Vulture Funds

September 8, 2015

When an individual or a company goes bust there are well established legal frameworks and rules that ensure that it happens in an orderly, predictability and relatively fair way. In the case of an individual non-essential assets (property and possessions) and excess income are used to pay off your creditors (those you owe money to). You are not made to starve or thrown onto the streets in order to maximise creditor pay back. At the end of the bankruptcy period most outstanding debts are ‘discharged’ (cancelled). When a company is declared bankrupt a court appointed liquidator manages the process of liquidating all available assets and then uses the funds raised to fairly and equally pay as much as possible of the claims of outstanding creditors. All creditors are treated equally (excerpt for the inland revenue as any outstanding tax is paid before taking into account the claims of other creditors) and no creditor can take additional legal action to ‘jump the queue’ and get their claims paid off faster or to get a bigger share of the funds of the liquidated company.

When a country goes bust things are very much less clear and less orderly and there is no recognised international framework governing what happens. And this means that the financial vultures can swoop.

When a country fails to pay its creditors on time, it is said to go into “default”, the national equivalent of going bankrupt. But sovereign defaults are quite different from business bankruptcies as it is far harder for creditors to repossess the assets of a sovereign entity than to repossess the assets of a company. In order to curry favour in international financial markets so that they will be able to borrow once again at some point in the future, defaulting countries tend to restructure their debt rather than simply refusing to pay anything at all. These so-called “haircuts”, where the original value of a bond is reduced, can involve considerable reductions in the net value of the bond and big losses for the bond holders. Greece defaulted in 2012 and holders of Greek government bonds were forced to take hits as high as 50%, this included many of Greece’s pension funds and the losses due to the haircut is a big contributor to the current pension crisis in Greece.

Western governments, mostly acting in the interests of their banks, have put significant efforts into preventing government defaults and ensuring that reckless lenders continue to be repaid. Their efforts range from providing bailout loans for the banks through institutions such as the International Monetary Fund (IMF), World Bank, or recently the EU, to scaremongering about the false consequences of a potential default. As long as banks continue to receive bailouts, government debt remains a low-risk but high-profit option.

In Europe prior to the crisis of 2007 the banks made vast amounts of speculative and risky loans, mostly to fund property asset bubbles but also to fund the Greek government spending binge. When the crisis struck many European banks were facing insolvency, and the entire European banking system was stuffed with bad debt. Unfortunately these banks were now too big for their respective national governments to bail them out. The resulting pan-European bail out, necessary to prevent a banking collapse in Europe, was funnelled through the respective national governments and so in order to bail out the banks a mountain of public national debt was created. It was a similar story in Greece where the reckless loans made by banks (banks often located in the UK, Germany and France) to previous Greek governments were bailed out with EU and IMF funds channeled via the Greek government. This meant that a private bad debt became a public bad debt and that all attention switched from restructuring and reforming the financial system to cutting public expenditure and a policy of austerity. As long as reckless lenders continue to be repaid, the cycle will continue and the same thing can happen all over again.

Debt restructuring, or outright default, are wholly legitimate and sometimes essential routes out of debt crisis, allowing countries to restore the provision of basic public services and recover their economies, as happened to Argentina after its first debt default. But defaults are not an easy option and they can be very painful for the offending country, particularly if they are unexpected and disorderly. Domestic savers and investors, anticipating a fall in the value of the local currency, will scramble to withdraw their money from bank accounts and move it out of the country. To avoid bank-runs and precipitous currency depreciation, the government may shut down banks and impose capital controls. As punishment for default, capital markets will either impose punitive borrowing rates or refuse to lend at all.

