Between Mandate and Market: Contract Transition in the Shadow of

Emory School of Law

Emory Legal Scholarship Working Paper Series

Year  Paper 

Between Mandate and Market: Contract

Transition in the Shadow of the International

Order

Robert B. Ahdieh

∗

Emory Law School, rba7@law.georgetown.edu

This working paper is hosted by The Berkeley Electronic Press (bepress) and may not be commer-

cially reproduced without the permission of the copyright holder.

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2005 by the author.

Between Mandate and Market: Contract

Transition in the Shadow of the International

Order

Robert B. Ahdieh

Abstract

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 cor-

porate 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 transac-

tion 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, re-

placing 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 ap-

parent 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 be-

cause 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 regu-

latory 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 efﬁ-

cient 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 inter-

national regulation generally given the limits of hard power within a community

of sovereign states.

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BETWEEN MANDATE AND MARKET:

CONTRACT TRANSITION IN THE SHADOW OF THE

INTERNATIONAL ORDER

Robert B. Ahdieh*

NTRODUCTION ................................................................................................693

I. THE SLOW AND SUDDEN EVOLUTION OF SOVEREIGN

DEBT CONTRACTS ................................................................................697

A. Unanimous and Collective Action in Sovereign

Debt Restructuring .......................................................................

698

B. Holdout Creditors and the Bumpy Road to

Debt Restructuring .......................................................................

702

1. An International Bankruptcy Regime?...................................705

2. Institutional Versus Contractual Remedies

to the Restructuring Dilemma ................................................

707

II. A NETWORK THEORY OF SOVEREIGN DEBT CONTRACTING ................710

A. Toward a Network Conception of Sovereign

Debt Contracting..........................................................................

710

B. Network Effects, Stasis, and Change in

Sovereign Debt Contracting.........................................................

721

III. COORDINATION GAMES, FOCAL POINTS, AND A CUEING

THEORY OF SOVEREIGN DEBT TRANSITION .........................................728

A. A Game Theoretic Account of Sovereign

Debt Contracting..........................................................................

729

B. Regulatory Cues in Sovereign Debt Contract Transition.............736

1. Regulatory Cues of Creditor States

and the Official Sector ...........................................................

736

2. Emerging Market Regulatory Cues........................................740

C. The Nature and Role of Regulatory Cues.....................................743

* Associate Professor of Law, Emory University School of Law. A.B., Princeton University; J.D., Yale

University. Thanks to Mitu Gulati for inviting me to participate in Georgetown University’s Conference on

Sovereign Debt Restructuring: The View from the Legal Academy, and for his generous assistance in

educating me in the complexities of sovereign debt. For their guidance on earlier drafts of this Article, I am

grateful to Ralph Brubaker, Lee Buchheit, Bill Buzbee, Bill Carney, Steve Choi, Michael Gibson, Allen Kamp,

Bill Klein, Peter Linzer, Marc Miller, Ashok Mody, James Nehf, Robert Schapiro, and David Slawson. Thank

you also to my research assistants, for their indefatigable labors.

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1. Cues and Coercion in Sovereign Debt Contracting

...............

743

2. Regulatory Cues as Sources of Information...........................748

3. The Shifting Role of Regulatory Cues in Sovereign

Debt Contracting....................................................................

749

IV. REGULATORY CUES IN THE INTERNATIONAL

FINANCIAL ARCHITECTURE..................................................................751

A. Between Mandate and Market: Cueing Transition

in Sovereign Debt Contract Transition ........................................

751

B. The Continuing Role of Regulatory Cues in Sovereign

Debt Contract Transition .............................................................

756

C. Convergence and Fragmentation in Sovereign

Debt Contracting..........................................................................

758

CONCLUSION....................................................................................................760

* * *

BSTRACT

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

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2004] BETWEEN MANDATE AND MARKET 693

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.

INTRODUCTION

This is more about sending a signal to the international markets than

it is about reducing our borrowing costs.

Mexican Finance Ministry official,

introducing collective action term in

new sovereign debt contracts

In the corner of every room in which the terms of sovereign debt contracts

are negotiated and considered sits the 800-pound gorilla of potential debt

restructuring. The sovereign bond contractby which nation-states receive an

influx of investment for national growth and development, in exchange for a

Mexico Pioneers Plan to Ease Debt, FIN. TIMES INVESTOR, Feb. 24, 2003.

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694 EMORY LAW JOURNAL [Vol. 53

stream of principal and interest payments

is one designed with a strong

premonition of breach. Yet the international financial order lacks any effective

cage for its gorilla. Nation-states go bankrupt, but this does not force them and

their creditors into bankruptcy court

an institution alien to the international

financial architecture. It leads them back to the negotiating table.

Contract terms have consequently been relied on to define the ways and

means of sovereign debt restructuring and default. Sovereign bond contracts

issued under New York law

the most typical choice of law, especially among

emerging market debtors, those most susceptible to default

have long

incorporated boilerplate language permitting restructuring of the bond, but

only with the bondholders’ unanimous consent. Yet this stricture has proven to

be a high barrier to debt restructuring. Most importantly, a unanimity

requirement opens the door to abuse by holdout creditors, who can, and often

do, insist on inflated side payments to accede to a restructuring plan already

agreed to by most other creditors.

Notwithstanding such holdout problems

and other collective action difficulties, however, little has changed in the

conventions of debt contracting for decades. Even the increased pressure for

change triggered by a series of emerging market financial crises in the late

1990s seemed to provoke little response from the market.

Against this backdrop of longstanding stasis, few observers of the

sovereign debt markets in early 2003 would have predicted any shift away

from unanimous action provisions in the near future. Yet over the course of

only a few months in the middle of 2003, this conventional wisdom was

disproved. By the end of the year, the longstanding norm of unanimous action

for debt restructuring had been all but abandoned. In a complete inversion of

the status quo, once-familiar unanimous action provisions have become the

exception in sovereign debt contracts, while collective action clauses

permitting restructuring by a qualified majority of bondholders are the

expected norm.

One might reasonably expect contract normsalong with other social

normsto be products of evolutionary patterns of adjustment and reform.

Decentralized in their origins, and diffuse in their operation, the drafting

conventions behind contract boilerplate and standardized contracts seem

Corporate and other domestic debtors effectively avoid holdout problems through the bankruptcy

regime and its automatic stay, cramdown, and other mechanisms, by which holdout creditors can be pressed

into agreement.

See infra Part I.B.2.

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unlikely candidates for rapid and revolutionary change. Many have

consequently puzzled over the recent shift in sovereign debt contract

conventions. As Mitu Gulati and David Skeel have queried: “What does this

sudden move from a point of unwillingness to try even minimal change to one

of everyday experimentation tell us about the dynamics of the underlying

system? . . . [W]hat produces movement out of the status quo[?]”

