankruptcy laws offer a goldmine of sound,consolidated rules to deal with this economic phenomenon.

We have to bear in mind that the common characteristics a rule may have in different legal systems

does not necessarily give rise to a common principle of quality at the international level.77

Also, apartfrom verifying the basis of the rule itself, we have to appropriately synthesize and adapt it to the level atwhich we plan to explore its application.

Resorting to the comparative law method in order to detect and shape responsibility for abusiveloans as a principle to be applied in international law stems from the idea that general legal problems existand comparative law allows us to incorporate a variety of solutions and their adequate evaluations. 78Abusive loans are one of these general problems79as both domestic reality and global finances quite oftendramatically shows us.

2.3. The content of this particular responsibility

2.3.1. General theory in domestic lawThe commercial and bankruptcy laws of several legal systems recognize the validity of the so-called

liability for granting abusive loans.80This liability stems from the understanding that a creditor that grants aloan without following the most elementary precautionary guidelines with regard to the analysis of creditrisk can cause negative externalities in the market.81

The market absorbs the information generated by a credit institutions activity because ittheoretically helps in terms of transaction costs and, thus, with efficiency. These institutions are importantproducers of social capital,82 and they basically help to reduce or cushion the negative effects ofasymmetric information in markets.83

While leaving room for broad discretion appropriate to the risk implicit in this activity, financialrules impose minimal standards of professional diligence in relation to the evaluation of credit risk of loantransactions.84 That means that lenders are not completely unaffected by the consequences that theirloans may have on borrowers and third parties. The externalities generated in the market by such

behaviour are not minor, and have led to the acceptance of this special ethic in the banking and financialprofessions. When we say that too much credit was given we implicitly recognize that a false image can begenerated and this information can in turn become part of the market. The law seeks to prevent this

76Ibid.77See PISTOR,Katharina, The Standardization of Law and its Effect on Developing Countries,The American Journal ofComparative Law, 50, 2002, pp. 97 ss.78LARENZ, Karl,Methodenlehre der Rechtswissenschaft, Springer-Verlag, Berlin, New York, 1969.79Development of legal doctrine regarding protection of expectations is transnational and fundamental, independentof the particularities and variables that each positive law presents, seeDE CASTRO PORTUGAL CARNEIRO DA FRADA,Manuel, Teoria da Confiana e responsabilidade civil, Almedina, Coimbra, 2004, pp. 33-7.80For a comparative analysis of the American, Argentinean, Belgium, English, French, German, Italian and Spanishlegal systems specifically in terms of this kind of responsibility, see B OHOSLAVSKY,Juan Pablo, Crditos abusivos.

Sobreendeudamiento de Estados, empresas y consumidores, Abaco Ed., Buenos Aires, 2009, (Ph.D. dissertation); SIMONT,Lucien & BRUYNEEL, Andr,La responsabilit extra-contractuelle du donneur de crdit en Droit Compar, Feduci, Siena, 1984.81On externalities and how one persons decision can affect another person who was not part of the first one, seeCOASE, R.H., The Firm, the Market, and the Law, University of Chicago Press, Chicago, 1988, pp. 23-4.82For more on the social capital concept seeCOLEMAN,James, Social capital in the creation of human capital,AmericanJournal of Sociology, Vol. 94, 1988, pp. 95-120.83BEBCZUK, Ricardo, Informacin asimtrica en mercados financieros, Cambridge University Press, Madrid, 2000, pp. 19.84J. STOUFFLET, Devoirs et responsabilites du banquier a loccasion de la distribution du credit, in GAVALDA,Responsabilitprofessionnelle du banquier: contribution la protection des clientes de Banque, Economica, Pars, 1978, pp. 23.


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situation by assuming the existence of a general principle based on protection of legitimate expectations.85

Abusive loans are not proportionate to the borrowers repayment prospects and are granted in anirreversibly distressed economic situation of this same borrower.86 The extent of this lack ofproportionality is economically intrinsic to the situation of the borrower. The economic circumstance thatcharacterizes an abusive loan is the fact that the situation of the borrower limits any hope that it itssituation will improve and its loans be paid,87allowing and facilitating the aggravation of its situation and,

thus, affecting other creditors.88

In fact, when the abusive lender realizes that the end is coming, itchanges its behaviour and tries to protect its interests by granting loans that go directly against the mainobjectives of any bankruptcy law.