Critically, there is no international law or court for settling sovereign defaults, which helps explain why they are so varied in length and severity. This legal vacuum means that no agreed bankruptcy procedure exists for when governments cannot afford to repay debts, and there is no way to investigate whether the debts that governments owe are actually legitimate, whether they were contracted by democratically accountable governments acting in the interests of their people or were the result of rampant corruption for example. More international regulation has been proposed—including powers to prevent minority holders from hijacking the process—but such conditions ultimately remain up to the issuing country. The first bond issuances since the new proposals (by Kazakhstan and Vietnam) include these clauses. Other countries might follow suit, but this doesn’t resolve the $900 billion of bonds outstanding that were issued under the old rules.

The Vulture Funds

Because international debt has been a largely lawless arena where power is in the hands of creditors, predatory financial organisations have grown up to exploit the lack of a proper legal framework in order to make a profit. These predatory funds are called Vulture Funds and their business model is simple. When a country defaults, and thus when its existing bondholders are facing a ‘haircut’, the vulture funds buy up the debts cheaply from creditors who are desperate to off load what looks like bad debt. Then the vulture funds refuse to take part in negotiated debt reductions, instead they sue the defaulting country, usually in a US or UK court, seeking full payment on the bonds they holding. Even it takes years their legal claim for full payment of the face value of bond, which they bought at a huge mark down, is usually endorsed by the courts and thus when the bonds are paid in full the Vulture Funds make a huge profit.

The legal proceedings undertaken by vulture funds most often takes place in US and UK courts because when bonds are issued many governments have to offer them within the framework of strong commercial law in order to entice buyers and this often entails offering bonds within US and UK legal frameworks. In 2013 there was an early day motion in the UK parliament attempting to end the exploitation of UK law by vulture funds.

Vulture funds buy debt often at deep discounts and sue the debtor for full recovery which makes for high returns, vulture funds have average recovery rates of about 3 to 20 times their investment, equivalent to returns of (net legal fees) 300%-2000%. The vulture fund modus operandi is simple: purchase distressed debt at deep discounts, refuse to participate in restructuring, and pursue full value of the debt often at face value plus interest, arrears and penalties through litigation, if necessary. The vulture funds grind down poor countries in cycles of litigation, a practice referred to as “champerty”. Litigation is typically protracted with many lawsuits taking three to ten years to “settle.” Legal documents indicate six years as a conservative medium estimate for recovery, which suggests that annualised returns average 50 to 333 percent. Some of these claims were bought at roughly 10 percent of face value, implying very high gross recovery rates. Subtracting legal costs, often recouped from the sovereign, these recovery rates are probably the highest in the distressed debt market.

A willingness and ability to pursue litigation appears central to the strategy and success of the vulture funds. In one recent case against Zambia, a vulture fund, having bought a debt for US$3 million, sued Zambia for US$55 million and was awarded US$ 15.5 million. The vulture funds exert pressure on the sovereign debtor by attempting to obtain attachment of the government’s assets abroad. Such proceedings are always burdensome to the debtors concerned, and can complicate financial and reserve management. In another recent case Themis Capital and Des Moines Investments Ltd won a case concerning debt from the Democratic Republic of Congo, in which they had bought for $18m. US Southern District of New York Judge Paul A. Engelmayer ordered the country to repay the investors the full amount borrowed plus interest – which came to $70m, as the debt originated from the early 1980s under the regime of dictator Mobutu Sese Seko.

Vulture funds were at work with Greek debt. Vulture fund company Dart Management, based in the Cayman Islands, received a €400 million payment from Greece at the height of the country’s crisis. Most of Greece’s creditors took a 50% ‘haircut’ on their debts, as part of a deal for Greece to receive a massive IMF and EU bailout with austerity conditions attached. But the vulture funds – which together control more than €6 billion of Greek debt – refused to join in, saying they would hold out for the full amount. The vulture funds can demand their pound of flesh because the debts are covered by English law. While under Greek law all creditors have to join in with the ‘haircut’, a fraction of the debt is written in foreign law, much of it English, meaning the Greek government cannot enforce the ‘haircut’.