Alongside

these questions one might add another: Why was the move so sudden?

Here, I attempt to respond to these inquiries with an eye to the evolution of

standardized contract terms generally. Can such terms be expected to evolve

naturally with changing conditions, or might their transition require regulatory

mandate? Most observers fall in one of two camps: In one camp sit those who

assert that efficient contract norms emerge naturally by way of the market,

while in the opposing camp are those who insist such norms must be dictated

by command regulation. This Article suggests an unconventional possibility,

between these conventional bounds. Standardized contract terms may not

evolve efficiently, and yet traditional regulation, with its characteristic

coercion, may not be the appropriate remedy. Drawing on the microeconomics

of network externalities, as well as a relatively unexplored corner of game

theory, I offer an explanation of the seemingly incongruous patterns of

longstanding stasis and abrupt change in sovereign debt contract terms, and

propose a narrowly confined, yet essential and perhaps ongoing, regulatory

role in the evolution of contract boilerplate.

See G. Mitu Gulati & David A. Skeel, Jr., International Financial Architecture: Has the Financial

World Arrived at a Collective Action Clause Consensus? 6 (June 20, 2003) (unpublished manuscript, on file

with author).

Distinct applications of the network theory and coordination game analysis of transition that I explore

in sovereign debt contracting herein can be found in Robert B. Ahdieh, Making Markets: Network Effects and

the Role of Law in the Creation of Strong Securities Markets, 76 S. CAL. L. REV. 277 (2003) [hereinafter

Ahdieh, Making Markets] (outlining network analysis of securities market transition) and Robert B. Ahdieh,

Law’s Signal: A Cueing Theory of Law in Market Transition, 77 S. C

AL. L. REV. 101 (2004) [hereinafter

Ahdieh, Law’s Signal] (developing regulatory cueing theory of law’s role in coordinating transition in network

industries).

In this issue of the Emory Law Journal, Steve Choi and Mitu Gulati offer the results of an empirical

analysis of the presence of network effects in sovereign debt contracting. See Stephen Choi & G. Mitu Gulati,

Innovation in Boilerplate Contracts: An Empirical Examination of Sovereign Bonds, 53 E

MORY L.J. 929

(2004). Supplementing their analysis, this Article considers the possible sources of network effects in

sovereign debt contracting, and their implications. Further, it attempts to theorize what might trigger transition

in network environments, including sovereign debt contracting. Yet, it does not assert any firm conclusion on

the strength of network effects in sovereign debt contracts. Rather, it outlines why network effects might be

predicted in sovereign debt contracts, and suggests the consistency of recent developments in sovereign debt

contracting with the presence of such effects.

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The dramatic proposal of the International Monetary Fund to create a

bankruptcy court-like Sovereign Debt Restructuring Mechanism (SDRM) and

even more limited suggestions that the IMF or United States mandate the

standardization of sovereign debt contracts

are therefore challenged by the

present analysis. The Article also questions, however, the contractual

approach that is posited as the alternative. Rather than a dichotomous choice

between creation of the IMF’s SDRM, or debtors’ voluntary, spontaneous

adoption of standardized (and presumably efficient) collective action clauses,

as the appropriate means to move away from unanimous action provisions and

other inefficient contract terms,

I develop and explore a gray area in the

middle. Specifically, I describe a noncoercive “cueing” function for law in

facilitating contractual change, and suggest that the recent shift in sovereign

debt contract terms was driven by just cues. This analysis offers lessons not

only for efficient transition in sovereign debt contract boilerplate, but also for

the role of the state in contract change generally, including in corporate and

real estate contracts, among others.

Part I describes the historical choice between unanimous action and

collective action clauses in sovereign debt contracts, the IMF’s proposal to

create an SDRM to deal with the inefficiencies of unanimous action clauses,

and the recent shift of the market to collective action contract provisions. Part

II develops a conception of sovereign debt contracting as characterized by

network effectsphenomena by which the individual benefits of a particular

good or service, as in the paradigmatic networks of telephone communication

and computer operating systems, grow as the same or compatible goods or

services are purchased by other consumers. Further, Part II suggests how

network effects in sovereign debt contracting can explain not only the

longstanding resistance of the sovereign debt markets to collective action

clauses, but also their abrupt and wholesale adoption of just such clauses over

the course of a few months in 2003.

Part III picks up where the network story leaves off, drawing on a relatively

unfamiliar corner of game theory to explain what might have triggered the

recent shift of the sovereign debt markets from stasis to change.

Proposals favoring IMF or U.S. dictation of standardized debt contract terms have arisen largely in the

aftermath of the shift from unanimous action requirements to majoritarian collective action clauses. See infra

notes 277-79 and accompanying text.

See William W. Bratton & G. Mitu Gulati, Sovereign Debt Reform and the Best Interest of Creditors,

57 V

AND. L. REV. (forthcoming 2004) (describing alternative arrangements for efficient sovereign debt

restructuring).

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Characterizing sovereign debt contracting as a “coordination game” of sorts, I

identify a role for regulatory cues in transition among the Nash equilibria

embedded in such games. After suggesting some of the possible cues in the

sovereign debt markets’ transition to collective action provisions, I use these

examples to explore the nature of regulatory cues as a distinct mode of state

action. Finally, in Part IV, I consider the ongoing role of regulatory cues in

sovereign debt contract transition, including the inevitable limits of that role. I

conclude by noting the broader implications of cueing forms of regulation for

standardized contracts generally, and perhaps for the growing effort to

introduce transnational regulatory norms and standards from international

finance to antitrust and securities law.

I. T

HE SLOW AND SUDDEN EVOLUTION OF SOVEREIGN DEBT CONTRACTS

Recent challenges to the international regime of sovereign debt

restructuring and dramatic changes in the conventions of sovereign debt

contracting have occurred against the backdrop of longstanding competition

among alternative standards for the restructuring of such debt. The market in

sovereign debt has thus long been characterized by two distinct norms for the

alteration of basic financial terms of sovereign debt contracts.

The majority of sovereign debt contracts, particularly those of emerging

markets, are issued under New York law. With few exceptions, these contracts

have long included unanimous action clauses (UACs) requiring unanimity for

any changes to their basic terms. As a consequence, they erected a significant

barrier to efficient debt restructuring.

Most basically, such inefficiency rests

on the substantial collective action obstacles that UACs place on the return of

sovereign debtors to financial health and stability, and to the financial markets

themselves.

Under UACs, holdout creditors may resist participation in any

agreed restructuring, absent substantial side payments outside any collective

agreement.

This has the potential to delay restructuring, if not to deter the

participation necessary for it to occur at all.

