Refinancing Venezuela's Debt: Local Legal and Policy Issues
Venezuela faces the greatest financial crisis of its history. Aggregate claims against the state-owned oil company Petróleos de Venezuela, SA (PdVSA) and other government-owned entities have been estimated at as much as US$175 billion,[2] excluding accrued and unpaid interest. This figure includes foreign external financial indebtedness such as unsecured bonds issued by the Republic and PdVSA, secured bonds issued by PdVSA, promissory notes issued by PdVSA to suppliers, loans owed to multilateral lenders (e.g., CAF and Interamerican Development Bank), debt owed to bilateral lenders such as China Development Bank and Japan Bank for International Cooperation, and trade debt due to suppliers and contractors. The aforesaid amount also includes claims arising from international arbitration awards rendered against the Republic and PdVSA.
Given the current size of Venezuela’s economy, aggregate claims against the country are equivalent to several multiples of its gross domestic product (GDP).
The complexity of a Venezuelan restructuring stems from myriad factors, ranging from the mundane to the philosophical and arcane. The complexities inherent to any sovereign debt restructuring are compounded by US sanctions, competing executive and legislative branches of power, and a humanitarian crisis playing out on top of the world’s largest oil reserves.
Below are thoughts on the legal and policy questions that will arise in a Venezuelan restructuring.
Legislative approval
The Republic
The Executive branch of the Venezuelan government requires approval from the National Assembly (Venezuela’s legislature) to incur any form of indebtedness.[3] Legislative approval is required under the Organic Law on Financial Management of the Public Sector (the Public Finance Law).[4] The Venezuelan Constitution requires that an annual indebtedness special draft bill be submitted by the Executive to the National Assembly together with the annual draft budget bill.[5]
The National Assembly grants its approval for the Republic to incur indebtedness by enacting the Annual Indebtedness Law, which specifically (1) approves the maximum indebtedness amount allowed to be incurred by the Republic for the given fiscal year, (2) approves the use of the proceeds raised or borrowed from the financings that may be incurred during the fiscal year, and (3) authorises the stock of treasury bills that may remain outstanding within the fiscal year.[6]
Under the Public Finance Law, the Executive branch does not require approval from the National Assembly for each specific indebtedness transaction, unless the contracts qualify as ‘national public interest contracts’ that will be entered into with foreign states, foreign authorities or entities that are not domiciled in Venezuela.[7]
In principle, the Republic may not incur any type of indebtedness that has not been previously approved by the National Assembly by means of an Annual Indebtedness Law. Nevertheless, there are exceptions to this legislative approval.
Refinancing and restructuring exceptions
Even setting aside the legitimacy issues levelled at some point on the National Assembly, the political realities of Venezuela complicate its legislative process, especially the approval of budgetary and public credit appropriations.
The Public Finance Law exempts the Executive branch from legislative approval to incur debt under special situations. Specifically, Article 99 exempts ‘refinancing’ or ‘restructuring’ transactions that extend maturities, reduce interest payments, convert external debt into internal debt or otherwise generate cash flow savings for the Republic.[8]
Therefore, if the Republic enters into a set of transactions through which it reduces interest payments, extends duration, converts external indebtedness into internal indebtedness or otherwise reduces cash outflows, no approval by the National Assembly will be required.
In our view, the requirements of Article 99 are not necessarily cumulative. It should be sufficient for any one of the requirements to be present for the refinancing or restructuring transaction to qualify for exemption from legislative approval.
