Sovereign Debt Restructuring and the Best Interest of Creditors

79 Pages Posted: 14 Mar 2003 Last revised: 25 Dec 2014

See all articles by William W. Bratton

William W. Bratton

University of Pennsylvania Carey Law School; University of Miami School of Law; European Corporate Governance Institute (ECGI)

Mitu Gulati

University of Virginia School of Law

Date Written: August 13, 2010


In April 2002 the International Monetary Fund introduced a sovereign bankruptcy proposal only to be rebuffed by the United States Treasury. Where the IMF wanted a mandatory bankruptcy regime, the Treasury wanted to solve distress problems with contractual devices. Sovereign bondholders and sovereign issuers themselves flatly rejected both proposals, even though they were nominally the beneficiaries of both proponents. This Article addresses and explains this bondholder reaction. In so doing, it takes a highly skeptical view of the IMF's proposal even as it shows that the incentive structure surrounding sovereign lending renders untenable the Treasury's contractarian proposal. The Article's analysis follows from a review and restatement of the economic learning on sovereign debt relationships.

The IMF and the Treasury share the objective facilitating restructuring by substituting a regime of collective action for the prevailing practice of requiring unanimous bondholder consent to significant amendments of bond contracts. In so doing they follow a conventional wisdom respecting bond contracts under which standard unanimity provisions are inefficient and irrational. The Article shows that this dismissal of the unanimity requirement comes too quickly. Under our analysis of the problem the debtor distress, bondholders rationally may prefer to make compositions harder to conclude. There is no first best equilibrium bond contract; instead bondholders select from a menu of second best forms, making trade offs between unanimous action and collective action provisions in an imperfect world.

One factor leading lenders to favor unanimous action is the need to self protect. In a world without a good faith backstop, creditors motivated by side deals can take advantage of majority rule to impose suboptimal compositions. Holding out is the only weapon available to the minority creditor. The Article argues that, given such side deals, a stable majoritarian regime cannot be achieved as a matter of free contract. Mandate will be necessary. It follows that the Treasury's contractarian approach is implausible absent a backstop regime of intercreditor good faith duties. The Article draws on the history of corporate reorganization prior to the enactment of the section 77B of the Bankruptcy Act of 1934 to show that courts have grappled with these questions before, intervening aggressively on equitable principles.

JEL Classification: F34, G33, H63, K33

Suggested Citation

Bratton, William Wilson and Gulati, Mitu, Sovereign Debt Restructuring and the Best Interest of Creditors (August 13, 2010). Vanderbilt Law Review, Vol. 57, Pg. 1, 2004, GWU Law School, Public Law Research Paper No. 59, Georgetown Law and Economics Research Paper No. 387880, Available at SSRN: or

William Wilson Bratton (Contact Author)

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States

University of Miami School of Law ( email )

P.O. Box 248087
Coral Gables, FL 33146
United States

European Corporate Governance Institute (ECGI) ( email )



Mitu Gulati

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

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