In slightly different terms, such

See G. Mitu Gulati & Kenneth N. Klee, Sovereign Piracy, 56 BUS. LAW. 635, 642-43 (2001); Steven

L. Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, 85 C

ORNELL L. REV.

956, 960-61 (2000).

See Marcel Kahan, Rethinking Corporate Bonds: The Trade-Off Between Individual and Collective

Rights, 77 N.Y.U. L. R

EV. 1040, 1054 (2002); Schwarcz, supra note 8, at 960-61, 980.

See Kahan, supra note 9, at 1055-56; Schwarcz, supra note 8, at 961.

See Schwarcz, supra note 8, at 961.

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holdouts inevitably increase transaction costs and reduce predictability in

sovereign debt restructuring.

Given the latter possibilities, unanimous action requirements may also

increase the moral hazards of sovereign debt. By delaying, if not preventing,

efficient sovereign debt restructuring, UACs increase the prospect of official

sector bailouts. These, in turn, produce the moral hazard of looser restraints on

both lending and borrowing practices, and attendant efficiency losses.

To avoid this parade of horribles, collective action clauses (CACs)

the

norm in sovereign debt contracts issued under English law

permit

restructuring by a qualified majority of bondholders. Collective action

provisions have been widely favored by academics and policymakers alike.

Yet their enthusiasm was to little avail. Until early 2003, the market in

sovereign debt continued to be characterized by a dominant preference for

UACs. By the end of the year, however, the tide had turned. UACs had

become largely a historical artifact. Notwithstanding the long resistance to

change, collective action is now the norm in nearly every newly negotiated

sovereign debt contract.

A. Unanimous and Collective Action in Sovereign Debt Restructuring

Since the late nineteenth century, majority voting provisions have been the

norm in sovereign bonds issued under English law, which include a significant

minority of all sovereign bonds.

So-called majority action clauses (MACs)

have allowed a supermajority of bondholders to alter the basic financial terms

of the relevant bond issue, including restructuring payments, adjusting interest

rates, and reducing principal.

By contrast, sovereign bonds issued under New

See Celeste Boeri, How to Solve Argentina’s Debt Crisis: Will the IMF’s Plan Work?, 4 CHI. J. INT’L

L. 245, 248 (2003); Lee C. Buchheit & G. Mitu Gulati, Sovereign Bonds and the Collective Will, 51 EMORY

L.J. 1317, 1351 (2002).

See Schwarcz, supra note 8, at 961-62, 1004 n.279.

Unanimous action provisions have also been the norm in debt issued by Russia. See Nouriel Roubini

& Brad Setser, Improving the Sovereign Debt Restructuring Process: Problems in Restructuring, Proposed

Solutions, and a Roadmap for Reform 13 (Mar. 9, 2003) (unpublished manuscript, on file with author); see

also B

ARRY EICHENGREEN ET AL., CRISIS RESOLUTION: NEXT STEPS 35 nn.47-48 (IMF Working Paper No.

03/196) (forthcoming in B

ROOKINGS TRADE F.).

Under the broader rubric of “collective action clauses,” other opportunities for collective action by

creditors, besides majority restructuring, have also been included or proposed in sovereign bond issues.

“Collective representation clauses,” for example, establish a creditor committee or other representative

arrangement for bondholders. “Majority enforcement clauses” (or “initiation clauses”) mandate that twenty-

five percent of bondholders approve any acceleration of debt, but allow fifty percent of bondholders to rescind

any such acceleration. Such acceleration provisions, notably, were included in New York law bonds as well.

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York law, which constitute the majority of sovereign debt issuances,

particularly by emerging markets,

have traditionally not permitted majority

See

Buchheit & Gulati, supra note 12, at 1335. “Engagement clauses” dictated early and regular interaction of

the sovereign debtor with its bondholders, and outlined the overall process of restructuring. See Press Release,

Under Secretary of Treasury John B. Taylor, Using Clauses to Reform the Process for Sovereign Debt

Workouts: Progress and Next Steps (Dec. 5, 2002) [hereinafter Taylor, Using Clauses],

available at

http://www.ustreas.gov/press/releases/po3672.htm; Press Release, Under Secretary of Treasury John B.

Taylor, Sovereign Debt Restructuring: A U.S. Perspective (Apr. 2, 2002) [hereinafter Taylor, Sovereign Debt

Restructuring], available at http://www.ustreas.gov/press/releases/po2056.htm. Some engagement clauses,

furthermore, also provide for the appointment of a trustee.

See Barry Eichengreen & Ashoka Mody, Is

Aggregation a Problem for Sovereign Debt Restructuring 2 (Jan. 2003) (unpublished manuscript, on file with

author). Finally, a standard provision in nearly every bond contract provides for a majority (or supermajority)

of bondholders to amend the nonfinancial terms of the bond.

Various authors have characterized these collective action provisions in a variety of ways. On the

provisions for collective action in English MACs, see Andrew Yianni, Resolution of Sovereign Financial

Crises—Evolution of the Private Sector Restructuring Process, FIN. STABILITY REV., June 1999, at 78. More

generally, on the various types of CACs, see Barry Eichengreen,

Restructuring Sovereign Debt, J. E

CON.

ERSP., Fall 2003, at 83-84, and Eichengreen & Mody, supra, at 2. See also Jack Boorman, Alternative

Approaches to Sovereign Debt Restructuring, 23 C

ATO J. 59, 65 (2003) (suggesting alternative characterization

of various CACs); Bratton & Gulati, supra note 7 (same); Arturo C. Porzecanski, A Critique of Sovereign

Bankruptcy Initiatives, B

US. ECON., Jan. 2003, at 39, 40. On the U.S. Department of the Treasury’s

conception of the various CACs, see Taylor, Using Clauses, supra, and Taylor, Sovereign Debt Restructuring,

supra. Finally, to a similar extent, Nouriel Roubini and Brad Setser have described four potential

configurations of the various contract provisions for sovereign debt restructuring: (1) The use of New York

law documentation, which requires the unanimous consent of all creditors to change “key financial terms”

(defined as payment dates and amounts), is the first possibility. All other terms would be subject to

amendment by one-half to two-thirds of bondholders. Some New York law bonds, furthermore, require the

support of twenty-five percent of bondholders to initiate litigation. (2) The second configuration involves the

adoption of English law documentation, which allows seventy-five percent of bondholders present at any

meeting at which there is quorum to amend any terms. Litigation limitations are also common in English law

bonds. (3) Another option, the draft clauses prepared by the G-10, would adopt the English law convention,

with additional provisions to encourage the use of trustees and thereby facilitate communication. (4) Finally,

the Group of Six, comprised of major creditors, has also drafted proposed terms, which would allow

amendment of a broader set of “financial terms” by eighty-five percent of bondholders, so long as no more

than ten percent of bondholders object. Other terms can be amended by seventy-five percent of bondholders,

with the exception of terms concerning the ability of creditors to sue, which would not be subject to

amendment. Finally, the debtor would have to meet additional disclosure requirements and would be liable for

the expenses of a creditor committee. See Roubini & Setser, supra note 14, at 8-9; see also Buchheit & Gulati,

supra note 12, at 1329.