This view is reflected in Regulation No. 2 of the Public Finance Law, which provides that refinancing or restructuring transactions[9] that meet any of the requirements of Article 99 (formerly Article 88, at the time Regulation No. 2 was issued) will not require approval by the National Assembly.[10]
Given that the majority of Venezuela’s foreign external financial indebtedness is represented in bonds issued under New York law, it is not inconceivable that a restructuring could take place by means of an exchange of all or part of the Republic’s existing bonds for new bonds. The terms of the new bond or bonds that would be offered in such an exchange would be driven by the extent of the ‘hair cut’ that is ultimately agreed by the Republic and its bondholders, based on Venezuela’s experience under the Brady Plan and as originally proposed by Buchheit and Gulati for Greece:
The terms of the new instrument or instruments that would be offered in such an exchange will be a function of the nature and extent of the debt relief the transaction is designed to achieve. At the soft end of the spectrum would be a simple ‘reprofiling’ of existing bonds (or some discrete portion of them, such as bonds maturing over the next three to five years) involving a deferral of the maturity date of each affected bond. Uruguay (2003) stretched out the maturity date of each of its bonds by five years, while leaving the coupons untouched. At the sharper end of the spectrum would be a transaction designed to achieve a significant net present value (‘NPV’) reduction in the stock of debt. If Brady Bonds were chosen as the model for the transaction, this might entail allowing holders to elect to exchange their existing credits for either a Par Bond (a new bond exchanged at par for existing instruments, having a long maturity and a low coupon), or a Discount Bond (a new bond exchanged for existing instruments at a discount from the face amount of those instruments, but typically carrying a higher coupon and perhaps a shorter maturity than the Par Bond). The precise financial terms of the Par Bond and the Discount Bond would be calibrated to achieve an equivalent NPV reduction.[11]
It is not entirely clear but, in our view, an exchange of existing bonds for new bonds that extends the maturities of the existing bonds on the same basis but otherwise leaves coupons unaltered would probably fall within the restructuring exemption and would not require approval from the National Assembly. The same could be said for a new bond exchanged for existing bonds at a discount from their nominal value, but with a higher coupon.
The refinancing exemption raises multiple issues that may call for a political compromise that could be effected via approval of the legislature. This could also ensure the avoidance of any legal doubts as to what may fall within the refinancing exemption, such as:
- a refinancing that generates savings for the Republic because it reduces interest payments or extends duration, but also increases the Republic’s debt stock because it involves raising new money;
- a transaction that extends maturities but increases the interest rate on the debt that is refinanced; or
- a qualifying refinancing that does not raise new money but includes oil price-linked or GDP-linked payments that may potentially increase cash outflows during the life of the new debt.
PdVSA and its affiliates are not subject to legislative approval to borrow or raise money. PdVSA is only required to publish an audited financial statement annually, showing its total financial indebtedness. This financial statement must be audited by an auditing firm registered with Venezuela’s securities watchdog. Other than the audited financial statement, PdVSA is not legally obliged to obtain any legal or regulatory approval to incur indebtedness.
PdVSA’s restructuring regime
There are two insolvency procedures under Venezuelan law: (1) the moratorium (atraso) process, and (2) the bankruptcy (quiebra) process. Although the regime may be used either to liquidate business enterprises or to reorganise them, recent practice seems to show that if a company is salvageable, most stakeholders prefer to have an out-of-court restructuring. The Venezuelan bankruptcy process is seen as vexatious, reflecting in part the fact that there is still a social stigma attached to businesses that go bankrupt.[12]
There is much speculation as to whether Venezuelan public entities can be subject to the Code of Commerce’s insolvency regimes. PdVSA and its subsidiaries in Venezuela are organised as public limited companies (sociedades anónimas) under the Code of Commerce and logic would dictate that the Code’s bankruptcy provisions should apply to them.
However, PdVSA’s oil and gas transportation and distribution infrastructure is protected from local attachments. Specifically, any provisional remedy, or remedy in aid of the execution of judgments rendered against PdVSA’s oil and gas distribution infrastructure located in Venezuela, must be automatically stayed for 45 days while the Ministry of Energy and Petroleum deploys a plan that will ensure the uninterrupted supply of oil, derivatives and gas to the market.[13] This protection from attachments and provisional remedies has been regarded by scholars as a type of immunity that would complicate the application of the bankruptcy regime of the Code of Commerce to PdVSA.
Some might say that PdVSA’s insolvency would require the procedural rules currently in effect in Venezuela to be adapted to take account of the underlying public policy issues involved to avoid affecting the provision of a public service of general interest.[14] Other legal commentators have taken a different view. Neither position has been tested in the Venezuelan courts in relation to the oil and gas industry.[15] If the bankruptcy regime of the Code of Commerce were to be considered not to be applicable to PdVSA by the competent court, which in our view would be the Venezuelan Supreme Court, there would be no other specific set of rules that would regulate PdVSA’s insolvency or its liquidation.
