Restructuring of the Venezuelan Debt

I. Sovereign Debt

Sovereign debt has certain characteristics that, according to some experts, make it more complex, especially when it comes to restructuring.

Sovereigns involve significant obstacles and risks. Sovereigns, by their very nature, possess powers that can pose very specific risks not typically found in other debtors (e.g., legislative power, control over institutions). Sovereigns also enjoy privileges and immunities, which can complicate the exercise of rights by their creditors.

II. Venezuelan Case

Before delving into the specific issues surrounding Venezuela’s debt, it is important to highlight some distinctive features of the Venezuelan case in general.

2.1 Legitimacy of the Authorities and the Unusual Political Situation. According to analysts, Venezuela finds itself in an unusual political situation that appears to be temporary in nature. This political situation and its potential transience are factors that may pose additional risks in the context of a sovereign debt restructuring process.

2.2 Economic Decline. It is no secret that the Venezuelan economy has suffered a catastrophic collapse, with estimates of a contraction exceeding 75% of its GDP, a loss in the value of its currency, and massive emigration of its population, among other signs of this catastrophe.

2.3 Lack of reliable data and the interruption of cooperation with multilateral entities, which could be key to a restructuring process. We understand that the absence of reliable data and the, recently reversed, lack of cooperation with multilateral entities are prerequisites that must be resolved to initiate a negotiation process with creditors, as they form the basis for determining the sustainable debt level that will guide the restructuring process. In particular, we understand that a DSA (Debt Sustainability Analysis) by the International Monetary Fund (IMF) is of material significance for a sovereign restructuring.

2.4 Decline of important infrastructure to development. In the notes, we provide specific comments on the electricity sector and its potential impact on the growth of the oil sector. Again, in the Venezuelan case, the oil sector is expected to play the leading role in the redevelopment of the Venezuelan economy and to be the primary generator of the cash flows necessary for debt repayment.

2.5 Sanctions. The decision to invest in Venezuela, as well as the decision to restructure its debt, may require the lifting or modification of sanctions that have been imposed on certain Venezuelan individuals and institutions (e.g., the Central Bank of Venezuela and Petróleos de Venezuela S.A. (PDVSA)). We do not foresee a restructuring process without changes to the sanction’s regime currently in place. Some of these changes are already taking place, it can be argued that those changes may not have a debt restructuring as the underlying motivation, but certainly the sanctions regime is currently being modified.

III. The Venezuelan Debt

Venezuela’s external debt is estimated at over $150 billion. It is characterized by being extraordinarily fragmented, encompassing bonds issued by the Republic, PDVSA bonds, Electricidad de Caracas bonds, bilateral debt (e.g., China and Russia), debt to multilateral entities, commercial debts, promissory notes, and debt resulting from awards obtained in arbitration procedures.

3.1 Specific Characteristics

• Dual Primary Debtor: Unlike most sovereign crises, Venezuela has two major entities in default: the Republic itself and its state-owned oil company, PDVSA.
• Absence and Deficiency of Collective Action Clauses (CACs): PDVSA bonds lack CACs, meaning that any modification to payment terms requires unanimous approval from bondholders, greatly hindering restructuring and facilitating the emergence of holdout creditors. Meanwhile, some Republic’s bonds do have CACs, but they require very high approval thresholds (75% to 85%) and operate on a series-by-series basis, without allowing all bonds to be aggregated into a single vote as is the case with more modern CACs.
• Extreme dependence on oil: The country’s ability to repay its debt depends almost exclusively on its ability to produce oil. However, restoring oil production first requires massive investment to stabilize basic electrical infrastructure, making electricity an indispensable prerequisite.

3.2   Main Obstacles

• OFAC Sanctions: The U.S. sanctions framework prohibits U.S. persons and entities from acquiring "new" Venezuelan debt, making a traditional bond swap (exchanging old bonds for new, restructured ones) not possible to execute at this time.
• “Alter Ego” Risk and Protection of Citgo: U.S. courts (in the Crystallex case) have determined that PDVSA is the “alter ego” of the Republic, erasing the corporate separation and allowing the State’s creditors to pursue PDVSA’s assets abroad, as is the case at Citgo. Furthermore, the PDVSA 2020 bond holds a direct security interest in 50.1% of Citgo Holding’s shares.
• Illegitimate debt and constitutional disputes: A new government may decide to challenge and audit debts incurred under the previous regime, including reviewing their authorizations issued by the, then in charge, governmental entities. This would likely involve seeking the nullity of certain contracts or classifying certain obligations as “odious debt.”
• Geopolitical complexity: Given that China and Russia are major creditors and hold veto power on the UN Security Council, it may prove unfeasible to implement a global asset protection resolution similar to the one granted to Iraq in 2003, as the geopolitical interests of these countries may clash with those of the United States.