We already described the specific consequences of abusive loans: they conceal insolvency, give thedebtor an extra lease on life during which its situation worsens,89and operate under a contractual freedomthat impedes creditors from appropriately reacting and defending their credits.

Inappropriate loans imply the assumption of unreasonable risk in providing financial support thatonly delays the inevitable bankruptcy, further eroding the net worth of debtor assets. More specifically,the so-calledprevious (that is, to the abusive loan) creditorssuffer financial losses as a result of the economicdeterioration of the common debtor that the abusive loans facilitated, allowing the debtor to continueeroding its net worth since there was no possible escape to the bankruptcy.

The later creditors are victims of the appearance that the abusive loans generated,90 and thus they

acted based on the trust artificially provoked by the economic cautionnement.91If the creditors had knownthe real situation they would surely have behaved differently, for example not signing the contract ortaking other defensive and/or preventive measures.92

The abusive loan may be granted negligently or wilfully, seeking unfair advantage. The legalreactionas we will see in the comparative analysisis not unanimous in the first case, where the levelof state intervention in the economy and the general openor closednature of the tort liability systemthat each country has adopted seem to determine the extent of this liability.93

Owing to the purpose of this paper, we will concentrate on the case of wilfully abusive loans sincethis is the point where the minimal similarities that international law requires for internationalisinggeneralprinciples are found. This restrictive technique has been used since the famous Haute-Silsie polonaise(1926) case.94

We are now interested in focusing on the behaviour of creditors who, through granting abusiveloans, wilfully violatepar condictio creditorum.For example, thanks to these loans a creditor can delay defaultand thus consolidate his collateral, seek repayment in advance, or convert old loans into new ones and,thus, reduce bank exposure.95Blatant violation of the legal and financial rules that establish how credit

85DE CASTRO PORTUGAL CARNEIRO DA FRADA, op. cit., esp. pp. 474-9.86BONNEAU, Thierry, Droit Bancarie, Montchrestien, Paris, 1994, p. 426.87BAUMBACH, Adolf & HOPT, Klaus, Handelsgesetzbuch, Beck'scher Kurz-Kommentar, Beck, Mnchen, 2005 (mimeo).88VEZIAN, Jack, La responsabilit du baquier en droit priv franais, Litec, Paris, 1983, pp. 144.89According to the definition of damage in the famous French case Laroche(Cour de Cassation Ch. Com., January7 1976, Recueil Dalloz Sirey, 1976, I, pp. 277; Revue des Socits, 1976, Jurisp. Gnrale Dalloz, Pars, pp. 126 ;Revue Trimestrielle de Droit Commercial, 1976, I, pp. 171) the assets of the debtor are also dramatically reducedduring this period because of the same moral hazard problems and the claims that some creditors start makingagainst the debtor, which erode the debtors wealth.90VEZIAN, op. cit., p. 156.91LIKILLIMBA, Guy-Auguste, Le soutien abusif dune entreprise en difficult, 2nd Ed., Litec, Paris, 2001, p. 69.92 VISCUSI, Amalita Concessione abusiva di credito e legittimazione del curatore fallimentare allesercizio dellazione diresponsabilit,Banca, Borsa e Titoli di Credito, 2004, p. 662.93VV.AA., Responsabilit du banquier: aspects nouveaux, Association Henri Capitant, T. XXXV., Ed. Economica, 1984,p. 10; LIKILLIMBA, op. cit., p. 158; SIMONT& BRUYNEEL, op. cit., pp. 205.94Recueil des Arrts of the Permanent Courtof InternationalJustice,A, N 7, 1926.95 DI MARZIO, op. cit., p. 172; ZENNER, Alain, Responsabilits du donneur de crdit,Revue de la Banque, 1974, pp.723.


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risk must be assessed and other circumstantial evidence, such as the potential benefit to the creditor fromgranting the abusive loans, help to prove whether the lender was wilfully abusive.