To complicate matters, Venezuela owns all hydrocarbons while they are underground at the reservoir. Title to hydrocarbons passes to the holder of a concession or licence (i.e., PdVSA, PdVSA Petróleo, SA, Corporación Venezolana del Petróleo, SA or joint venture) at the wellhead, pursuant to the terms of the relevant licence.[16] It could be said that the Republic (owner of the reserves) and a royalty creditor to PdVSA, would be acting as judge (through the bankruptcy court) as well as a creditor of PdVSA under an insolvency proceeding.
Given these uncertainties, it would be convenient for Venezuela to adopt a modern insolvency statute to govern state-owned entities, which incorporates modern insolvency principles and makes a PdVSA insolvency proceeding in Venezuela eligible for recognition in relevant jurisdictions, most importantly under Chapter 15 of the US Bankruptcy Code.
A new PdVSA?
The Republic could create a new entity and grant to that entity all or some of the oil and gas licences that are currently held by PdVSA and its operating subsidiaries, namely PdVSA Petróleo, SA and the joint ventures.
PdVSA and the Republic have chosen to have their international bonds governed by New York law. An interesting issue would be if the creation of a ‘new PdVSA’ to which all (or a substantial portion) of PdVSA’s assets were transferred, including the right to carry out primary oil activities and undertake the international sale of crude and derivatives, would be considered liable for PdVSA’s bonds under successor liability.[17]
Security interests and guarantees
Pursuant to the terms of Venezuela’s bonds, liens on oil or oil accounts receivable (other than permitted liens) created by Venezuela to secure public financial debt, granted by the Venezuelan Central Bank or any government agency (a definition that includes PdVSA and its subsidiaries) within certain thresholds (taking into account Venezuela’s operating reserves) will cause Venezuela to equally and ratably secure its outstanding bonds.
In general terms, Venezuela is currently legally restricted under domestic law from granting security interests to secure debt and guarantees to secure the debts of other entities.[18]
If Venezuela were to secure bonds issued in the context of a restructuring, it would probably need the passage of a restructuring law that authorises it to post collateral or otherwise secure the new bonds to be issued in the restructuring. Such a law was passed to enable the Republic to post US Treasury bonds to secure a series of Venezuela’s Brady Bonds.
PdVSA and its affiliates generally have few restrictions on granting security interests over assets that are not used for public utilities.
New legal framework
The country’s enormous reserves have the potential (assuming that US sanctions affecting the industry are lifted) to generate the cash flow required to address the current humanitarian crisis and to sustain the restructured debt. Any attempt to refinance Venezuela’s and PdVSA’s debt will be ill-fated if not accompanied by a recovery of the country’s oil and gas industry. To ensure such a recovery, Venezuela should enact a new oil law that establishes an internationally competitive legal and fiscal framework to attract investments in the amounts required to increase oil and associated natural gas production and Venezuela’s fiscal revenues.
Debt-to-equity conversions
Debt-to-equity conversions should also be explored in the context of a comprehensive restructuring of Venezuela’s debt. Debt equity swaps will not increase Venezuela’s foreign exchange reserves. However, they have the potential to help reduce the country’s and PdVSA’s aggregate debt, and to increase the country’s capital stock. If the programme is well executed, it could also help to promote foreign direct investment; this, in turn, would increase the country’s reserves, capital stock and export capacity.[19]
Comprehensive restructuring
There are no local legal restrictions that would prohibit the Republic, PdVSA and all other government-owned entities from conducting a full-scale restructuring that encompasses all their creditors.
However, this would require a political compromise rarely seen in Venezuela’s political landscape. The role of external stakeholders will be critical in helping to crystallise any form of restructuring.
Footnote
[1] Fulvio Italiani, Carlos Omaña and Roland Pettersson are partners at D’Empaire.
[2] See Richard J Cooper and Mark A Walker, Venezuela’s Restructuring: A Path Forward (2019).
[3] The following types of transactions qualify as indebtedness (operaciones de crédito público) and are therefore subject to approval by the National Assembly (Public Finance Law, Art. 80): (1) the issuance and placement of securities, including treasury bills, which constitute borrowings or treasury operations, except for those issued for tax refund purposes; (2) the opening of credits of any nature; (3) the financing of public works, services or acquisitions, in which all or part of their payment is made within one or more fiscal years; (4) the granting of guarantees; (5) the consolidation, conversion, unification or any form or refinancing or restructuring of existing public debt; and (6) any other transactions destined to raise funds that imply a repayable financing.