3.3 Proposed Resolution Mechanisms

Below, we briefly outline various tools and methods that have been suggested as applicable to the restructuring of Venezuela’s debt.

• Debt-for-equity swap: The proposal is to offer creditors the opportunity to exchange their claims for the right to develop certain productive assets of Venezuela. This is typically tied to a commitment to provide fresh capital for the start-up or operational improvement of the asset received.
• Enactment of a new bankruptcy law and then resort to (Chapter 15): Experts propose that Venezuela enact a new local insolvency law for state-owned entities, which would allow for the restructuring of PDVSA. One of the objectives would be permit the recognition of this process by the courts of the United States, under Chapter 15 of its bankruptcy code, to stay litigation and protect the company’s international assets. Another possible objective would be the creation of a reliable forum for the classification and rating of PDVSA’s commercial debt.
• Exit consents and change of debtor: To neutralize holdout creditors, it has been suggested to use simple majorities to eliminate protective clauses (such as the waiver of sovereign immunity or the pari passu clause) from the old bonds prior to the swap, or even to transfer PDVSA’s obligations to a new entity, leaving the holdouts with worthless instruments or against a debtor without resources. However, I assume such actions may result in a high degree of controversy and litigation.
• Value recovery instruments: To compensate for the steep haircuts that creditors are expected to absorb, it has been suggested to issue “oil warrants,” or instruments that allow creditors to receive additional returns if prices, oil production, or some agreed-upon index exceeds baseline recovery projections.

3.4 Challenges

The restructuring of Venezuela’s and PDVSA’s debt faces a series of exceptionally complex legal challenges, ranging from contractual obstacles to complications under international and constitutional law:

• Risk of legal action under the "Alter Ego" doctrine.
• Enforcement of the PDVSA 2020 bond collaterals: This bond was issued with a pledge over 50.1% of the shares of Citgo Holding, which again, could compromise control over that subsidiary if the collateral is successfully enforced. Notwithstanding, I understand enforcing the collateral would require changes to the sanctions regime still in place.
• Absence of Collective Action Clauses (CACs) in PDVSA: As noted, unlike many bonds issued by the Republic, no PDVSA bond contains Collective Action Clauses. Some experts have cited PDVSA’s bankruptcy as an alternative to this obstacle.
• Holdout Creditors and the “Pari Passu” Clause: There is a risk that creditors that decide not to participate in a restructuring may go to court to demand full payment, invoking the pari passu clause. As occurred in the Argentina litigation, this clause has been interpreted to prohibit the debtor from paying restructured creditors unless it also pays the litigants, thereby blocking the entire process.
• Constitutional illegality and "Odious Debt.
• OFAC sanctions.
• Lack of a legal bankruptcy framework for state-owned enterprises: There is a debate whether the bankruptcy regime under the Venezuelan Commercial Code can be used to achieve an orderly restructuring of a state-owned enterprise such as PDVSA and to protect its assets against international legal actions. The conclusion is that there is no generally accepted position, as the applicability of this regime to state-owned enterprises is questioned; and even if applicable, its effectiveness in protecting creditors’ claims is questioned because, we understand, our existing bankruptcy regime may not be eligible for international recognition.
• Public Interest Contracts: There is debate over whether debt issuance contracts and/or restructuring agreements should be classified as Public Interest Contracts. This classification carries severe regulatory consequences, including a more complex authorization regime by the Venezuelan National Assembly.