We have already said that a debtors economic situation that leads loans to be qualified as abusiveis characterized by irreversible distress. This kind of loan does not eliminate insolvency, but rather hides itand may aggravate it, prolonging the interval between asymptomatic and symptomatic insolvency. Thepoint here is that this doctrine does not affect the banks right to make mistakes.96 A borrower can go

bankrupt after a loan and the lender will not be liable. The situation that this doctrine isolates is thefollowing: the lender, applying minimal diligence, should have known that the effect of the loan wouldonly delay the inevitable bankruptcy of the client; plus, he tried to acquire unfair advantage over othercreditors, thereby violating the equal treatment principle.

All creditorsbanks and othersmust fulfil their own obligations of assessing the credit risk ofany transaction in which they want to participate. Liability for granting abusive loans does not affect theseduties. If a creditor claims that it was a victim of an abusive credit and such creditor behaved withoutfollowing the rules attributable to it, the harm will have been the result of its own fault and nemo auditorquid propria turpitudinem allegans.97Each creditors duty to take due care depends on a variety of factors,including the nature, profession, and economic size of the lender, the volume of the loan, etc.

2.3.2. Comparative analysis

Although a broader survey including other countries would be ideal, if we look at the domestic legalsystems of most of the major creditor countries (in terms of developing country external debt), we findcommon denominators among them relating to this specific kind of responsibility. The strong presenceof creditor countries in this survey is important since most of the bonds and financial contracts to whichdeveloping countries are party stipulate that the legal jurisdiction and applicable law are, precisely, ofthose countries. In other words, the selection of legal systems from which to develop the comparativeanalysis is consistent with the goal of this survey.98

The French, Belgian, Italian, German, English, American, Spanish andas a good example of adebtor countrythe Argentinean legal systems all recognize, to differing degrees and with varying effect,the obligation to rebuild net worth after harm has occurred through abusive credit lending. Depending onthe legal system involved, this can be channelled through civil liability or solutions that are typicallybankruptcy procedural tools, with subordination being the most important among them.

This specific kind of responsibility is usually seen as a response to a collective action problem thatarises in time of insolvency when some creditors try to take unfair advantage at the expense of others.This is the reason why the abusive loan issue is usually thought of, made visible, and addressed incontexts of bankruptcy.

The contractual freedom of financial institutions operates within the limits imposed by law,fundamentally through the guidelines that have been established by case law. Each legal system imposesdifferent limits, but they coincide in certain circumstances, as we will see in the following paragraphs.

This legal theory was born in France more than 120 years ago,99and has developed vigorously sincethe early sixties.100The so-called openFrench tort law system (sections 1382 and 1383, civ. code) allowedan offended person to register a claim even when he was negligently harmed.101 Liability for granting

96CA de Pau, February 22 1990, (mimeo).97Blanc c/ Socit gnrale, Cass. Com. Paris, February 21 1995, N 374 DF, RJDA, July 1995, N 868, p. 702.98SCHIER,op. cit., pp. 94.99Cass. Civ., August 1 1876, S 1876, I, p. 457; Req. July 27 1897, D. 1897, I, p. 607.100STOUFFLET, Jean, Louverture de crdit peut-elle tre source de responsabilit envers les tiers?, JCP, 1965, I, 1882; ibid.,Devoirs et responsabilits du banquier loccasion de la distribution du crdit, Rapport au colloque de droit bancaire,Universit de Paris I, February 10-11 1977, Economica, 1978, pp. 21. An ample and contemporary study of thescholar and judicial evolution of this issue in France, LIKILLIMBA, op. cit.101GAVALDA, Christian & STOUFFLET, Jean, Droit bancaire. Institutions. Comptes. Oprations. Services, Litec, Paris, 1992,pp. 415; RIVES LANGE, Jean & VEZIAN, Jack, Banquiers,JCP Annexes, Fas 8, 11, 1970, pp. 28.