See Bratton & Gulati, supra note 7. Thus, the sovereign debt market is primarily divided between

English and New York law bonds. See id. at 30; Eichengreen, supra note 15, at 84, 85 tbl.2 (noting that at the

end of 2001, seventy percent of international sovereign bonds outstanding were issued under New York or

German law); Richard Portes, The Role of Institutions for Collective Action, in M

ANAGING FINANCIAL AND

CORPORATE DISTRESS: LESSONS FROM ASIA 64 (Charles Adams et al. eds., 2000); see also EICHENGREEN ET

AL., supra note 14, at 3 nn.2-3, 35 n.47; Eichengreen & Mody, supra note 15, at 8; Porzecanski, supra note 15,

at 39, 40 n.4; Roubini & Setser, supra note 14, at 13 n.9; Taylor, Using Clauses, supra note 15.

See Ashoka Mody, What Is an Emerging Market? (Apr. 2004) (unpublished manuscript, on file with

author).

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700 EMORY LAW JOURNAL [Vol. 53

action, but instead required unanimous action for changes to the basic financial

terms.

The divergence between London and New York restructuring provisions

can be traced back to corporate bond issuances in England and the United

States in the late nineteenth century. In the early 1800s, corporate bonds in

England and elsewhere included no provision for collective decisionmaking.

Rather, alteration of payment terms could only be accomplished with the

unanimous consent of bondholders.

Yet this requirement led to the forced

liquidation of many borrowers that faced merely a liquidity, rather than

solvency, crisis.

In addition, it allowed holdout creditors to threaten

liquidation, in order to secure side payments at the expense of other creditors.

To overcome these difficulties, in 1879, Francis Beaufort Palmer, an English

barrister, introduced the possibility of majority action clauses in corporate

bond issues.

Such clauses would permit a supermajority of creditors to

approve a deferment or change in payment terms, which would then be binding

on all creditors.

Such clauses quickly caught on, and remain a standard

feature of both corporate and sovereign bonds issued under English law. For

the minority of sovereign debtors that issue their debt under English law,

including even a few developing country debtors, who generally issue under

New York law, majority action is therefore available to overcome collective

action obstacles to debt restructuring.

In the United States, by contrast, MACs were not widely introduced in the

late 1800s, for at least three reasons.

First, issuers and investors worried that

bonds containing MACs would not qualify as negotiable instruments and

would therefore lack marketability.

Second, in the late nineteenth century,

when MACs were coming into fashion in England, the majority of U.S. bonds

were being issued to foreign investors who, it was feared, might hesitate to buy

The same was long true of bonds issued under German law, see Taylor, Using Clauses, supra note 15,

and Japanese law, see Bratton & Gulati, supra note 7.

See Buchheit & Gulati, supra note 12, at 1324.

See id.

Such borrowers could well have been saved by a short deferment or reduction in payments. See id.

See id.

See id. at 1325; see also EICHENGREEN ET AL., supra note 14, at 32.

See Buchheit & Gulati, supra note 12, at 1324.

Other reasons might also be offered for the absence of MACs in New York law bonds. See Bratton &

Gulati, supra note 7; see also David A. Skeel, Jr., Can Majority Voting Provisions Do It All?, 52 E

MORY L.J.

417 (2003).

See Buchheit & Gulati, supra note 12, at 1326 (noting negotiable instruments law requirement that

bonds contain “an unconditional promise or order to pay a sum certain in money”).

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bonds that could be altered by majority vote.

Finally, due to a wave of

mergers in the 1800s, the corporate structure of most U.S. railroads

the

primary issuer of corporate bonds



was extremely complex, with the number

of different classes of bonds too great for MACs to be effective.

In lieu of MACs, the United States employed a variety of other methods to

assist financially distressed debtors and avoid holdout creditor problems.

Around 1848, debtors and creditors turned to equity receiverships, by which a

court appointed a receiver for borrowers nearing default, in conjunction with

whom the debtor and its creditors negotiated a reorganization plan.

Most

commonly, such plans involved selling the debtor’s assets to a new company

organized by creditors of the old company.

Potential holdout creditors

generally agreed to these plans for lack of any viable alternative.

The use of equity receiverships, however, began to decline after creation of

the U.S. Securities and Exchange Commission (SEC) in 1934. One of the

SEC’s first acts was to prepare a report that concluded that equity receiverships

were unfair to investors.

Yet the SEC did not have a taste for MACs either.

It feared that corporate insiders who owned equity in financially distressed

borrowers would buy up a majority of MAC bonds,

and then vote to defer

payment or change the terms of those bonds. The equity owners would

thereby invert “the normal priorities in a corporate bankruptcy by which a

company’s debt holders are paid off before the equity holders.”

Thus, instead of promoting MACs as a substitute for equity receiverships,

Congress added section 77B to the U.S. Bankruptcy Act in 1934. A precursor

to Chapter 11, section 77B provided for debt reorganization under the

supervision of a bankruptcy court. With the knowledge that debtors could now

avoid liquidation, by relying on section 77B,

Congress went further, to enact

section 316(b) of the Trust Indenture Act (TIA).

This section essentially

precluded the introduction of MACs in corporate bond instruments, by

See Skeel, supra note 25, at 420.

See id. at 420-21.

See Buchheit & Gulati, supra note 12, at 1327.

See id.

See SEC. AND EXCH. COMM’N, REPORT ON THE STUDY AND INVESTIGATION OF THE WORK, ACTIVITIES,

ERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES 10-60 (1937-1940).

See Buchheit & Gulati, supra note 12, at 1328.

Id.

See id. at 1329.

Trust Indenture Act of 1939, ch. 411, 53 Stat. 1172 (codified as amended at 15 U.S.C. § 77 (2000)).

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“prohibit[ing] any reduction in the amount due under a publicly issued

corporate bond without the consent of each affected bondholder.”

U.S.

corporate bonds therefore became unanimous action bonds, by definition.

The TIA’s bar on collective action, however, did not speak to sovereign

bond issuances. Nonetheless, nearly all sovereign debt issued under New York

law came to exclude MACs as well. Among other explanations for this

pattern, it has been suggested that drafting inertia in the large law firm practice

groups often responsible for drafting both types of debt contracts

a path

dependence of form contracts

may be behind this pattern.