IV. Debt-for-Equity Swap

According to some proposals, a debt-for-equity swap program could serve two objectives: (i) reducing the debt stock and (ii) increasing the flow of productive investment, but it faces the following challenges:

• Timing of Implementation: The issue of government legitimacy may affect creditors’ investment decisions.
• Mechanics of the Swap: This would involve bondholders acquiring the country’s assets in exchange for canceling or surrendering existing debt. This poses a challenge in valuing both the asset and the debt being surrendered in exchange for it.
• Injection of fresh capital: The decision may involve not only exchanging the debt for a stake in an asset, but also committing additional fresh capital to manage the asset received in exchange for the debt.
• Regulatory risk. In general, an investment decision must take into account not only the legal framework governing the investment but also the risk of changes to that framework and its stability. Venezuela has not been consistent in its treatment of investors; therefore, this may represent a significant obstacle.

V. Iraq Case

Experts view the case of Iraq’s debt restructuring as a significant precedent for a potential restructuring of Venezuela’s debt, as the two share notable similarities but also have fundamental differences.

Key similarities:

• Extreme dependence on oil and the need to protect assets: Like Venezuela, Iraq derived virtually all of its foreign exchange earnings from oil sales. In the event of a payment default absent the UN resolution, referred below, and the subsequent local regulations enacted by the different creditor countries (e.g. Executive Order, in the case of the U.S.), Iraq’s creditors could have seized its crude oil shipments and the associated payments, stifling its recovery. For Venezuela, protecting its overseas assets and cash flow is the same primary challenge.
• Diversity and complexity of creditors: Both countries accumulated enormous debts with an extraordinarily fragmented creditor base. Iraq’s profile included more than 60 governments (Paris Club and others), hundreds of private entities, banks, construction companies, and suppliers. Venezuela faces an equally diverse landscape, which may require a massive and highly complex claims reconciliation process.
• The role of oil prices in sustainability analysis: In both cases, projected future oil prices and production capacity are critical factors that the International Monetary Fund (IMF) and creditors will use to determine how much debt the country can actually repay.

Key differences and challenges for Venezuela:

• The magnitude of the debt reduction (haircut): Thanks to strong geopolitical pressure from the United States, Iraq secured an 80% debt write-off. Some financial analysts estimate that Venezuela could aim for a smaller debt reduction than Iraq’s.
• The asset protection mechanism (The geopolitical factor): To protect Iraqi oil from creditors, the UN Security Council issued Resolution 1483, which granted global immunity to Iraq’s crude oil sales. Experts note that this solution may be unfeasible for Venezuela, since any similar UN resolution would likely be vetoed by China or Russia, which are major creditors of Venezuela and have geopolitical interests opposed to those of the United States.
• The massive presence of bondholders: A key difference is that Iraq had no debt issued in the form of international bonds. In contrast, Venezuela has a considerable debt represented by bonds issued by the Republic and PDVSA. This introduces the risk of so-called “vulture funds” or holdout creditors, which require much more sophisticated legal strategies in the restructuring (such as the use of Collective Action Clauses) that were not necessary in the case of Iraq.
• The debate over “odious debt” and legality: In Iraq, there was debate over whether the debt incurred by Saddam Hussein was “odious debt” and therefore that of should not be paid. We understand this argument was set aside once the 80% face value debt reduction was secured. In Venezuela, a new government could attempt legal actions regarding the validity of certain debts. However, we understand that experts assign little probability of success to such arguments, as they have not been successful in the past and due to the potential reputational risk this strategy could pose. I assume markets may be cautious with a country that has attempted legal actions to question the validity of outstanding obligations.

VI. Energy Infrastructure

The condition of the electrical infrastructure has a fundamental and direct impact on the oil industry, to the extent that electricity generation is considered an indispensable prerequisite for oil extraction rather than a mere ancillary operation. According to sources, the impact of the decline of the electrical grid is reflected in the following aspects: Extreme operational dependence: The extra-heavy crude oil from the Orinoco Belt requires heating, dilution, and upgrading processes in specialized facilities before it can be refined operations that are heavily dependent on electricity.

• Vulnerability to system collapse: Historically, the Guri hydroelectric plant supplied the power to sustain production of more than 3 million barrels per day at its maximum capacity. However, after massive failures analysts note that these infrastructure limitations and the lack of electricity availability represent enormous obstacles to operations.
• Investment and recovery: For major oil companies evaluating capital investments over 10 or 15 years, the reliability of the power grid is not just an operational detail, but perhaps a necessary condition for investment.
• Essential prerequisite: In conclusion, any large-scale recovery of the oil industry resulting from sustained long term investments appears to first require the stability of the power grid and the modernization of the system serving this industry.