(Bloomberg) -- A legal change in the bonds that will emerge from a debt restructuring in the South Asian island of Sri Lanka could set a precedent for sovereign debt contracts.
The country’s officials and its international bondholders have agreed to keep New York as the governing law of new notes to be issued under a $12.6 billion rework, but are introducing a mechanism that allows creditors to request a change to English or Delaware law, according to a government statement on Thursday.
The change was triggered by the Sovereign Debt Stability Act, legislation proposed in New York that would limit investors’ recoveries after a debt restructuring. Even though the bills have failed to pass the legislature, with the latest attempt earlier this year, supporters and state politicians have vowed to renew their push in 2025.
About half of all hard-currency debt from developing nations — around $800 billion outstanding — is governed by New York law, making the state the most important jurisdiction for those bond issuers. But tension has been brewing between Wall Street and New York state lawmakers in the past two years over bills meant to overhaul the process of renegotiating defaulted government debt.
In Sri Lanka, the change of governing law would require a three-step mechanism, according to people familiar with the matter, and it would mark the first time that a request to change the governing law in sovereign bonds can be kicked off by the creditors.
The government would have no veto power if all conditions are met, the people added, asking not to be named because the details haven’t been made public.
“If creditors think they’re going to scare New York legislators with a hypothetical future contract change, they’re in for a surprise,” said Ben Grossman-Cohen, director of campaigns at Oxfam America, a nonprofit organization and one of the sponsors of the Sovereign Debt Stability Act. “Changing venues would not impact New York in any material way, and legislators won’t take this spectacle seriously.”
The government and bondholders agreed on terms of a restructuring including a 27% haircut on the nominal amount of existing bonds, shortly before Sri Lanka’s presidential election on Sept. 21.
A representative for the creditor group declined to comment. A Sri Lanka Finance Ministry official didn’t immediately reply to a request for comment. The committee is represented by its legal adviser White & Case LLP, while the country is represented by Clifford Chance LLP.
A New Mechanism
Bondholders of at least 20% of any of a country’s dollar notes would need first to notify the government that they would like to change the governing law. If the percentage is met, the government then launches a consent solicitation for the holders of that bond to vote on a change, the people said. The governing law would change in the contract if a super-majority of creditors votes in favor.
The super-majority percentage is still under discussion, one of the people said, adding that it’s not yet clear if the contract will also include a mechanism to alter the governing law of all series of bonds. More talks between the two sides are set to resume after an agreement in principal for the restructuring is confirmed following Saturday’s presidential vote.
The upcoming election is shaping up to be a close race between three candidates, including the incumbent Ranil Wickremesinghe who negotiated a $3 billion loan program with the IMF amid an economic crisis. The main opposition leader in parliament Sajith Premadasa, and leftist Anura Kumara Dissanayake said they will reopen negotiations with the multilateral lender, if elected.
--With assistance from Anusha Ondaatjie.
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