The network

theory of sovereign debt contracting offered herein might also be important.

Regardless of the particular cause, unanimous action requirements came to

dominate sovereign debt contracts to nearly the same extent they did corporate

debt. Given emerging markets’ preference for New York law, meanwhile,

UACs emerged as the dominant norm in sovereign debt contracts as a whole.

B. Holdout Creditors and the Bumpy Road to Debt Restructuring

As noted above, unanimous action requirements give rise to significant

collective action problems in sovereign debt restructuring.

In essence,

unanimous action provisions require a difficult and time-consuming, if not

impossible, effort to secure the agreement of every creditor, in order for a

restructuring plan to proceed.

UACs thus enable a dissenting, holdout

creditor to sue for full repayment, and thus delay restructuring until the debtor

or other creditors pay a premium to secure the holdout’s agreement.

The

possibility of this result, of course, may deter creditors as a whole from

consenting to a restructuring plan, preventing the return of the sovereign debtor

Id. It bears noting that the English regime does not rely exclusively on MACs to facilitate corporate

restructuring, but now has its own bankruptcy process. Even if all relevant bonds of a given corporation

include MACs, other debts of the corporation necessarily require some form of bankruptcy regime.

Until the adoption of the TIA in 1939, MACs were relatively rare in the United States, but not unheard

of. See Bratton & Gulati, supra note 7. See generally Buchheit & Gulati, supra note 12. Thus, the sharp

divergence between New York and English law debt restructuring provisions is of recent provenance. See

Portes, supra note 16, at 68 n.43.

Cf. Marcel Kahan & Michael Klausner, Standardization and Innovation in Corporation Contracting

(Or “The Economics of Boilerplate”), 83 V

A. L. REV. 713, 718 (1997); Michael Klausner, Corporations,

Corporate Law, and Networks of Contracts, 81 V

A. L. REV. 757, 762, 785 n.89 (1995).

See infra Part II.B.

See supra notes 8-13 and accompanying text.

See Felix Salmon, Bond Investors Feel the Pinch, EUROMONEY, Nov. 2002, at 90.

See Lee C. Buchheit, Majority Action Clauses May Help Resolve Debt Crisis, INT’L FIN. L. REV., Aug.

1998, at 13.

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to financial health and stability.

In the case of corporate debt, this strategic

dynamic is readily curtailed. The bankruptcy system, with its automatic stay

and other restructuing provisions, obviates holdout creditor problems in

corporate restructuring. In the international financial order, however, no

bankruptcy regime is available as a fall back. Nor are creditors likely to find

significant assets to attach.

Consequently, holdout creditor and other

collective action obstacles are far greater barriers to sovereign debt

restructuring than corporate restructuring.

Until the 1990s, however, holdout creditors remained a limited concern

even in sovereign debt restructuring, because notwithstanding the prior use of

bonds in sovereign finance,

the primary source of emerging market financing

by the 1980s was syndicated bank loans.

Sovereign debt creditors were

primarily repeat player banks with concentrated holdings. Expectations of

future encounters, and resulting reputational constraints, reduced the incentive

to hold out for more favorable restructuring terms.

Following the emerging

See Choi & Gulati, supra note 5, at 939; Christopher C. Wheeler & Amir Attaran, Declawing the

Vulture Funds: Rehabilitation of a Comity Defense in Sovereign Debt Litigation, 39 S

TAN. J. INT’L L. 253,

259-60 (2003).

See Schwarcz, supra note 8, at 960 n.16. The political dimensions of sovereign financial distress also

distinguish it from domestic corporate bankruptcy.

The nearly universal application of the TIA’s bar on majority action to sovereign debt contracts,

not withstanding its formal inapplicability, is particularly puzzling in this light. See supra notes 36-40 and

accompanying text.

See Buchheit & Gulati, supra note 12, at 1334-35.

See Bratton & Gulati, supra note 7; Eichengreen, supra note 15, at 81; Barry Eichengreen & Richard

Portes, Debt Restructuring With and Without the IMF 15, 17 (Feb. 2000) (unpublished manuscript, on file

with author).

See Benjamin Klein & Keith Leffler, The Role of Market Forces in Assuring Contractual

Performance, 89 J. P

OL. ECON. 615 (1981). Sovereign debt restructuring can be modeled as a standard-form

Prisoner’s Dilemma game among creditors. In this familiar dynamic, a creditor will secure a higher payoff if

he, and he alone, defects from an agreed restructuring plan by demanding, for example, a side payment for his

participation. If all creditors act on this common incentive, however, the ultimate payoff to each creditor is

lower than if none had defected from the original agreement. In sovereign debt contracting, the latter would

occur if the sovereign debtor simply declined to restructure, or pay, as Argentina essentially has in recent

years.

One way to avoid defection in Prisoner’s Dilemma games, however, is through repeat plays. See

OBERT AXELROD, THE EVOLUTION OF COOPERATION 10-11 (1984); Richard L. Revesz, Congressional

Influence on Judicial Behavior? An Empirical Examination of Challenges to Agency Action in the D.C.

Circuit, 76 N.Y.U. L. R

EV. 1100, 1111 (2001). In essence, if a given participant knows that he will participate

in the game successively, the return on any single defection, even if successfully executed (i.e., even if other

players do not respond by altering their strategy), is dwarfed by the losses that follow from the relevant

player’s subsequent inability to secure agreement with its counterparts. In repeat Prisoner’s Dilemma games,

defection ceases to be a productive strategy. For this reason, a sovereign debt market financed by a handful of

large banks—as distinct from the present financing of sovereign debt by an innumerable, anonymous, and

constantly changing collection of small, individual bondholders—was less susceptible to holdout problems.

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market debt crises of the 1980s, however, banks largely pulled out of emerging

market finance and the sovereign debt markets turned back to bonds.

Yet

bonds aggravate holdout creditor problems, and creditor coordination problems

generally, because of the dispersion of bond debt among a wide universe of

small, anonymous players, who are less likely to be subject to repeat player

constraints.

This dynamic is further aggravated by the tradable nature of the

relevant bonds.

The holders of a given sovereign bond issue are not only

numerous and difficult to identify; they are constantly changing.

Citing the consequent inefficiencies of unanimous action requirements, a

growing array of academics and practitioners, developed countries, and official

sector institutions, including the IMF, began to press for the abandonment of

UACs in New York law bonds. The G-10 highlighted this need with its call

for the replacement of UACs with CACs in 1996.

Encouragement from other

international and national bodies, as well as individual attorneys, economists,

and others, quickly followed.