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abusive loans has been treated as any other tort, requiring the typical elements of civil liability,102particularly focusing on the causal link between the loan, the aggravation of the borrowers situation, andthe affectation of other creditors.103

The recent Act of July 25, 2005modifying section 650 of the French code de commercelimited thisspecific type of liability to cases of fraud. The legislative technique, however, was defective and there isconfusion about the real extension of this legal reform.104

The Belgian legal system followed the same path as the French. The courts started to implementit a relatively long time ago105and it has grown strongly over the past thirty years.106The most importantdifference between the French and Belgian systems is that the latter did not institute a legislative reformin order to limit liability for negligence.107

In Italy the development of this type of liability has been directly linked to the evolvinginterpretation of the element of injusticethat Art. 2043 Civ. Code requires in order to find a tort. 108Oncethe open systemwas consolidatedit does not require a specific tort or duty of care to hold a tort feasorliable anymore109the doctrine quickly moved forward to deal with the fundamentals and details ofliability for granting abusive loans.110

If a bank violates the general dovere di corretezaby granting loans to an already insolvent clientbehaviour that can be aimed at taking some advantage of other creditors, or disregarding negligently themost basic rules of assessing the credit riskthe jurisprudence is very clear on condemning the lender to

compensate the damages equivalent to the aggravation of the borrowers situation that he facilitated, evenin case of negligence.111Nowadays, the toughest discussions are related to a procedural issue: whether thetrustee or the creditors have the right to sue the abusive lenders.112

102Cass. Com., January 7 2004, J.C.P., 2004, IV, 1399; Cass. Com., March 17 2004, Juris-Data, n2004-023168; Cass.com., March 22 2005, Banque et droit, 2005, N 102, p. 71.103Cass. Com. Ass. pln., July 9 1993, Societ Gnrale c. Guiraud, es qualit syndic SA Astre et Cie., eta.,JCP, 1993, d.E, II, 22122.104 BONHOMME, Rgine, La responsabilidad por concesin abusiva de crdito conforme a la ley 2005-845, de 26 de julio de2005, Revista de Derecho Concursal y Paraconcursal, N 5, 2006; DAIGRE, Jean-Jacques, Crances bancaires etcrances ordinaires dans la faillite du client: vers deux poids et deux mesures ?,Rev. Dr. Banc., July-August 2005; LEGEAIS,Dominique, Les concours consentis une entreprise en difficult (C. com. Art. 650-1),J.C.P. E, 2005, N 1510.105Brussels , April 13 1914, Pas., 1914, II, p. 226, in ZENNER, Alain, Responsabilits du donneur de crdit,Revue de la

Banque, 1974, p. 707.106Lige, April 29 2004, 7e chambre; Bruxelles, Septembre 6 1999, R.D.C., 2000; Comm. Bruxelles, Septembre 122000, R.D.C., 2001, p.787; Civ. Anvers, Novembre 28 2000, R.W., 2001-2002, p. 1072. In the legal literature seeCATTARUZZA, Jean, Le banque et lentreprise en difficult,Revue de la Facult de Droit de Lige, 1997, pp. 602-3.DEMONTY, Bernard, Derniers dveloppements en matire de responsabilit du banquier dispensateur de crdit, in LINSMEAU,Jacqueline (coord.), Droits bancaire, cambiaire et financer, Formation Permanent (CUP), Vol. XXIV, Lige, 1998, pp. 75;VAN OMMESLAGHE, Pierre, La responsabilit du banquier dispensateur de crdit en droit belge,Socit Anonyme Suisse, 49,1977, pp. 110.107CUIGNET, Roger, Responsabilit juridique du banquier donner de crdit,Revue de la Banque, 1976, 1, p. 15.108 ANELLI, Franco, La responsabilit risarcitoria delle banche per illeciti commessi nellerogazione del credito, Diritto dellaBanca e del Mercato Finanziario, 1998, pp. 142.109FRANZONI, Massimo, Fatti iliciti. La lesione dellinteresse legittimo , dunque, risarcibile, Contratto e Impresa, 1999, N3, pp. 1039.110See CASTIELLO DANTONIO, Antonio, La banca tra concessione abusiva e interruzione brutale del credito,Il DirittoFallimentare, 2005, N 5; ibid., Responsabilit della banca per concessione abusiva di credito,Il Diritto Fallimentare, 2002,