The origins of Vulture Funds

One firm in particular, led the way in the emergence of the modern Vulture Fund. In 1977, Paul Singer founded the hedge fund Elliott Associates L.P. with $1.3 million from friends and family. For nearly two decades, the firm grew by investing in various equities markets. But in 1995 Elliott Associates transformed from just another New York City hedge fund to a pioneer in the world of international finance. In October 1995, Elliott Associates L.P. purchased approximately $28.7 million of Panamanian sovereign debt for the discounted price of $17.5 million. The banks holding those bonds, a group that included heavy hitters like Citi and Credit Suisse, had given up on repayment from Panama. To cut their losses they sold their holdings to Elliott. When Panama’s government asked for a restructuring of its foreign debt in 1995, the vast majority of its bondholders agreed. Not Elliott. In July 1996, Elliott Associates, represented by one of the world’s most high-profile securities law firms, filed a lawsuit against Panama in a New York district court seeking full repayment of the original $28.7 million — plus interest and fees. The case made its way from a district court in Manhattan to the New York State Supreme Court, which sided with Elliott. Panama’s government had to pay the firm over $57 million, with an additional $14 million going to other creditors.

It was a groundbreaking moment in the modern history of finance. By taking the case to a New York district court, Elliott broke with long-standing international law and custom, according to which sovereign governments are not sued in regular courts meant to deal with questions internal to a nation state. Further, the presiding judge accepted the case — another break with custom. It set the stage for two decades of such cases.

When Elliott’s case against Panama upended established international norms about how to negotiate sovereign default, journalists and researchers didn’t pay much attention. But Wall Street did. Following Elliott’s victory, other funds emerged trying the same strategy. Dart Container Corp and EM Ltd., both linked to Kenneth Dart, is one of the most famous names in the world of vulture funds. NML Capital, a Cayman Islands-based fund associated with Elliott also got into the game. Another company Gramercy Advisors, a Greenwich, Connecticut-based firm, focused on Ecuadorian and Russian debt.

One of the biggest victories for a Vulture Fund came in August 2013 when a group of vulture funds led by billionaire Paul Singer forced Argentina into default for the second time in 13 years. In 2012, Judge Thomas Griesa of the Southern District Court of New York ruled that whenever Argentina paid the majority of its creditors who had accepted a haircut it would also have to pay its holdouts the full par value plus costs and interest. Most bondholders from the last Argentine crisis, in 2001, agreed to accept about a third of what they were owed and move on when the country renegotiated its debt and traded new bonds for the old ones. Singer, whose Elliott Management oversees $24.8 billion, wanted more. He went all the way to the U.S. Supreme Court to make sure bondholders who compromised can’t get paid until he does, and his victory there in June 2013 meant the country would default unless it surrendered to him. Argentina said its hands were tied, and it simply couldn’t sweeten Singer’s deal. It defaulted for the second time. An earlier success may have emboldened Singer. He spent about $11 million on government-backed Peruvian bank debt in 1996, and Peru agreed in 2000 to pay him $58 million. That meant he got better than a 400 percent return. All it took was trips to court in the U.S., U.K., Luxembourg, Belgium, Germany, and Canada.

At least twenty heavily indebted poor countries (HIPCs) have been threatened with or have been subjected to legal actions by commercial creditors and vulture funds since 1999 including Sierra Leone by Greganti Secondo and ARCADE, and by Industrie Biscoti against Cote d’Ivoire and Burkina Faso. Other countries that have been targeted include Angola, Cameroon, Congo, Democratic Republic of the Congo, Ethiopia, Liberia, Madagascar, Mozambique, Niger, Sao Tome and Principe, Tanzania, and Uganda.

The IMF reports that in some cases the claims by vulture funds constitute as much as 12 to 13 percent of a country’s gross domestic product (GDP). The IMF reports that eleven HIPCs have been targeted so far in forty-six lawsuits and that the litigators (plaintiffs) are concentrated in three countries. The lawsuits are concentrated in only a few courts.

