Ecuador and Many Other Nations on Verge of Sovereign Debt Default

Client Advisory

December 9, 2008
by and Karl Schaffer

While the financial credit crisis continues to grip the world markets, a largely unrelated credit crisis is brewing in Latin America, and may be replicated in other corners of the globe. Holders of sovereign debt issued by these countries must prepare for a legal battle.

Ecuador Misses $30.6 Million Interest Payment

On November 15, 2008, the Republic of Ecuador failed to make $30.6 million in interest payments on its bonds due in 2012.[1] The country is now in a 30-day grace period; if it does not pay bondholders the interest due by December 15, 2008, an event of default will have occurred potentially leading to litigation and enforcement actions.[2] The 2012 bonds require twice-yearly interest payments at a rate of 12% per annum.[3] 

Ecuador last defaulted on its sovereign debt in 1999 during an economic crisis so severe the country abandoned its own currency and adopted the U.S. dollar as part of its economic reform. This time, the decision whether or not to default on its foreign debt obligations is more motivated by internal politics. Ecuador’s debt amounts to only 21% of its GDP, and the country was awash in funds until recently from high oil prices.[4] But Ecuador’s leftist President Rafael Correa vowed to default on his country’s foreign debt when he ran for president in 2006, promising to use the money on anti-poverty programs instead. In February 2007, one month after Correa took office, Correa threatened to withhold a $135 million interest payment, only to make the payment on time while announcing the formation of an audit commission to investigate the legitimacy of the debt. The report, running about 30,000 pages, was issued on November 20, 2008.[5]

Many Other Countries Also at Risk of Default

The risk of default by sovereign nations is certainly not limited to Ecuador. Many countries, such as Russia, Argentina, Hungary, Ukraine, Belarus, Romania, and Pakistan are hard hit by either the economic downturn or their own mismanagement, and appear to be at risk of default.[6] 

Other Latin American countries including Venezuela, Bolivia, and Paraguay, are, like Ecuador, questioning the “legitimacy” of their foreign debt.[7] The perceived level of risk of default in the market can be evaluated on a day to day basis by watching spreads on the credit default swaps for each country’s sovereign debt.

Ecuador’s Options

Ecuador Finance Minister Maria Elsa Viteri said that before deciding whether to pay the foreign debt, the government would review the audit commission report regarding the legitimacy of the country’s bonds due in 2012 and 2030, with a total outstanding principal of about $3.9 billion.[8] The “legitimacy” of the bonds due in 2015, which were negotiated in 2005, was also questioned by the commission. In a radio address on November 15, 2008 Correa reportedly said: “We'll take until December 15 to decide if we’ll keep paying or if we’ll fight a legal battle, because those debt renegotiations were a veritable robbery for the country.” He added: “We’re not playing around. If there is a sufficient basis for us to say: ‘we can’t pay this debt because it’s illegitimate’ that’s what we’ll do. Let the bond prices fall, let the country risk go up ... that doesn’t interest us at all, that doesn’t concern us at all.”[9] According to press reports, Ecuador has hired the Boston-based law firm Foley Hoag LLP to prepare a possible lawsuit to fight the debt in court.[10]

The global 2012 and 2030 bonds are the product of a debt refinancing in 2000. At the time, Ecuador had defaulted on its debt and was in an economic slide that forced 42 Ecuadorian banks to close their doors and the nation to abandon its local currency for the U.S. dollar to halt hyperinflation. Former Ecuador president Gustavo Noboa issued the 2012 and 2030 bonds in 2000 to refinance so-called Brady bonds issued in 1994, after the country defaulted on its debt the year earlier. Noboa was later accused by a subsequent government of mishandling foreign debt negotiations during his presidency. However, any claim that the bonds were issued improperly appears to have no merit: Ecuador was represented by Cleary, Gottlieb, Steen & Hamilton LLP, a highly regarded law firm that represents many governments in the issuance of foreign debt, and the terms of the bonds were similar to other foreign debt issued at the time. Cleary, Gottlieb and Ecuador ended their relationship earlier this year.[11]  

If Ecuador defaults, bondholders could sue the country in New York courts to recover the money they are owed. Ecuador’s bonds are governed by New York law and Ecuador is subject to jurisdiction in New York courts. Like other nations, Ecuador waived immunity under the Foreign Sovereign Immunities Act, which otherwise protects foreign governments from lawsuits in the United States.[12]

Another option would be to attempt to restructure the terms of the bonds, something the auditors told reporters was an option under consideration.[13] The bonds issued in 2005 with maturity dates of 2015 include a collective action clause (CAC) which makes it possible for a majority of bondholders to agree to a restructuring that is binding on a hold-out minority. However, the bonds due in 2012 and 2030, which are the focus of the audit commission’s report, have more stringent requirements. These bonds require that 100% of the bondholders approve of a modification to the stated maturity of principal or interest on their bonds or a reduction in principal or interest on the bonds or certain additional amounts.

