Venezuela faces the greatest financial crisis of its history. Aggregate claims against the state-owned oil company Petróleos de Venezuela, SA (PdVSA) and other government-owned entities have been estimated at as much as US$175 billion, excluding accrued and unpaid interest. This figure includes foreign external financial indebtedness such as unsecured bonds issued by the Republic and PdVSA, secured bonds issued by PdVSA, promissory notes issued by PdVSA to suppliers, loans owed to multilateral lenders (e.g., CAF and Interamerican Development Bank), debt owed to bilateral lenders such as China Development Bank and Japan Bank for International Cooperation, and trade debt due to suppliers and contractors. The aforesaid amount also includes claims arising from international arbitration awards rendered against the Republic and PdVSA.
Given the current size of Venezuela’s economy, aggregate claims against the country are equivalent to several multiples of its gross domestic product (GDP).
The complexity of a Venezuelan restructuring stems from myriad factors, ranging from the mundane to the philosophical and arcane. The complexities inherent to any sovereign debt restructuring are compounded by US sanctions, the spillover effects of the polarised domestic political dynamics over the country’s institutions, and sensitive humanitarian issues playing out on top of the world’s largest oil reserves.
Below are thoughts on the legal and policy questions that will arise in a Venezuelan restructuring.
The Executive branch of the Venezuelan government requires approval from the National Assembly (Venezuela’s legislature) to incur any form of indebtedness. Legislative approval is required under the Organic Law on Financial Management of the Public Sector (the Public Finance Law). The Venezuelan Constitution requires that an annual indebtedness special draft bill be submitted by the Executive to the National Assembly with the annual draft budget bill.
The National Assembly grants its approval for the Republic to incur indebtedness by enacting an Annual Indebtedness Law, which specifically (1) approves the maximum indebtedness amount allowed to be incurred by the Republic for the given fiscal year, (2) approves the use of the proceeds raised or borrowed from the financings that may be incurred during the fiscal year, and (3) authorises the stock of treasury bills that may remain outstanding within the fiscal year.
Under the Public Finance Law, the Executive branch does not require approval from the National Assembly for each specific indebtedness transaction, unless the contracts qualify as ‘national public interest contracts’ that will be entered into with foreign states, foreign authorities or entities that are not domiciled in Venezuela.
In principle, the Republic may not incur any type of indebtedness that has not been previously approved by the National Assembly by means of an Annual Indebtedness Law. Nevertheless, there are exceptions to this legislative approval.
Refinancing and restructuring exceptions
Even setting aside the legitimacy issues levelled at some point on the National Assembly, the political realities of Venezuela complicate its legislative process, especially the approval of budgetary and public credit appropriations.
The Public Finance Law exempts the Executive branch from legislative approval to incur debt under special situations. Specifically, Article 99 exempts ‘refinancing’ or ‘restructuring’ transactions that extend maturities, reduce interest payments, convert external debt into internal debt or otherwise generate cash flow savings for the Republic.
Therefore, if the Republic enters into a set of transactions through which it reduces interest payments, extends duration, converts external indebtedness into internal indebtedness or otherwise reduces cash outflows, no approval by the National Assembly will be required.
In our view, the requirements of Article 99 are not necessarily cumulative. It should be sufficient for any one of the requirements to be present for the refinancing or restructuring transaction to qualify for exemption from legislative approval.
This view is reflected in Regulation No. 2 of the Public Finance Law, which provides that refinancing or restructuring transactions that meet any of the requirements of Article 99 (formerly Article 88, at the time Regulation No. 2 was issued) will not require approval by the National Assembly.
