Restructuring a Sovereign Debtor's Contingent Liabilities

Abstract

How should the contingent liabilities of a sovereign be treated in a general restructuring of the debts of that sovereign? This question has played only a minor role in past sovereign debt restructurings because the size of such contingent liabilities has in most cases been small. In recent years, however, slathering government guarantees on third party debt has become the tool of choice for many countries in their efforts to quell an incipient panic in their financial markets. Some of those sovereigns are now, or may soon be, in the position of needing to restructure their debts. Ignoring large contingent liabilities in a sovereign debt restructuring may plant a land mine on the road to debt sustainability once the restructuring closes. That said, the answers to the questions of whether and how to restructure contingent liabilities are not obvious. Is the restructurer to assume that some, all or none of those contingent liabilities will eventually wind up as direct claims against the sovereign? Even if the underlying instrument can be successfully restructured, the guarantee will typically stand as an independent obligation of the guarantor that will require separate treatment in the restructuring.