These provisions restrict the ability of Ecuador to restructure the bonds by changing their terms. It would be virtually impossible for 100% of the bondholders to convene at a bondholder meeting. There are, however, alternatives for Ecuador. It could, for example, offer to purchase the bonds for a percentage of the total outstanding principal and interest without actually changing their terms. If this happens, bondholders can try to negotiate with Ecuador to secure the highest payout and best terms. Forming a committee to speak for bondholders and retain professionals such as attorneys and financial advisors would facilitate this process.

If Ecuador attempts to restructure its debt by offering to purchase the bonds, it is likely that there will be bondholders who are unwilling to accept Ecuador’s initial offer. They may attempt to negotiate for better terms. These bondholders take a risk that Ecuador will refuse to negotiate with them at all and that, if negotiations or litigation take place, the process of negotiating a settlement or litigating will take years to reach a resolution, if it does.

Possible Market Manipulation Claims

Ecuador is also potentially liable to bondholders for market manipulation claims. Former Economy Minister Ricardo Patino resigned last year after a video surfaced apparently showing him tipping off select investors about upcoming price fluctuations based on market turmoil just days before Ecuador changed course and announced that it would make its interest payment after all.[14] Ecuador has subsequently followed the same pattern: making public statements raising into question its intention to pay its debt, followed by payments. If Ecuador tipped off inside investors, or made the statements merely to drive down the price of the bonds so it could buy them back at a lower rate, bondholders would have a market manipulation claim.  


It appears that bondholders are facing a protracted legal battle with Ecuador to hold the country to the terms of its sovereign debt obligations. Bondholders holding debt from many other countries can also expect similar battles regarding the sovereign debt for countries facing similar economic or political challenges.

Questions regarding this advisory should be addressed to Kenneth S. Levine (212-238-8622, or Karl Schaffer (212-238-8659,



[1] See Jeanneth Valdivieso, “Ecuador delays debt payment, raising default fears,” Associated Press, Nov. 14, 2008, available at

[2] Offering Memorandum for 2012 Global Bonds, dated August 23, 2000, “Events of Default,” pages 125-126.  

[3] Id. at page 13. 

[4] See Alonso Soto and Alexandra Valencia, “Ecuador to jump-start economy, threatens default,” Reuters, Nov. 18, 2008, available at; Jeanneth Valdivieso, “Ecuador delays debt payment, raising default fears,” Associated Press, Nov. 14, 2008, available at 

[5] See “Can pay, might not,” The Economist (print edition), Nov. 27, 2008, available at

[6] See Ambrose Evans-Pritchard, “Russian default risk tops Iceland as crisis deepens,” The Telegraph, Oct. 24, 2008, available at; George Kopits, “Saving Hungary's Finances, Budapest's four-step plan for fiscal alcoholics,” Wall Street Journal, Dec. 3, 2008, available at; “Pakistan Faces Default on Its Huge Foreign Debt,” BusinessWeek, Oct. 20, 2008, available at

[7] See “Paraguay favours scrutinizing legality of foreign debt,” Merco Press, Dec. 3, 2008, available at 

[8] Jeanneth Valdivieso, “Ecuador delays debt payment, raising default fears,” Associated Press, Nov. 14, 2008, available at

[9] See “Ecuador auditing sovereign bonds delays interest payments,” Merco Press, Nov. 16, 2008, available at  

[10] See Stephan Kueffner, “Ecuador Looking at Possible Ways to Repudiate Debt,” Bloomberg News, Dec. 4, 2008, available at 

[11] See Kintto Lucas, “Correa May Cancel Payment of Some "Illegitimate" Debt,” Inter Press Service, Sept. 29, 2008, available at; Felix Salmon, “Market Movers: Ecuador Approaches Default,”, Nov. 17, 2008, available at

[12] See Offering Memorandum, pages 130-131.

[13] See “Ecuador could rework ‘illegitimate’ debt -- auditors,” Reuters, Nov. 17, 2008, available at

[14] See Gabriel DeSanctis, “Ecuador: SEC and bondholders could take legal action as a result of market manipulation claims – sources,” Financial Times, May 25, 2007, available at 

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2018 Carter Ledyard & Milburn LLP.
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