Between Mandate and Market: Contract Transition in the Shadow of the International Order

Not unlike the average American, nations from the United States to Burkina Faso have long relied on credit to survive. Taking various forms over the years, such debt has most recently been financed through sovereign bonds. Like their corporate cousins, sovereign bonds amount essentially to a contract obligating the debtor to make recurring payments of principal and interest until a maturity date, on which any remaining balance of principal comes due. Unlike corporate bond contracts, the terms of sovereign debt contracts are set out with a firm expectation of future debt restructuring, when the sovereign issuer?perhaps inevitably?faces financial distress. In the face of this premonition, contract boilerplate in sovereign debt instruments issued in the United States long dictated the unanimous consent of bondholders to any debt restructuring. This requirement persisted for decades, notwithstanding widespread consensus that such unanimous action provisions increased transaction costs, produced inefficient delays in debt restructuring, enhanced the moral hazards of the sovereign debt market, and otherwise triggered collective action failures. Yet, the sovereign debt markets have recently made an about-face, replacing the unanimity requirement for debt restructuring with less demanding provisions for collective, or majority, action by creditors. Completed over the course of just a few months in 2003, this unexpected and dramatic shift offer a natural experiment of sorts: Why might contract boilerplate not respond to apparent efficiency demands for extended periods? What might cause it to respond eventually? In particular, what role might state action have in the evolution of boilerplate contract terms and in contract transition generally? In the realm of international finance, these inquiries demand urgent analysis, both because the relevant sovereign debt contract standards continue to evolve, and because the appropriate role of national authorities and the official sector (e.g., the International Monetary Fund) in shaping the sovereign debt restructuring regime remains an open question: Most broadly, can the market be expected to facilitate efficient transition in contracts with significant boilerplate elements, or is regulatory mandate essential to such change? Challenging this dichotomous choice between market or mandate, this Article proffers a “third way” toward efficient contract transition. While the market may not always produce efficient transition, ordinary public regulation may not be the answer. Instead, this Article identifies state action grounded in noncoercive “regulatory cues” as the mechanism of efficient transition in standardized contract terms. In the face of growing reliance on boilerplate contract terms and standard-form contracts, public intervention in the form of regulatory cues may, paradoxically, help to facilitate meaningful choice in contract design, and hence a true freedom of contract. The role of regulatory cues in sovereign debt contracts, moreover, may also pressage a potential role in international regulation generally given the limits of hard power within a community of sovereign states. 16891-TEXT.NATIVE.1115237184 5/4/2005 1:10 PM BETWEEN MANDATE AND MARKET: CONTRACT TRANSITION IN THE SHADOW OF THE INTERNATIONAL ORDER