Yet the market exhibited little receptivity to

change. While English law bonds, as well as those of certain other

jurisdictions, continued to include MACs, New York law bonds, encompassing

the largest share of the sovereign debt market, continued to be issued with

UACs, rather than CACs. UAC bonds were particularly preferred by emerging

market debtors, moreover, for whom the choice of restructuring terms was

Other collective action problems, including an inability to communicate effectively, were also of diminished

importance.

See Bratton & Gulati, supra note 7.

See Choi & Gulati, supra note 5, at 939; Ronald J. Silverman & Mark W. Deveno, Distressed

Sov ereign Debt: A Creditor’s Perspective, 11 A

M. BANK. INST. L. REV. 179, 179-80, 183-84 (2003); Wheeler

& Attaran, supra note 44, at 253 n.2; see also James A. Dorn, International Financial Crises: What Role for

Government?, 23 C

ATO J. 1, 3 (2003); Eichengreen & Portes, supra note 48, at 21-22; Portes, supra note 16, at

63 (noting increased complexity of sovereign debt compositions following shift from bank to bond financing,

given increased number of interested parties who are less susceptible to central bank pressure).

See Silverman & Deveno, supra note 51, at 183-84. See generally Wheeler & Attaran, supra note 44,

at 253.

Yakov Amihud, Kenneth Garbade, and Marcel Kahan have described this dynamic as the dispersion

and fluidity of bondholders. See Yakov Amihud et al., A New Governance Structure for Corporate Bonds, 51

TAN. L. REV. 447, 450 (1999).

See Boorman, supra note 15, at 65; Anna Gelpern, How Collective Action Is Changing Sovereign

Debt, I

NT’L FIN. L. REV., May 2003, at 19; Portes, supra note 16, at 66, 69-70 (describing G-7’s

encouragement of CACs); Barry Eichengreen, Crisis Resolution: Why We Need a Krueger-Like Process to

Obtain a Taylor-Like Result 10 (Apr. 29, 2002) (unpublished manuscript, on file with author) [hereinafter

Eichengreen, Crisis Resolution]; see also Barry Eichengreen, Is Greater Private-Sector Burden Sharing

Impossible?, in R

EFORMING THE INTERNATIONAL MONETARY AND FINANCIAL SYSTEM 10 (Peter Kenen &

Alexander Swoboda eds., 2000).

See Buchheit & Gulati, supra note 12, at 1358; Choi & Gulati, supra note 5, at 973; Gulati & Skeel,

supra note 4, at 1-2.

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most important. No amount of pressure seemed to have any impact on this

pattern.

1. An International Bankruptcy Regime?

In November 2001, in the wake of the dramatic collapse of the Argentine

economy and ensuing social chaos, Anne Krueger, Deputy Managing Director

of the IMF, proposed a radical restructuring of the international financial

architecture by introducing a bankruptcy regime for sovereign states.

Specifically, she proposed the creation of a Sovereign Debt Restructuring

Mechanism under the auspices of the IMF, charged with facilitating efficient

debt restructuring and thereby minimizing the need for the massive debt

bailouts that had littered the 1990s.

As originally outlined, the IMF’s SDRM

plan was based on Chapter 11 of the U.S. Bankruptcy Code, and sought to

define a binding set of rules that would allow crisis-stricken countries to work

out their debts in an orderly fashion.

It also granted the IMF extensive new

powers and placed decisionmaking authority squarely with the IMF,

drawing

strong attacks.

The plan was consequently modified, with the IMF proposing

a “twin track approach” to sovereign debt restructuring in 2002.

This revised

proposal incorporated both a “contractual approach,” encouraging the use of

CACs in bond issuances, and a “statutory approach,” which called for an

See Boorman, supra note 15, at 62; Eichengreen & Mody, supra note 15, at 3; Gulati & Skeel, supra

note 4, at 3; see also Battling Over the Bankrupt, E

CONOMIST, Oct. 5, 2002; Jennifer Galloway, What CACs

Lack, L

ATINFINANCE, Dec. 2003, at 24.

See Susanne Soederberg, The International Dimensions of the Argentine Default: The Case of the

Sov ereign Debt Restructuring Mechanism, 28 C

AN. J. LATIN AM. & CARIBBEAN STUD. 97, 115 (2003). The

country in crisis would be able to halt debt payments as it negotiated debt restructuring with private sector

lenders, under the auspices of a new international judicial body. During such negotiations, the IMF would

protect the debtor country from litigation. Ultimately, the conditions of repayment would be determined by a

supermajority vote of the creditors. The terms would then be binding on all creditors and the debtor country.

See id. The voting process would be overseen by the IMF, which would also adjudicate any disputes that

arose. See generally Paul Blustein, Bankruptcy System for Nations Fails to Draw Support, W

ASH. POST, Apr.

2, 2003, at A14.

See Soederberg, supra note 57, at 115.

See id. The U.S. Treasury’s criticism was driven at least in part by the fierce opposition to the SDRM

on Wall Street, where bankers warned that capital flows to emerging markets would dry up if creditor rights

were infringed. See Blustein, supra note 57. Emerging market governments likewise resisted the SDRM out

of fear of losing access to cheap foreign funds. See id. Investors, finally, believed that the SDRM would

submerge their interests to junior creditor status, causing the IMF to be repaid first, and in full, ahead of

bondholders and other private sector creditors. See Felix Salmon, SDRM Finds Few Friends in the Market,

UROMONEY, Nov. 1, 2002, at 94.

See Porzecanski, supra note 15, at 40.

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SDRM, but with greater creditor control and no new powers for the IMF.

particular, the new plan eliminated the IMF’s control over any temporary

suspension of payments and the precise restructuring of the debt.

The revised SDRM would thus permit a supermajority of creditors to

approve a debt restructuring agreement with the debtor country, either in

anticipation of or after default.

Minority creditors would be bound by this

restructuring agreement, thereby avoiding holdouts.

A supermajority of

creditors could also vote to stay any litigation while the restructuring

negotiations were proceeding in order to protect the sovereign’s assets from

deleterious legal action.

To facilitate ongoing economic activity, the creditors

could also vote to give seniority to new private financing.

controversially, the SDRM would provide a dispute resolution forum, akin to

an international bankruptcy court, to administer creditor claims and resolve

disputes between debtors and creditors.

This dispute resolution forum would

have exclusive jurisdiction and its decisions would be legally binding on all

IMF member nations.

The SDRM proposal was seen by its proponents as having several

advantages over CACs as a solution to the shortcomings of UACs, even

assuming the market’s longstanding resistance to CACs could actually be

overcome. First, upon ratification of the SDRM, its provisions would be

immediately applicable to all sovereign debt, including previously issued

bonds.

Thus, the SDRM would universalize the treatment of sovereign debt.

