Contracts are pretty neat things, even when they don’t feature elaborate iconography. One reason is that they reveal a lot about how parties anticipate and plan for disputes. I’ve been thinking about this subject lately in connection with a project examining old sovereign bonds and related contracts (e.g., the contract between the issuing country and the underwriting bankers). I’ve written a bit about these contracts in the modern setting, but the older ones I’m now looking at are from around 1860-1930, and they raise an interesting puzzle: Why do parties invest negotiating capital haggling over unenforceable terms?
First, a bit of background: As I described in the earlier post referenced above, formal legal enforcement mechanisms are of limited use when the issuer is a sovereign state. Reputational constraints – primarily the threat of exclusion from future borrowing – serve as the primary inducement to debt repayment. That’s true today, but it was especially true during the period of interest here, when states were immune from suit, and their assets were immune from execution, in most foreign courts. In many jurisdictions, even explicit advance consent to jurisdiction or arbitration would not overcome the issuer’s immunity at the time of suit. For example, a 1924 English case (Duff Development v. Gov’t of Kelantan) allowed a sovereign state to invoke its immunity to prevent enforcement of an arbitration award even though it had agreed to arbitrate in the relevant contract and had actually participated in the arbitration. So a creditor whose contract included an arbitration clause, say, wasn’t much better off than a creditor whose contract said nothing about dispute resolution. In either case, the creditor’s ability to obtain and enforce a judgment depended on the sovereign’s consent at the time of suit. If the sovereign didn’t willingly participate in the litigation, there wasn’t much the creditor could do.
To some degree, each term in a contract between a private party and a sovereign state raises this puzzle, because it's always hard for the private party to obtain and enforce a judgment. Yet there are still benefits to writing a detailed contract. After all, concern for its reputation may induce the sovereign to comply for part or all of the contract term, and the parties need to know how to behave and detect non-compliance during that time. But dispute resolution terms seem different, and far more likely to require the support of some coercive external enforcer. For one thing, these terms typically become relevant only after cooperation has broken down. An issuer that defaults on its payment obligation, for example, has already suffered a far more serious blow to its reputation than any it will suffer by refusing to participate in a lawsuit or arbitration against it. So why would it participate willingly? (To be sure, the issuer might plausibly contend that it had no choice but to default on payment terms, while its refusal to participate in a dispute resolution process would obviously be intentional. But that seems a minor distinction. Once payment stops, I doubt many lenders would be surprised, or especially offended, to hear that the issuer won't voluntarily assist them in obtaining and enforcing a judgment against it.)
To avoid making this post longer than it already is, I’ll return to this topic in a later post. The fundamental question, though, is why parties invest negotiating capital ex ante on a dispute resolution process that requires the sovereign’s ex post consent. Two possibilities occur to me, which I’ll elaborate on later. First, although I’m fairly early in the process of gathering and reviewing the relevant contracts, it seems that dispute resolution clauses were especially likely to appear when the relevant lender had significant extra-legal leverage, such as the ability to deny access to a particular capital market. (They didn't always appear in these contracts, but they sometimes did.) Second, in some cases private parties included dispute resolution provisions in their contracts with sovereign states in what appears to have been an attempt to harness the enforcement capacity of other sovereign states, especially the lender's home state. Together, these practices suggest that the usual story – in which lenders effectively had no remedy until the modern era of restricted sovereign immunity – is seriously incomplete.
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