In July 1979, the Republic of Zambia, a former British colony, signed a $15 million Credit Agreement with Romania. Zambia used the credit to purchase Romanian tractors, minibuses, and various farming implements from government-owned companies, including Astra Trading SA (Autoexportia), Universal Tractor SA, and Auto Dacia SA. Zambia agreed to pay 5.5 percent interest on the debt.
Over the following 20 years, Zambia made minimal payments on the debt. Romania and Zambia attempted numerous times to negotiate a mutual settlement on the debt without success.
Donegal got involved with Zambia’s debt in early 1998 when it negotiated an agreement with the Government of Romania to buy the debt for 11 percent of the then-outstanding principal amount of $15 million. Approximately $15 million of interest owed to Romania was to be assigned to Donegal at no cost. Under the agreement, Donegal had to pay for the debt prior to December 31, 1998.
On December 18, 1998, a Zambian Government delegation traveled to Romania to reconcile the outstanding amounts and to seek a resolution of the debt. In the process of this negotiation, Zambia recognized the total debt outstanding as $29,834,368.06. In doing so, it capitalized the interest, meaning it accepted the debt to include the accumulated interest.
Donegal missed its December 31st deadline for closing and proposed to purchase the debt in the first week of January 1999, only to be informed that it must double its purchase price due to the interest capitalization recognized by Zambia. Having devoted much time and energy to the project, Donegal nevertheless agreed to purchase the larger principal debt at the higher price and made a firm offer to Romania of $3.28 million, equivalent to 11 percent of the total debt.
Donegal was unaware that Zambia, during this period, was negotiating to buy back the debt from Romania. Donegal subsequently discovered that Zambia had discussed repurchasing the debt for 12 percent of the newly reconciled figure – $29,834,368.06 – with payment to occur over several months.
The Government of Romania compared Zambia’s proposal (no contract was signed) with Donegal’s firm written bid “in terms of price, payment period and security.” Zambia’s proposal was “not secured and the repayment period [was] over one year.”1 In addition, for nearly 20 years Zambia had failed to repay its debt and there was little assurance it would do so in the future.
At the time of the sale, Romanians were suffering many hardships. Their economy was shrinking and the unemployment rate topped 10 percent. From 1996 to 1999, the country’s poverty rate had jumped from 20 to 40 percent.2 In short, the Government of Romania was in desperate need of funds to provide assistance to its citizens and decided to sell the debt to Donegal. A contract was signed on January 19, 1999.
Debt-for-Equity Swap
Prior to purchasing the debt, Donegal had had positive discussions with Zambian government officials on using debt-for-equity swaps to leverage investment in commercial projects in Zambia. Such swaps produce jobs and tax revenue for the debtor government, while reducing debt at a discount.
Debt-for-equity swaps, like debt-for-development swaps, involve the purchase of a debtor country's obligations at a discount and then the cancellation of the debt in exchange for local currency or local currency notes, which are then invested in the debtor country. Swaps are especially attractive for countries experiencing large external debt burdens, severe economic problems, and low foreign investment.
These were exactly the conditions prevailing in Zambia in 1999 when Donegal bought the debt. The country’s economy was in turmoil. Prices for copper – a major export – were low, foreign investment was almost non-existent, inflation and devaluation levels were very high and unemployment was rife. The county’s privatization process had stalled and tax revenues were low.
Donegal was optimistic a swap could be negotiated that would be a win-win for all parties concerned. Mr. Sheehan had formulated debt conversion initiatives in other countries.
From 1999 to 2002, Donegal proposed a variety of debt-for-equity funded investments to the Government of Zambia.3 The evidence before Justice Andrew Smith, was that Donegal made considerable efforts to reach arrangements with Zambia with a view to bringing new investment to Zambia. Meetings were arranged with members of the government, including then-President Frederick Chiluba and with other officials.4
In one proposal, Donegal offered to swap the debt for local currency to restart the Zambian National Lottery using wireless technology. Donegal offered in another deal to invest conversion equity in the Kafue Textiles Company in anticipation of the opening of the U.S. market to African textiles. Donegal put together a proposal to swap the debt for long-term local currency bonds – an initiative that would have assisted the Zambian Treasury in issuing and placing bonds with longer maturities, the goal of any sovereign issuer.
In its last offer, Donegal proposed to take over the Development Bank of Zambia (DBZ) in conjunction with Loita Capital Partners, an investment banking firm based in Johannesburg, South Africa, that specializes in the management and operation of banks in Africa. The government-owned DBZ was near collapse and discussions were underway to turn the bank into a private institution. Loita Capital had agreed to invest $1 million of new capital in the bank and to bring trade lines of $30 million from European banks with which it had existing relations.
Sadly, all of the proposals were rejected by Zambian officials, usually without any comment or written response. Donegal looked for other debt conversion arrangements, assuring Zambian officials that investments would be in the “priority sectors of mining, finance, housing, and agriculture,”5 but every offer was steadfastly ignored. With prospects negligible for arrangement of an equity-for-debt swap in Zambia, Donegal offered to negotiate a potential settlement in "hard currency." Not surprisingly, this effort too led to a dead end. Finally, Donegal turned to the last resort available - legal action.