N 5; DI MARZIO, op. cit.; GALGANO, Francesco, Civile e penale nella responsabilit del banchiere,Contratto e Impresa,1987, I; INZITARI, Bruno, Irregolarit del fido e responsabilit della banca per concessione abusiva del credito, en AA.VV.,Scritti in onore di Luigi Mengoni, T II, Giuffr Ed., Miln, 1995; TERRANOVA, Giuseppe, Profili dellattivit bancaria,Giuffr, Miln, 1989.111The two first cases in which a bank was held liable to another bank were Corte di Cassazione, January 13 1993,Cassa di Risparmio di Livorno c. Cassa di Risparmio di Modena e altri,Sent. N 343, Banca, Borsa e Titoli di Credito,1994, II, pp. 258-266, with notes of Nicoletta MARZONA& Andrea PERRONE, pp. 266-283; Rivista Diritto dellaBanca e del Mercato Finanziario, N 1, 1993, pp. 399-411, with note of Bruno INZITARI, pp. 412-423; the secondcase was Corte di Cass., January 8 1997, Banca di Roma s.p.a. c. Banca Popolare di Ancona soc. coop. a r.l.,Sent. N 72,


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In Germany, since section 823 of the Brgerliches Gesetzbuch(BGB, Civil Code) requires a creditorto violate an absolute (erga omnes) right or commit a breach of a statute that specifically protects a personor interest (rule of Schutzgesetz),113 and the financial damages that are of interest to this paper are notamong such categories of illicit acts, the liability under analysis cannot be based on this norm. The case isdifferent when there was an intention of causing harm, in which case the action falls in Section 826 BGB,which reacts by defending bona fide creditors in instances where some creditors tried to create undueprivilege over the debtors assets.114

This can happen, for example, when a bank postpones its clients bankruptcy petition in order tocollect its loans through collateral that it is able to obtain during this period or goods that still remain inthe debtor possession (Konkursverschleppung).115Regarding the economic situation of the borrower, if thecredit-granting entity seriously evaluated the financial perspectives of the debtor company and itsattempts to remedy its troubles, and they indicated that the company could be recovered, the lendercannot be held liable.116

The so-called cooperation duties (Kooperationspflichten) that creditors should observe toward othercreditors,117and the fundamentals of new Articles 241 and 311 BGB that consolidated protective effects forthird parties, can also play a role in configuring the illegality of the abusive loans.118

In the United States there is no specific tort aimed at preventing abusive loans, basically becausethere is a certain aversion to recognizing compensation in such cases of indirect (non-contractual)

economic loss.119

It is not absolutely clear if this requirementnamely of establishing a contractual linkbetween the victim and the tort feasorhas formal legal support in the American system.120In any case,special statutes relating to insolvency have provisions that apply to the facts this paper seeks to explore.

On the one hand, with the exception of a situation involving control by a bank, which generatesspecial stewardship duties,121 a trustee can only attempt to obtain a declaration of nullity of certaintransactions if it is able to demonstrate that the creditor attempted to hinder, delay, or defraud theinterests of the remaining creditors (Bankruptcy Code Sec. 548). The Uniform Fraudulent Transfer Act(Sec. 4.b) provides some circumstantial evidence of the existence of dolus, such as when the debtorreceived less than reasonably equivalent value in exchange for a transfer or obligation, the debtor wasinsolvent, or there was a notable growth of the debt after transfer.

