The controversy surrounding the recent purchase of Venezuelan government bonds by Goldman Sachs is a great reminder of the role that “preemptive contract sanctions” could play in the struggle against odious regimes like that of Nicolas Maduro. In 2010, CGD released a working group report explaining in detail how this new sanctions tool could work. While the political forces have not yet aligned to try this tool against other odious regimes, such as those in Syria or South Sudan, the Maduro regime in Venezuela is more isolated regionally and globally and could be the perfect candidate. To smooth the way, the US Congress should amend the Foreign Sovereign Immunities Act to remove any legal obstacles to applying this sanctions tool in the event that the “planets become aligned.”
What are preemptive contract sanctions?
Preemptive sanctions would work as follows: The United Nations, a regional organization, or individual countries would declare that a legitimate successor to a (named) illegitimate regime would not be bound by contracts, notably including loans, that the illegitimate regime signs after the date of the declaration. The declaration signatories would not allow such contracts, nor any arbitral awards or foreign judgments associated with those contracts, to be enforced in their courts if the successor government repudiates them. Any party owning such a contract would face the significant risk that it may be worthless at some point in the future. Given the role of New York and London in financial markets and contract enforcement, the United States and the United Kingdom would need to be part of any sanctioning coalition. But it would have more legitimacy if the United Nations or an appropriate regional organization sponsored the declaration.
The benefits of applying such a tool are clear. First, it aligns the lender/investor’s profit motives with the declaring countries’ goals. Knowing that a successor regime would have a financial incentive, and legal justification, to repudiate previously contracted debt would deter creditors from signing such contracts in the first place. The illegitimate regime would be starved of external resources because contracts signed by parties in third countries will be at risk because they are unenforceable in declaring countries. Second, this approach avoids the cost of the typical financial sanctions approach involving enforcement of penalties on entities that transact business with the sanctioned regime. And third, it would protect a legitimate successor regime from having to repay the odious debt, without facing higher costs of borrowing, as would likely occur with an ex poste repudiation of the debt. Indeed, Seema Jayachandran and Michael Kremer, who co-chaired the CGD working group with John Williamson, have argued that preemptive contract sanctions might reduce the cost of borrowing by legitimate governments.
Can the politics align?
In 2012-13, CGD scholars argued that the international community should deploy preemptive contract sanctions against the Assad regime in Syria. But Russian support for the regime, plus concerns about the role of terrorist groups in the opposition, undercut support for trying this tool. Since its independence from Sudan six years ago, South Sudan has spiraled downward into what is arguably the worst economic, political, and humanitarian situation in the world. In February, the United Nations declared famine in South Sudan, calling it a man-made disaster that threatens 100,000 with starvation, with another million on the brink of famine. Yet here again, regime change could be messy, and China and others argue that more time is needed to give the current regime a chance to implement an inclusive national dialogue.
Venezuela is more isolated and represents the most viable case for applying preemptive contract sanctions. While President Maduro won the 2013 election, there is increasing doubt within Venezuela about the legitimacy of his presidency, particularly in the wake of his announcement that he will convene an assembly to rewrite the constitution. Moreover, international support for the Venezuelan government appears to be crumbling, even among countries within the region that normally do not take an active role in this type of matter. Given its historically strong political and financial support for Maduro, China will play a pivotal role. As the situation within Venezuela deteriorates, it may be in China’s best interest to add its support for preemptive contract sanctions. By doing so, it may stand a better chance of protecting the value of its current investments in Venezuela, including the value of the loans that will inevitably need to be restructured. Such a move may also enhance China’s status in other Latin American countries that object to Maduro’s actions. And, it could be a demonstration of a willingness to work with the Trump administration on the world stage.
The IMF could be an obstacle
While the 2010 CGD report argues that a small group of developed countries, particularly those that are major legal and financial centers, could effectively employ preemptive contract sanctions, the International Monetary Fund’s (IMF) Lending into Arrears (LIA) policy could stand in the way. The LIA policy prohibits lending to a country that is in arrears to private creditors unless, among other things, the country is “making a good faith effort to reach a collaborative agreement with its creditors.” Certainly a repudiation of debt owed by a successor regime could not be deemed to be “a good faith effort.” Therefore, the set of countries making the declaration, or at least recognizing the declaration, would need to include those that could reject any attempt at the IMF Board of Directors to invoke the LIA policy. This would likely reflect the membership of the UN Security Council, at a minimum.
Getting the USG house in order
The executive branch’s current authority to make a legally enforceable preemptive contract sanctions declaration is uncertain. The CGD report argues that a US declaration could be enacted and enforced under current law, most importantly the Trading with the Enemy Act of 1960 and the International Emergency Economic Powers Act of 1977. However, there are questions about whether the declaration could be made effective or maintained under these laws. A much neater approach would be to amend the Foreign Sovereign Immunities Act to clearly describe the circumstances under which a suit to enforce a contract of a regime declared illegitimate would not be enforced in US courts. The US Congress should begin working with the US State Department on legislation that would support a declaration of preemptive contract sanctions if the international community unites around the goal of getting rid of the illegitimate Maduro regime.