By contrast, because of their contractual nature, CACs would only apply to

those future bonds in which they were included. To achieve greater

universality, sovereign debtors would have to agree to exchange existing bonds

with UACs for new CAC bonds, potentially at great cost and only after an

extended delay. Additionally, while CACs permit restructuring of a single

debt instrument, they do not effectively facilitate coordination among creditors

See Boeri, supra note 12, at 246; Battling Over the Bankrupt, supra note 56. On the revised proposal,

see Bratton & Gulati, supra note 7.

See Soederberg, supra note 57, at 117.

See Boorman, supra note 15, at 62.

See id.

See Boeri, supra note 12, at 248.

See id. The SDRM would be created by amending the IMF’s Articles of Agreement, by a two-thirds

vote of IMF shares. See id. at 247.

See Boorman, supra note 15, at 62; Gelpern, supra note 54, at 20.

See Salmon, supra note 59, at 94.

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holding distinct debt instruments.

The SDRM, on the other hand, could serve

to coordinate restructuring more generally.

Finally, proponents of the SDRM

argued that its bankruptcy tribunal would help promote good faith among

creditors and between creditors and debtors, an essential need that might be

more difficult to accomplish by way of a contractual approach.

Yet there were also strong criticisms of the SDRM proposal. Perhaps most

broadly, the SDRM was seen by many as a significant invasion of national

sovereignty, well beyond existingand already controversial

forms of IMF

conditionality. To similar effect, the SDRM was criticized as a gross

interference in the contractual autonomy of sovereign debtors and their

creditors. In essence, an SDRM would rewrite bond contracts after the fact,

notwithstanding the parties’ indisputable awareness of the substantial potential

for financial crises, and their decision not to address that potential

prospectively, by contract. Following directly from the latter, the SDRM’s

diminishment of creditor rights was unsurprisingly objected to by creditors.

However, it was also a concern for debtor states, which feared an increased

cost of capital, if not exclusion from the international debt markets, if an

SDRM were introduced.

Institutional concerns were also voiced. In

particular, given that the IMF is a party to the relevant sovereign credit

relationship, as a creditor, a preference for IMF interests might be expected in

any SDRM-driven restructuring. Unless complete independence from the IMF

could be assured, private creditor interests might therefore be especially

jeopardized under an SDRM. Finally, particularly given the foregoing array of

risks and the substantial costs of an SDRM, many questioned whether such a

regime was even necessary.

2. Institutional Versus Contractual Remedies to the Restructuring Dilemma

With the IMF’s SDRM proposal in November 2001, the battle between

institutional change and contractual change in the evolution of the sovereign

debt regime was joined. To one side stood those who continued to encourage

the replacement of UACs with CACs as the appropriate, and fully adequate,

remedy to the collective action problems of the existing UAC regime. Most

See Boorman, supra note 15, at 62.

See id.; Gelpern, supra note 54, at 20.

See Gelpern, supra note 54, at 20; see also infra notes 302-10 and accompanying text.

See Hal S. Scott, A Bankruptcy Forum for Sovereign Debtors?, 37 INT’L LAW. 103, 103 (2003).

On the criticisms of the SDRM, see Eichengreen, Crisis Resolution, supra note 54, at 18-20. See also

supra note 59.

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prominently, this group included the United States, most private creditor

representatives and institutions, and even a number of emerging market

debtors. On the other side were those, including the leadership of the IMF and

a substantial part of its membership, that favored adoption of an SDRM of one

sort or another.

At least at the outset, the United States and several other G-7

members resisted any alternative to the contractual approach of CACs.

At the

IMF’s 2002 annual meeting, however, the G-7 endorsed the IMF’s “twin track

approach,” including the SDRM.

Even the United States signaled some

receptivity to the SDRM.

Many saw this endorsement as purely strategic, however, serving to signal

to emerging market debtors and private sector lenders that if they resisted the

United States’s preferred approach of CACs for too long, things might prove

much worse.

This assessment arguably gains credence from the IMF’s

ensuing decision, made at the April 2003 meeting of the International

Monetary and Financial Committees, to prioritize the contractual approach and

put the SDRM proposal on hold.

Rather than finalize an SDRM proposal at

the meeting, as was intended, the IMF instead abandoned it in favor of the

contractual approach.

Yet this decision was not entirely surprising, given the much more dramatic

announcement by Mexico, only a few weeks earlier, that it was offering an

unexpected $1 billion bond issue. The latter would be issued under New York

law. Breaking with the nearly universal convention, however, Mexico

announced that the bond would include CACs.

The new bond contracts thus

permitted amendment of basic financial terms, including payment and timing

terms, upon approval of seventy-five percent of aggregated principal amounts

See Boorman, supra note 15, at 62. Generally, support for the SDRM was stronger in Europe than the

United States. See Alan Beattie, U.S. Set to Block “Sovereign Chapter 11” Proposals, F

IN. TIMES, Mar. 31,

2003, at 13; Blustein, supra note 57.

See Boeri, supra note 12, at 246; see also Bush Plan to Let Struggling Nations Rework Payment Terms

Backed, B

OSTON GLOBE, Apr. 10, 2002, at C7.

See Boeri, supra note 12, at 246-47; Felix Salmon, Market Resists Restructuring Reform,

UROMONEY, Oct. 1, 2002, at 18.

See Taylor, Using Clauses, supra note 15; see also Gulati & Skeel, supra note 4, at 3; infra Part

III.B.1.

See Battling Over the Bankrupt, supra note 56; Beattie, supra note 76, at 13.

See Rupert Cornwell, U.S. Forces IMF to Shelve Debt Default Scheme, INDEPENDENT, Apr. 11, 2003,

at 22; Dealing with Default, E

CONOMIST, May 10, 2003, at 63.

See EICHENGREEN ET AL., supra note 14, at 3.

See id. at 3, 9; Gelpern, supra note 54, at 19.

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outstanding.

Contrary to long-standing speculation, moreover, investors did

not impose any discount on the bonds, notwithstanding their inclusion of

CACs.

With Mexico’s decision, the floodgates quickly opened. Mexico issued an

additional $2.5 billion in New York law bonds in April 2003, again with

collective action provisions.

On April 10, 2003, Uruguay followed Mexico’s

lead, offering an exchange of its existing UAC bonds for new bonds with

CACs.

Uruguay’s CACs were similar to those in the Mexican issuance, but

also included a limit on future exit consents,

a bar on issuing new debt to

dilute a restructuring vote, and a tighter set of nonreserve amendment rules.

In addition, the Uruguay exchange contract included the first aggregation

voting provision, or “super-CAC,” in a bond.

In essence, this provision will

allow Uruguay’s creditors to amend multiple bond instruments in a single vote.