Given that the majority of Venezuela’s foreign external financial indebtedness is represented in bonds issued under New York law, it is not inconceivable that a restructuring could take place by means of an exchange of all or part of the Republic’s existing bonds for new bonds. The terms of the new bond or bonds that would be offered in such an exchange would be driven by the extent of the ‘haircut’ that is ultimately agreed by the Republic and its bondholders, based on Venezuela’s experience under the Brady Plan and as originally proposed by Buchheit and Gulati for Greece:
The terms of the new instrument or instruments that would be offered in such an exchange will be a function of the nature and extent of the debt relief the transaction is designed to achieve. At the soft end of the spectrum would be a simple ‘reprofiling’ of existing bonds (or some discrete portion of them, such as bonds maturing over the next three to five years) involving a deferral of the maturity date of each affected bond. Uruguay (2003) stretched out the maturity date of each of its bonds by five years, while leaving the coupons untouched. At the sharper end of the spectrum would be a transaction designed to achieve a significant net present value (‘NPV’) reduction in the stock of debt. If Brady Bonds were chosen as the model for the transaction, this might entail allowing holders to elect to exchange their existing credits for either a Par Bond (a new bond exchanged at par for existing instruments, having a long maturity and a low coupon), or a Discount Bond (a new bond exchanged for existing instruments at a discount from the face amount of those instruments, but typically carrying a higher coupon and perhaps a shorter maturity than the Par Bond). The precise financial terms of the Par Bond and the Discount Bond would be calibrated to achieve an equivalent NPV reduction.
It is not entirely clear but, in our view, an exchange of existing bonds for new bonds that extends the maturities of the existing bonds on the same basis but otherwise leaves coupons unaltered would probably fall within the restructuring exemption and would not require approval from the National Assembly. The same could be said for a new bond exchanged for existing bonds at a discount from their nominal value, but with a higher coupon.
The refinancing exemption raises multiple issues that may call for a political compromise that could be effected via approval of the legislature. This could also ensure the avoidance of any legal doubts as to what may fall within the refinancing exemption, such as:
- a refinancing that generates savings for the Republic because it reduces interest payments or extends duration, but also increases the Republic’s debt stock because it involves raising new money;
- a transaction that extends maturities but increases the interest rate on the debt that is refinanced; or
- a qualifying refinancing that does not raise new money but includes oil price-linked or GDP-linked payments that may potentially increase cash outflows during the life of the new debt.
PdVSA and its affiliates are not subject to legislative approval to borrow or raise money. PdVSA is only required to publish an audited financial statement annually, showing its total financial indebtedness. This financial statement must be audited by an auditing firm registered with Venezuela’s securities watchdog. Other than the audited financial statement, PdVSA is not legally obliged to obtain any legal or regulatory approval to incur indebtedness.
PdVSA’s restructuring regime
There are two insolvency procedures under Venezuelan law: (1) the moratorium (atraso) process; and (2) the bankruptcy (quiebra) process. Although the regime may be used either to liquidate business enterprises or to reorganise them, recent practice seems to show that if a company is salvageable, most stakeholders prefer to have an out-of-court restructuring. The Venezuelan bankruptcy process is seen as vexatious, reflecting in part the fact that there is still a social stigma attached to businesses that go bankrupt.
There is much speculation as to whether Venezuelan public entities can be subject to the Code of Commerce’s insolvency regimes. PdVSA and its subsidiaries in Venezuela are organised as public limited companies (sociedades anónimas) under the Code of Commerce and logic would dictate that the Code’s bankruptcy provisions should apply to them.
However, PdVSA’s oil and gas transportation and distribution infrastructure is protected from local attachments. Specifically, any provisional remedy, or remedy in aid of the execution of judgments rendered against PdVSA’s oil and gas distribution infrastructure located in Venezuela, must be automatically stayed for 45 days while the Ministry of Energy and Petroleum deploys a plan that will ensure the uninterrupted supply of oil, derivatives and gas to the market. This protection from attachments and provisional remedies has been regarded by scholars as a type of immunity that would complicate the application of the bankruptcy regime of the Code of Commerce to PdVSA, as a significant portion of the national oil company’s most valuable operational assets may fall outside the reach of compulsory liquidation proceedings.
Some might say that PdVSA’s insolvency would require the procedural rules currently in effect in Venezuela to be adapted to take account of the underlying public policy issues involved to avoid affecting the provision of a public service of general interest. Other legal commentators have taken a different view. Neither position has been tested in the Venezuelan courts in relation to the oil and gas industry. If the bankruptcy regime of the Code of Commerce were to be considered not to be applicable to PdVSA by the competent court, which in our view would be the Venezuelan Supreme Court, there would be no other specific set of rules that would regulate PdVSA’s insolvency or its liquidation.