The Public Finance Law also provides that prior to executing indebtedness agreements on behalf of the Republic, the Executive must consult with the Venezuelan Central Bank about the monetary impact and financing conditions of the transaction, although this opinion is not binding (Public Finance Law, Art. 96). The approval by the President of the Council of Ministers is also required (Public Finance Law, Art. 17, Regulation No. 2) as well as the receipt of a non-binding opinion from the Attorney General Office on the contract evidencing the indebtedness (Attorney General Office Law, Art. 12; Public Finance Law, Art. 29, Regulation No. 2).
[4] Official Gazette, Extraordinary Issue No. 6,210, 30 December 2016.
[5] Constitution, Art. 312.
[6] Public Finance Law, Arts. 82 and 83. Treasury bills are defined as debt securities issued by the Republic that mature within the fiscal year in which they were issued.
[7] Public Finance Law, Art. 97. Until the current Public Finance Law was passed by the National Assembly on 30 December 2015, the Executive branch of government also required approval from the Permanent Finance Committee of the National Assembly for each specific indebtedness transaction, including approval of each specific transaction’s terms and conditions, in addition to requiring approval of the maximum debt amount approved by the National Assembly via the Annual Indebtedness Law.
[8] See Public Finance Law, Art. 99.
[9] Art. 3 of Regulation No. 2 defines the term ‘refinancings’ as a ‘Group of Public Credit Operations performed by the Republic and/or any other entity entitled pursuant the Public Sector Financial Management Organic Law through which new public debt is issued in order to pay, swap, cancel, rescue or repurchase preexistent public debt’.
[10] See Public Finance Law, Art. 57 and Art. 58, Regulation No. 2.
[11] See Lee C Buchheit’s and Mitu Gulati’s paper titled ‘How to Restructure Greek Debt’, Duke Law Scholarship Repository, 2010.
[12] Fulvio Italiani and Carlos Omaña, ‘Insolvency Proceedings in Venezuela: A 19th Century Statute is Ill-Equipped to Navigate Current Times’, in Emerging Markets Restructuring Journal, 2017, 4.
[13] Pursuant to Art. 111 of the Law of the Office of the Attorney General of Venezuela, any provisional remedies or remedies in aid of execution of judgment, rendered on properties located in Venezuela that are used to the render a public service, such as oil and gas distribution and transportation, must be stayed for 45 days after notice is given to the Attorney General. The Venezuelan government entity in charge of rendering the public service may take any action to avoid the interruption of services, including, according to commentators, taking possession of the assets if such remedies endanger the continuity, quality or security of the public services provided. If the Attorney General does not notify the court about the provisional measures taken by the government to avoid discontinuance of the service entity within the 45-day notice period, the court may continue with the enforcement.
[14] Richard Levin and Roland Pettersson, ‘The transfer of Venezuela’s oil assets to a successor entity and fraudulent conveyance’, Capital Markets Law Journal, Volume 14, Issue 4 (Oxford Academic, October 2019), p. 547.
[15] In 1996, a power utility in southern Venezuela (CA La Electricidad de Bolivar) was declared bankrupt while under private ownership; the company was later taken over by the government under a law that nationalised the power sector. The company remained in bankruptcy while technically being government-owned and a final decision on the validity of an agreement akin to a restructuring agreement is still pending at the Venezuelan Supreme Court.
[16] The Republic owns all the hydrocarbons located in Venezuela while they are in the underground reservoir (Venezuelan Hydrocarbons Law, Art. 3). Pursuant to the Venezuelan Hydrocarbons Law, exploration, production, transportation and initial storage of hydrocarbons are reserved to the state (Art. 9). The aforesaid ‘primary activities’, as they are defined in the Hydrocarbons Law, may be carried out by the state directly, through wholly owned entities or through joint ventures (empresas mixtas), that are controlled by the Republic through a participation of 50 per cent or more (60 per cent or more if these activities are performed in the Orinoco extra-heavy crude basin).
[17] Under the Venezuelan bulk transfers provisions of the Code of Commerce (Art. 19(10)), the acquirer of all or part of a business (fondo de comercio) is joint and severally liable for the business’s debts and other liabilities if they are not settled within a mandatory period during which the sale must be advertised and registered.
[18] See footnote 2, above.
[19] See Fulvio Italiani and Carlos Omaña, ‘Debt Equity Conversions in Venezuela’, Global Restructuring Review (2020).
