Why is Debt Recovery Beneficial?

There are legal, economic, and financial reasons why the laws of nearly all countries allow governments to sue and be sued.

Sovereign Immunity & Industrialization

Sovereign governments around the world are actively engaged in commerce, buying and selling real and intangible assets. One of the commercial activities of sovereign countries is the issuance and sale of its own treasury bills and bonds and the signing of bank loans and guarantees for important investment projects in priority sectors.

Until the 1950’s, sovereign governments had immunity from jurisdiction and lawsuits. When countries defaulted on a contractual obligation, the counter-party could not sue and could only hope that someday compensation might be made for the default.

This complete sovereign immunity slowly changed, however, as more and more legislatures adopted what is termed the restrictive interpretation of sovereign immunity.

The specific laws vary from jurisdiction to jurisdiction, but generally speaking under the restrictive interpretation of sovereign immunity, a sovereign may be sued in a court of law if it defaults on an obligation undertaken in the context of a commercial activity. This doctrine expanded as a result of industrialization; more and more sovereigns became engaged in more and more commerce and therefore defaulted more frequently.

This, in turn, created a strong movement among companies and legislatures to reign in sovereign impunity by passing legislature restricting their immunity.

Benefits of Allowing Sovereigns to be Sued

There are primary and secondary markets for sovereign bonds and debt in which buyers and sellers are constantly buying and selling bonds, bank loans, promissory notes, bills of exchange, and open invoice balances owed or guaranteed by sovereign obligors such as governments and government-owned companies.

In these markets, each sovereign’s debt trades at different pricing based on its fundamental economic conditions, the amount and terms of its internal and external debt, its national income, and its track record or performance on paying its loans.

The more external debt a sovereign has in the market in relation to its total income, the greater the discount will be on the debt in a sale in the market.

Similarly, the greater the amount of debt there is in the market relative to income, the higher the interest rate a government will have to pay for new loans and the higher the insurance premium an investor in the country will have to pay to cover the risk of default.

With sovereign debts, there is always a price for the debt, even if its external debt is in default and it has no intention to pay. Unlike corporate obligations, the price of the sovereign debt never reaches zero. The reason there is always a price in the secondary market for sovereign debt is based on the premise that countries never go bankrupt. It is also because there is always an ultimate buyer for the debt no matter how dire the issuer’s economic situation.

If a country were to change its laws to prevent an investor from purchasing the debt and either converting it or recovering on it, the floor price will go away and defaulted claims on severely indebted lower income countries would go to zero. Importantly, lenders will become more reluctant to lend to impoverished countries on an unsecured basis or will require extraordinarily high interest on their loans.

Similarly, insurers who are insuring the sovereign risk will hike their premiums because a sovereign will not perform on a guarantee covering loans to a government-owned company for a priority project. They will do this to cover their own risk because, in the event of a default on the guarantee, there will be no buyer for the debt to which they become subrogated.

The view is that the “cost” to poor countries in the form of higher interest rates and insurance premiums will, on a global basis, far outweigh the “cost” of these governments having to pay out on judgments for debts on which they have defaulted.