To complicate matters, Venezuela owns all hydrocarbons while they are underground at the reservoir. Title to hydrocarbons passes to the holder of a concession or licence (i.e., PdVSA, PdVSA Petróleo, SA (a subsidiary), Corporación Venezolana del Petróleo, SA or joint venture) at the wellhead, pursuant to the terms of the relevant licence. It could be said that the Republic (owner of the reserves and a royalty creditor to PdVSA) would be acting as judge (through the bankruptcy court) as well as a creditor of PdVSA under an insolvency proceeding.
Given these uncertainties, it would be convenient for Venezuela to (1) adopt a modern insolvency statute to govern state-owned entities, which incorporates modern insolvency principles and paves the way for eligibility for recognition in relevant jurisdictions, and in particular under Chapter 15 of the US Bankruptcy Code, and (2) finally adopt the United Nations Commission on International Trade Law Model Law on Cross-Border Insolvency, which may provide readily available mechanisms to address the multiple potential cross-border issues that can be expected to arise from the insolvency of one of the historically largest national oil companies in the world (with significant assets and operational exposure outside Venezuela).
A new PdVSA?
The Republic could create a new entity and grant to that entity all or some of the oil and gas licences that are currently held by PdVSA and its operating subsidiaries, namely PdVSA Petróleo, SA and the joint ventures.
PdVSA and the Republic have chosen to have their international bonds governed by New York law. An interesting issue would be if the creation of a ‘new PdVSA’ to which all (or a substantial portion) of PdVSA’s assets were transferred, including the right to carry out primary oil activities and undertake the international sale of crude and derivatives, would be considered liable for PdVSA’s bonds under successor liability.
Security interests and guarantees
Pursuant to the terms of Venezuela’s bonds, liens on oil or oil accounts receivable (other than permitted liens) created by Venezuela to secure public financial debt, granted by the Venezuelan Central Bank or any government agency (a definition that includes PdVSA and its subsidiaries) within certain thresholds (taking into account Venezuela’s operating reserves) will cause Venezuela to equally and ratably secure its outstanding bonds.
In general terms, Venezuela is currently legally restricted under domestic law from granting security interests to secure debt and guarantees to secure the debts of other entities.
If Venezuela were to secure bonds issued in the context of a restructuring, it would probably need the passage of a restructuring law that authorises it to post collateral or otherwise secure the new bonds to be issued in the restructuring. Such a law was passed to enable the Republic to post US Treasury bonds to secure a series of Venezuela’s Brady Bonds.
PdVSA and its affiliates generally have few restrictions on granting security interests over assets that are not used for public utilities.
New legal framework
The country’s enormous reserves have the potential (assuming that US sanctions affecting the industry are lifted) to generate the cash flow required to address the current complex socioeconomic situation and to sustain the restructured debt. Any attempt to refinance Venezuela’s and PdVSA’s debt will be ill-fated if not accompanied by a recovery of the country’s oil and gas industry. To ensure such a recovery, Venezuela may move to revise key aspects of its current oil and gas regulatory framework to further incentivise private investments. One option would be to enact a new oil law that establishes an internationally competitive legal and fiscal framework to attract investments in the amounts required to increase oil and associated natural gas production and Venezuela’s fiscal revenues. Another possible option is for the legislature to pass specific amendments to current legislation to address issues such as the direct commercialisation of crude oil by private operators and to allow these private investors to assume majority control over upstream, public-private, joint ventures.
Debt-to-equity conversions should also be explored in the context of a comprehensive restructuring of Venezuela’s debt. Debt equity swaps will not increase Venezuela’s foreign exchange reserves. However, they have the potential to help reduce the country’s and PdVSA’s aggregate debt, and to increase the country’s capital stock. If the programme is well executed, it could also help to promote foreign direct investment; this, in turn, would increase the country’s reserves, capital stock and export capacity. Debt-for-equity swaps have already been used by Venezuela, in connection with state-owned assets located abroad.
There are no local legal restrictions that would prohibit the Republic, PdVSA and all other government-owned entities from conducting a full-scale restructuring that encompasses all their creditors.
However, this would require a political compromise rarely seen in Venezuela’s political landscape. The role of external stakeholders will be critical in helping to crystallise any form of restructuring.
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