WHEN COUNTRIES GO BANKRUPT:
The Virtues And Flaws Of The International Monetary Fund's Proposal Of An Insolvency Law For Nation-states

The International Monetary Fund's Anne Krueger, in a recent speech and later remarks elaborating upon it, has laid the foundations for a new global order. That order will be defined not by the remnants of colonialism, but by the rule of law. And the rule of law will govern nation-states not only when they prosper, but also when they are unable to pay their debts.

Currently, debt restructurings are granted on the basis of ad hoc solutions such as the IMF's Highly Indebted Poor Countries (HIPC)-initiative or the consultation of the Paris or London Club, where the state creditors and the banks, respectively, sit together to debate about possible debt restructurings. These procedures are neither predictable, nor transparent, nor reliable - that is, they lack the essential virtues that characterize the rule of law.

In light of this situation, the IMF is entirely right to urge that a new insolvency law for nation-states be devised. The mere existence of an insolvency law would exercise a disciplining influence on all participants - just as the existence of bankruptcy laws for individuals does upon individual debtors and their creditors. In the shadow of such a law, lenders must be more cautious before they lend, and borrowers must consider that if they resort to declaring themselves insolvent, they may, in the future, be deemed fiscally untrustworthy by others.

The IMF proposal for an insolvency law for nation-states is a good starting point. For one thing, it rightly allows only reorganization, not liquidation. (The destructive effect of a country's liquidating its assets would be unbearable in light of increasing global interdependence). But the IMF proposal also has some flaws that should be corrected.

The Need for an Objective Criterion As To When Proceedings Should Start

One of these flaws is that the filing of the petition should not be dependent on the IMF's approval, as the IMF has proposed. A country should not have to get the permission of the IMF - which usually will be one of its creditors, and thus will have a conflict of interest - to initiate the reorganization proceeding.

To require a country to get IMF permission before going bankrupt infringes its autonomy and sovereignty. A neutral, objective criterion - such as the country's proven inability to pay its debts on a timely basis based on the balance of its assets and debits - is a far better trigger for when insolvency proceedings should begin than the IMF's subjective, and perhaps biased, assessment. The IMF's assessment will inevitably be compromised by its own status as a creditor, and by the fact that its members, who will vote on the insolvency proceeding's initiation, include many other lenders.

The Need for a Truly Neutral Arbiter

The IMF proposal correctly seeks the appointment of a neutral person to supervise the proceeding. But the structure of that person's compensation and location does not provide for true neutrality.

The bankruptcy administrators, under the IMF proposal, will be paid by the IMF, and will reside in Washington, D.C., where the IMF resides. Debtors could be forgiven for assuming that, as a result, the administrators will likely have a close relationship with the IMF.

The administrators should be housed and paid by another institution. The best choice is probably the International Court of Justice, since many of the administrators' tasks are of a legal nature, and they may themselves be tantamount to bankruptcy judges.

At the ICJ, a new Chamber - an International Insolvency Court - should be founded. There, the administrators' independence and neutrality would be unquestionable, even if they were to cooperate (as they ought to, and will have to) with the IMF and the World Bank in fulfilling their tasks.

Crafting The Administrator's Duties and Powers, and the Plan Requirements

According to the IMF's proposal, the debtor country's petition must fulfill certain minimum requirements with respect to both form and substance. For example, the debtor must present a plan together with its filing.

To ensure this requirement is not merely a formality, the administrator should judge at the outset whether the plan submitted seems feasible - and force the petition and plan to be refiled at a later date if it does not. Final approval will lie with the creditors' vote, but the administrator should have the power to bounce reorganization plans that plainly will not work.

The administrator should also be able to check the lawfulness of the listed claims, ascertaining whether the debtor's filing is abusive. (For instance, is the debtor's inability to pay the result of reparation obligations after a lost war that should not be forgiven?)

Finally, the administrator should also supervise the discussion about, and voting over, the plan, and monitor whether the debtor country properly fulfills the terms of the approved plan. For most of these duties, the administrator certainly need the support of the Bretton Woods Institutions.

As for the substantive plan requirements, countries should be required to budget funds in the reorganization for domestic improvements to their school systems, food supplies, and other necessities, and to maintain a certain minimum standard of living for their people despite the austerity necessary to comply with the plan.

The primary goal of a plan proceeding is to bring the debtor back into the community of the global village rather than expelling it; accordingly, even in reorganization, the debtor should be required to act responsibly towards its own people, meeting the global community's standards for human rights and the provision of necessities.

Forcing Creditors Into the Reorganization Proceeding

An intricate and challenging question is who shall be included into the proceeding. A single nation has the legal authority to force all creditors of a given corporate or individual debtor to join a single proceeding or lose their legal claims against the debtor. However, on the global level, there is no such authority.

Thus, if public creditors, banks, individual bondholders, and so on, are to be forced to comply with the insolvency rules, there must be a contractual solution, under which creditors consent to let the majority of creditors approve a bankruptcy plan that binds everyone.

A system of majority voting is necessary to threaten objecting creditors with the risk of being out-voted if they do not cooperate in negotiating a fair plan. Whether a majority or a supermajority should be required; whether creditors' votes should be equal, or should depend on the amount of their claims; and whether and how the creditors shall be grouped together are subsidiary issues that nevertheless need to also be resolved, and resolved fairly.

We are currently witnessing the creation of a fascinating new area of law - bankruptcy writ large, with financial reorganizations that encompass not just a company, but a country. The IMF has taken a brave, laudable initial step. But it is important that it take further steps to make sure the procedures it implements are the best possible - the fairest to debtor countries, to their people, and also to the creditors to whom they owe large sums.