Banca, Borsa e Titoli di Credito, 1997, N 6, with note of Claudio SCOGNAMIGLIO, pp. 653-8. More recently,broadly developing the legal requirements for the responsibility for granting abusive loans, Tribunale di Foggia, May7 2002, Il Fallimento, 2002, pp. 1166.112Corte Cassazzione, Sezioni Unite, March 28 2006, N 7030, Il Diritto Fallimentare, 2006, N 5, pp. 615-642, withnotes of RUSSO, Libertino, Legitimazione del curatore allazione per abusiva concessione di credito, pp. 615-629, andNARDECCHIA, Giovanni, Labusiva concessione del credito allesame delle sezioni unite,pp. 616-642.113Jurisprudence has required these elements, for more seeBGHZ 10, 228; WM 1972, p. 441.114BHNER, Reinhard, La lutte contre la criminilat economique en Allemagne,in GAVALDA, C. (director), Responsabilitprofessionelle du banquier: contribution la protection des clientes de banque, Recherches Pantheon-Sorbonne Universit deParis I, Srie Sciences Juridiques Droit des Affaires, Ed. Economica, Paris, 1978, pp. 94 ss.115 MERTENS, Hans-Joachim, Zur Bankenhaftung wegen Glubigerbenachteiligung, ZHR, N 143, 1979, pp. 177;RMKER,Dietrich, Glubigerbenachteiligung durch Gewhrung und Belassung von Krediten,ZHR, N 143, 1979, p. 204.116BAUMBACH& HOPT, op. cit.117 EIDENMLLER, Horst, Die Banken im Gefangenendilemma: Kooperationspflichten and Akkordstrunsverbot im

Sanierungsrecht,ZHR, 160, 1996, pp. 343-373.118COESTER, Michael & BASIL, Markesinis, Liability of Financial Experts in German and American Law: An Exercise inComparative Methodology,The American Journal of Comparative Law, Vol. 51, 2003, pp. 290.119COOGAN, Peter in BRUYNEEL &SIMONT, ob.cit., p. 161.120PERRY, Ronen, The Unsolved Mystery of Tort Law,New York University School of Law, working paper, 2008.121BLUMBERG, Phillip, The Law of Corporate Groups. Problems in the Bankruptcy or Reorganization of Parent and SubsidiaryCorporations, Including the Law of Corporate Guaranties, Little, Brown & Company, Boston and Toronto, 1985, pp. 165-8.See cases Process-Manz Press, Inc., 236 F. Supp 333 (N.D. III 1964); 369 F. 2d 513 (7thCir. 1966); 386 U.S. 597(1967).


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On the other hand, the equitable subordinationaimed also at sanctioning fraud122of the loancan be claimed, among other reasons, if inequitable behaviour resulted in harm to remaining creditors orin unfair advantage detrimental to the interests of the rest (Bankruptcy Code Section 510 (c)).123 Theinsiders (shareholders, directors) logically bear more stewardship duties, but the outsiders (such as thecreditors) can also assume some fiduciary duties vis-a-vis other creditors in extreme cases, such as de factocontrol of the borrower and lending money in a unconscionable way, which can justify that their creditsbe subordinated.124

The constructive fraud contemplated by Section 548 establishes that there is no need todemonstrate the intent to defraud the remaining creditors. What is required is a lack of proportionbetween the performance and the occurrence of a situation in which the debtor is collapsing, or, morespecifically, an awareness of the lack of repayment capacity of the borrower. All of this indicates theimplicit dolusof the lender.125

In England there are no specific torts focusing on abusive loans. This means that under generalrules there is no area for this kind of responsibility. This idea is even clearer if one considers that there areno fiduciary duties between the lender and the creditors of his borrower.126 However, some specificbankruptcy rules allow for sanctioning behaviour under particular circumstances. When there was anintention to defraud the remaining creditorsand thus to take unfair advantage of them (fraudulent trading,Insolvency Act 1986, Section 213)this creditor can be held liable.

Moreover, according to Section 214 (3) of the same act (wrongful trading), when the company isinsolvent and its directors knew or should have known that this condition was irreversible and yet in spiteof that they contracted new, unfair, inappropriate debts,127 such directors can be held liable.128 Theconnecting point with the abusive loans is that these directors can be creditors when they act in the shadow,unfairly controlling the debtor, and when the abusive loans were tools used by the de facto director-creditor. The loans of those who engaged in this behaviour can be subordinated by the court.129

In Spain the academic debate has not paid much attention to this special kind of liability, 130although after the most recent reforms in its bankruptcy laws (Ley concursal, 2003) this particular statutehas been seen as the specific rule that should guide the abusive credit discussion.131

122 BAIRD, Douglas & JACKSON, Thomas, Cases, Problems, and Material on Bankruptcy, Little, Brown & Company,Boston and Toronto, 1985, pp. 254-7.123