Generally, these vulture funds have won their lawsuits. Significantly, the reported number of outstanding cases against debtor countries has doubled since 2004. On average eight new cases are filed each year. It is anticipated that the success rate of past litigation will generate even more lawsuits against HIPCs. At least three HIPCs namely Liberia, Cote d’Ivoire, and Sudan have large commercial creditor claims that are likely to be raised against these countries, although it is not yet clear who holds the various claims.

The IMF is a key player in all this as the Fund is often central to the default process and the resulting negotiations and settlement with creditors. Because the fund is often a troubled debtor’s only source of cash, the terms on which it lends can dictate whether or not other creditors get paid. It was seared by its experience of Greece, where (along with the European Union) it provided a giant bail-out in 2010 to avoid a restructuring that nonetheless took place in 2012. In response, it is proposing two changes to its rules. First, it wants greater leeway to support the “reprofiling” of sovereign debt. Reprofiling is a relatively gentle form of restructuring, in which the maturity of bonds is extended but the amount owed and interest rate stay the same.

The fund also wants to limit the risk of being dragooned into lending huge amounts to stave off default in a country whose debts are unlikely to be sustainable by getting rid of a “systemic exemption” to its lending rules. Introduced during the euro crisis under pressure from the EU, this exemption condones large loans to countries that are poor credit risks if they are important enough to pose a threat to the global financial system. The IMF was bounced by the EU during the original Greek bailout and has been trying to recover its position ever since.

The two proposals—which have yet to be approved by the IMF’s board—are much less ambitious than earlier ones. In 2002 the fund pushed for, but failed to get agreement on, a “sovereign-debt restructuring mechanism”, akin to an international bankruptcy court. The new plan would simply lead to more equal treatment for would-be borrowers and, at the margin, might encourage more countries to reprofile their debts earlier.

The UN has also been seeking to create a more organised and global framework for sovereign defaults. When Argentina, which has suffered a second recent default precipitated by vulture fund activity, tabled a motion calling for the UN to examine the issue of sovereign debt restructuring last autumn, 124 countries voted for it and 11 countries, including the UK and the US, with their powerful financial lobbies, voted against; and there were 41 abstentions. The 11 countries that objected hold 45% of the voting power at the IMF.

The proposed reforms, drawn up by the UN’s trade and development arm, Unctad, would create something like a bankruptcy procedure for countries. As a starting point, troubled governments would be given a standstill on repayments while talks with creditors take place. The aim would be to substantiate every claim on the country, whether from banks, governments or businesses; carry out a thorough sustainability analysis; and impose a debt write-off significant enough to make future repayments manageable and allow the stricken economy to recover. The aim would be to preclude Vulture Funds from going to national courts in the US and UK to seek full payments on their debt holdings and would force them to participate equally in any ‘haircut’.


The central criticism of the vulture funds is that, by purchasing distressed debt at discounted rates, refusing to participate in voluntary restructuring, and seeking to recover the full value of the debt through litigation, vulture funds are preying on both other creditors and on the indebted countries themselves. Countries whose debt is trading at deep discounts are almost by definition in deep financial trouble and many of them are poor. Holdout behaviour by vulture funds makes restructuring slower, more difficult, and uncertain. Debtors are harmed by the substantial uncertainty faced and also by being forced to repay individual creditors far more than the agreements negotiated with other creditors.

As long as sovereign defaults are messy and unregulated, and can be legally exploited in order to make a profit, the vulture funds will continue to swoop in and exploit (and worsen) the situation for profit. Similarly as long as lenders to governments are given special protection against making reckless loans compared to the risks they might face in making private loans then more risky lending to governments will take place. Ultimately this is part of the of the ‘too big to fail’ problem. The banking and finance system needs to be restructured so that all individual banks and finance companies are small enough so that any of them can be allowed to go bust as a result of making wrong or reckless decisions without bringing down the entire system.

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