Settlement Agreement
In November 2001, Donegal informed officials in Zambia that it had abandoned its plans for investment and called for immedate cash settlement of 36 percent of the principal debt. In response, Zambia arranged a meeting with Donegal in February 2002 to discuss a potential settlement.
In the months that followed, Donegal and Zambia negotiated with little progress. On July 4, 2002, Donegal informed Zambia that steps were underway to bring litigation to recover the debt. Still, Donegal said it preferred to resolve the matter without litigation and kept open the option of negotiating a settlement or conversion. Discussion continued with both parties exchanging draft settlement agreements.
The exchanges resulted in little actual progress until Donegal actually “filed for leave” to serve Zambia in the courts in the British Virgin Islands. The leave was granted, although Donegal never formally served the papers on Zambia, since Donegal was still seeking an amicable settlement. In December 2002, a senior Ministry of Finance official announced in a letter Zambia's intention to sign an agreement.
The following month, the Ministry of Legal Affairs took over the negotiations, and representatives of Donegal hammered out final details of the agreement with the Attorney General of Zambia. In March of 2003, the Attorney General then wrote the Minisiter of Finance instructing him to come up with an acceptable payment plan for settlement. Soon thereafter, in April 2003, a Settlement Agreement was signed.
In the Settlement Agreement, Zambia agreed to pay 33 percent of the outstanding principal and interest on the debt, which had grown since 1999 to $43,846,576.26. Payments were to be made monthly over a three-year period.6 Zambia also agreed it should not be immune from the claim and that the settlement was enforceable under UK law.
Zambia made payments on the debt in April and June 2003, each for $500,000. A further payment of $1.418 million was forwarded five months later. Notwithstanding this payment, Zambia was not complying with its payment obligations. As a result, a letter was sent by Donegal to Zambian officials on December 14, 2003, giving notice of default.
In June 2005, Donegal went to court in the UK to freeze Zambian assets in Britain, including shares owned by the Zambian Ministry of Finance and Economic Development in the UK company called MOFED. The company owns property in London leased by the Government.
In August 2005, Zambia sought to overturn the Settlement Agreement by seeking a court determination that it was a sovereign state and thus entitled to assert state immunity. In February 2006, Donegal applied for summary judgment against Zambia.
High Court Rulings
In March 2007, a UK High Court ruled that Donegal’s contract was lawful and binding. Justice Andrew Smith said he rejected “all the various arguments that Zambia advance[d] by way of challenge to the validity and enforceability and applicability of the Settlement Agreement….”7
Mr. Justice Smith also concluded that Zambia agreed in writing in the Settlement Agreement that Zambia “should not be immune as respects the claim that Donegal” brought before the court.
In seeking a summary judgment, Donegal said it was entitled to $55,568,545.74 because the Settlement Agreement provided that, in the event of default, the amount owed “clawed back” to the original amount owed prior to settlement, less payments made to the date of default, plus interest and penalty interest from the date of default until judgment. The sum, in short, represented the total debt in 2003 – $44,723,761.17 – plus contractual and penalty interest.
Zambia's actions were heavily criticized. It was recorded in the judgment that Zambia had "rejected their [Donegal's] reasonable proposals for settling the indebtedness and ... sought to evade their responsibilities."
The court continued the freezing order over Zambian assets in Britain, including the Government's shares of MOFED.
Donegal Awarded $15.5 Million
A hearing was scheduled in April 2007 to determine the amount of money Zambia would have to pay Donegal. The court voided the claw-back clause stating it was penal because the interest clause applicable on default in all the circumstances could not be seen as reinstating the interest provisions applicable under the original loan agreements.
The court therefore awarded Donegal only $15.5 million being the amount owed under the Settlement Agreement plus interest from the date of default at rates applicable in 2007.
Donegal expects to recover a significant amount of its legal fees. It also has spent substantial sums in travel and consulting fees. After nine and a half years in the investment, Donegal does not expect its yield on the asset to exceed 15 percent per annum.
Conclusion
The press coverage on the Donegal affair has been mostly one sided and focused on the Government’s allegations of impropriety. All allegations of impropriety were rejected by the UK Court.8 Missing in the coverage has been any serious discussion of the merits of debt conversion, and the transactions Donegal spent three years attempting to implement.
If Donegal’s initial transaction with Romania had gone forward in December of 1999, it would have been in a position to sell the debt back to Zambia at a price that was lower than what Zambia was proposing to pay Romania.
Similarly, if the subsequent conversion proposals had been accepted by Zambia, the resulting investment in Zambia would have produced offsetting revenue for the Government in the form of taxes and offsetting benefits in the form of employment.
1 Donegal International ltd. v. The Republic of Zambia and anr. P. 51
2 www.worldbank.org.
3 Donegal International ltd. v. The Republic of Zambia and anr. P. 76. at para 296.
4 Donegal International ltd. v. The Republic of Zambia and anr. P. 76. at para 296.
5 Donegal International ltd. v. The Republic of Zambia and anr. P. 80. at para 311.
6 The Settlement Agreement is similar to three other agreements negotiated by Zambia over the previous ten years and was less than another settlement with a Serbian creditor which was agreed at for 50 percent.
7 Donegal International ltd. v. The Republic of Zambia and anr. P. 124. at para 501.
8 “House Hearing Excoriates ‘Vultures.’” HedgeWorld Daily News. June 5, 2007.