HERBERT, Michael, Understanding Bankruptcy, Matthew Bender Irwin, US, 1995, p. 176.124COWANS, Daniel, CowansBankruptcy Law and Practice, Vol. III, 6thedition, West Publishing Co., St. Paul (Minn),1994, p. 126. Applying this principle, the Bankruptcy Court for the District of Montana recently subordinated abanks credit because of its lack of financial due diligence and inattention to borrowers abilities to repay the loans,seeIn re Yellowstone Mountain Club, LLC,Case No. 08-61570 (Bankr. D. Mont. May 13, 2009).125COOGAN, op. cit., p. 167. In one case the banks credit was subordinated because it had induced other creditorsof the common debtor to keep on granting loans to this borrower in order to avoid its bankruptcy (whicheventually happened), knowing its distressed situation, seeFrank S. Osborne and Doris Arlene Osborne, Debtors. Bank ofNew Richmond, New Richmond Farmer's Union Co-Op Oil Company and General Feeds, Inc., v. Production Credit Association ofRiver Falls, Wisconsin,United States District Court, W.D. Wisconsin, No. 84-C-43-C, Sept. 18, 1984, 42 B.R. 988,11 Collier Bankr.Cas.2d 1349, Bankr. L. Rep., p. 70.

126MEGRAH, Maurice, in SIMONT, Lucien & BRUYNEEL, op. cit., 1984, pp. 157-160.127 The jurisprudence is not unanimous regarding whether the director had to have shown a particular intentiontowards the damages, see PFTZM (in liquidation),2 AII ER 365, 1995 (CA) and Secretary of State for Trade and Industryv. Deverell,CA (Civ. Div.), 2000, All England Law Reports, 365 (CA).128HAMMERSON, Marc, What is a Shadow Director?New Law Journal, Vol. 151, N 7008, 2001, p. 1704.129STEVENS, Robert, National Report for England,in MCBRYDE,FLESSNER & KORMANN(eds.), Principles of EuropeanInsolvency Law, Kluwer Legal Publishers, Deventer, 2003, pp. 216.130 See the Spanish chapter of Jos GIRON TENA in SIMONT & BRUYNEEL, ob. cit., pp. 73-91; FERNNDEZ-ARMESTO,Juan & DE CARLOS BERTRN, Luis,El Derecho del Mercado Financiero, Civitas, 1992, Madrid, pp. 195, 202-4;SANCHEZ MIGUEL, Mara C., La responsabilidad de las entidades de crdito en su actuacin profesional,Revista de DerechoBancario y Burstil, N 37, 1990, pp. 319-342.131RUBIOVICENTE, Pedro, Concesin abusiva de crdito y concurso,Revista de Derecho Concursal y Paraconcursal, No.8, 2009, pp. 247-274.


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Applying the general alterum non laedere principle contemplated in Art. 1902 Civil Code, thedamage effectivelyprovokedby negligent behaviour must be compensated.132The free market constitutionalframework (Art. 78, Spanish Constitution) protects banks from the consequences of mistakes, but notfrom violation of their own professional duties of stewardship caused by serious imprudence (culpa lata).In this case, the victims own negligence operates as a defence for avoiding liability.133

As pointed out above, the new Ley concursaladded new procedural tools for channelling judicial

claims related to abusive loans. Seeking reconstruction of the economicactivemassand reinforcementof theequal treatment rule, fraudulent and/or harmful acts performed by insolvent debtors before default canbe challenged by the actions established under the new act (Art. 71). 134These credits can be subordinated(Art. 92) or a trustee can also file to protect the active mass related to the complicity of third parties withthe debtor, who helped him to simulate the real economic state of the debtor (Arts. 164-166). Theimportant consequence here is that the loan of the abusive lender is considered void and the lender iscompelled to pay compensation.135

Finally, we look at the Argentinean system, which is another example of an open tort model,strongly influenced by the Italian and French systems. The general principle in tort law (Arts. 1109, 1113Civil Code) indicates that any damage caused by negligent or wilful behaviour must be repaired,136facilitating the recognition of liability for granting abusive loans.

Specifically focusing on responsibility for abusive loans, the lenders behaviour is considered

wrongful when it violates the duties of the banking profession, its internal guidelines, and/or the rulesestablished by the central bank.137With regard to which aspect of the borrowers situation renders thelenders decision to grant a loan unlawful, this occurs when the economic distress is definite andirreversible and there is no option other than to default.138The trustee will have to prove that the lenderknew or should have known this situation and that this loan provoked, at least partially, the allegeddamages.

The plaintiff must prove that the abusive loan provoked the aggravation of the borrowerssituation or induced him to contract with this common debtor. The collective damages (inflicted on thecreditors as a group) must be claimed by the trustee, as a bankruptcy inefficacy action and/or as acompensation claim,139 while so-called particular damages must be claimed by the creditors individually

132LACRUZ BERDEJO, J.L., LUNA SERRANO, A., DELGADO ECHEVERRA, J. & RIVERO HERNNDEZ, F.,Elementos de

Derecho Civil. Derecho de Obligaciones, Vol. II, Bosch, Barcelona, 1987, p. 584.133GIRONTENA, op.cit., pp. 88.134The bad faith of the creditor can be represented by his intention of harming--or his knowledge that his behaviorhad or could have had a damaging effect over--the other creditors, Tribunal Supremo de Espaa,December 161997, FALCN FERR, Juan, Los crditos subordinados, Civitas, Aranzadi, Cizur Menor, 2006, 308 pp.135GARCA-CRUCES, Jos, in ROJO& BELTRN(director), Comentario de la ley concursal, T II, Civitas, Madrid, 2004, p.2577; FERRER BARRIENDOS, Agustn, in SAGREGA TIZN, SALA REIXACHS & FERRER BARRIENDOS (coord.),Comentarios a la ley concursal, T II, Bosch, Barcelona, 2004, p. 1715.GIRONTENA, op.cit., pp. 88.136Corte Suprema de Justicia de la Nacin, Santa Coloma, Luis F. y otros c. Empresa Ferrocarriles Argentinos,August 61986, La Ley, 1987-A, p. 442.137CHIAVASSA, Eduardo & RICHARD, Efran, Responsabilidad por abuso crediticio,paper presented at the I CongresoArgentino e Iberoamericano de Derecho Bancario y V Congreso de Aspectos Legales de las Entidades Financieras, Lomas deZamora (Buenos Aires), June 28- 29 2007.138 In Argentina, insolvency is tantamount to cessation of payment and therefore the bankruptcy solution is

unavoidable (arts. 1 and 78, ley de concursos y quiebras), see RIVERA, Julio Csar, Instituciones de Derecho Concursal,Rubinzal-Culzoni, Sante Fe, 1996, p. 119.1393rd Juzgado Proc. Concursal de Mendoza,Fernndez Darder, Juan J. s/ quiebra, February 7 1996, Revista Foro deCuyo, February 1996, pp. 122. The trustee petitioned the bankruptcy judge to reject the credit that a bank was tryingto verify in the procedure, alleging it was abusive. After describing the general elements of this specific kind ofresponsibility, which basically coincide with the framework explained above, the judge had to reject the claimbecause the trustee was not able to prove them empirically. For comments about this case seeRIBERA, Carlos, Unasentencia ejemplar del juez Mosso respecto a la concesin abusiva del crdito y los concursos,Derecho y Empresa, UniversidadAustral, September 2004.


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affected.140 Abusive credits can also provoke the nullification of collateral that a lender can otherwiseobtain through these kinds of loans.141

2.4. Checking the general theory: Some final remarks to determine and contextualize commondenominators

After reviewing eight different legal systems it is possible to state that the theory of responsibilityfor granting abusive loans is generally confirmed by all of them.

Indeed, these laws affirm that lenders cannot lend money with impunity, disconnectingthemselves from certain consequences that these contracts can bring about in foreseeable victims.Recognizing that there is ample room for discretion, a fact intrinsic to financial activity, financial ethicsimposes a minimal standard of professional due diligence when assessing the cred

sovereign insolvency, abusive lending, and distribution of losses

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