This surprising trend toward CACs in New York law bonds continued with

Brazil’s issuance of $1 billion in New York bonds containing CACs on April

29, 2003.

The latter represented yet a further leap forward, as Brazil was the

first speculative grade issuer to use CACs; that it did so with an eighty-five

percent threshold for restructuring, versus the seventy-five percent standard of

English law and the recent New York law bonds, was yet a further

innovation.

Brazil’s issuance was quickly followed by new CAC issues by

South Africa and South Korea.

Finally, Argentina announced that it too

would include CACs in its new debt issues.

By the end of 2003,

consequently, the contracting norm under New York law had come to dictate

See EICHENGREEN ET AL., supra note 14, at 3, 9.

See id.; see also Choi & Gulati, supra note 5, at 973. In point of fact, even prior to Mexico’s issue,

other sovereign debt issues under New York law had included CACs, but their small size, private placement,

or other exceptional characteristics seem to have kept them off observers’ radar screens. These included

placements by Thailand, Lebanon, Egypt, and Qatar. See E

ICHENGREEN ET AL., supra note 14, at 3, 9; Bratton

& Gulati, supra note 7; see also Choi & Gulati, supra note 5, at 961-62.

See EICHENGREEN ET AL., supra note 14, at 3, 9.

See Dealing with Default, supra note 81, at 63.

See infra notes 243-44 and accompanying text.

See Gelpern, supra note 54, at 21-23.

See id.; Gulati & Skeel, supra note 4, at 4-5; Dealing with Default, supra note 81, at 63. On

Uruguay’s various innovations, see Choi & Gulati, supra note 5, at 946.

See Skeel, supra note 25, at 418 n.3; Dealing with Default, supra note 81, at 63.

See EICHENGREEN ET AL., supra note 14, at 3, 9. Guatemala has since also adopted an eighty-five

percent threshold. See Choi & Gulati, supra note 5, at 981.

See Jacques de Larosiere, Reality Hits Debt Restructuring Debate, BANKER, Sept. 2003, at 26.

See Gulati & Skeel, supra note 4, at 5. Yet additional countries have since followed. See Choi &

Gulati, supra note 5, at 945, 949.

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the incorporation of collective action provisions for restructuring.

After

nearly a century of the persistent dichotomy of unanimous and collective

action restructuring provisions, years of unrequited pressure on New York law

issuers to shift from UACs to CACs, and every reasonable expectation that

nothing would change anytime soon, it did



overnight.

II. A NETWORK THEORY OF SOVEREIGN DEBT CONTRACTING

In the face of the long resistance of the New York law sovereign debt

market to the seeming efficiencies of collective action, and its consequently

surprising, yet rapid and wholesale, embrace of the latter in 2003, many have

puzzled over the nature and dynamics of sovereign debt contracting and legal

transition. Gulati and Skeel have described the recent shift as more in the

nature of “science” than “rational actor economics.”

Yet both the stasis and

change in New York law sovereign bond contract practice can be understood

from an economic perspective. It is the perspective of microeconomics,

however, rather than the more familiar macroeconomics of sovereign debt and

international finance. Specifically, the microeconomic phenomenon of

network effects suggests there should be little surprise at the otherwise

incongruous patterns of stasis and change in sovereign debt contracting.

A. Toward a Network Conception of Sovereign Debt Contracting

Network effects arise when the utility of a good to one user increases as

other users acquire or utilize it.

A telephone, for example, is only valuable to

See Dealing with Default, supra note 81, at 63.

See Gulati & Skeel, supra note 4, at 6.

While the analysis herein seeks to describe the broad influences of network effects in sovereign debt

contracting, it is not intended to deny the importance of individual and institutional agency in the actualization

of the network outcomes I identify. To the contrary, network effects in sovereign debt contracting are

important insofar as they alter the strategic calculus of individual debtors and creditors. Given network

effects, thus, I suggest that parties to sovereign debt contracts are more likely to affirmatively choose a

dominant standard or term, rather than an otherwise preferable, but less common, standard or term. Network

effects in sovereign debt contracting are thus not abstractions that stand behind market design; they are

concrete elements in shaping the consumption patterns of individual market participants.

See Mark A. Lemley & David McGowan, Legal Implications of Network Economic Effects, 86 CAL. L.

EV. 479, 481 (1998) (describing network markets as those “in which the value that consumers place on a

good increases as others use the good”); Howard A. Shelanski & J. Gregory Sidak, Antitrust Divestiture in

Network Industries, 68 U. C

HI. L. REV. 1, 5 (2001) (“A network externality, or ‘network effect,’ exists when

the value of a product or service increases with the breadth of demand for that product or service.”); see also

Gideon Parchomovsky, Publish or Perish, 98 MICH. L. REV. 926, 945 (2000); Larry E. Ribstein & Bruce H.

Kobayashi, Choice of Form and Network Externalities, 43 W

M. & MARY L. REV. 79, 110 (2001). I use the

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me if others own receivers as well. More importantly, its value to me grows as

additional receivers are purchased and placed into service.

Of greatest

importance for present purposes, the presence of such network effects can

impact consumption patterns. Network effects are thus a form of positive

consumption externality. The social gain from my adoption of a given network

technology can be expected to exceed my individual gain. Consumption may

therefore be suboptimal. Additionally, given the relative importance of

network size to a given consumer, the latter will adopt a relatively “inferior”

good (i.e., one that provides fewer desired services or capacities), if it

nonetheless possesses a larger network of users than its (otherwise superior)

competitor. In the aggregate, substantial welfare inefficiencies may result.

Scholars have argued that network effects may influence the choice of

terms in corporate contracts, including corporate bond indentures. Most

prominently, Michael Klausner and Marcel Kahan have drawn on network

economics to challenge the efficiency assumptions of corporate law’s

contractarian paradigm.

100

In essence, they argue that contracting parties will

term “network effects,” rather than “network externalities,” as the latter would seem to assume a market

failure, which may or may not arise from any given network effect. See S. J. Liebowitz & Stephen E.

Margolis, Network Externality: An Uncommon Tragedy, J. ECON. PERSP., Spring 1994, at 133, 135; see also

Lemley & McGowan, supra, at 482 n.5.

See Klausner, supra note 39, at 772; Lemley & McGowan, supra note 98, at 488 (noting that “owning

the only telephone or fax machine in the world would be of little benefit because it could not be used to

communicate with anyone”). On the growth in network utility with additional users, see Michael L. Katz &

Carl Shapiro, Network Externalities, Competition, and Compatibility, 75 A

M. ECON. REV. 424 (1985); Lemley

& McGowan, supra note 98, at 488–89 (“The value of the telephone or fax machine one has already purchased

increases with each additional purchaser, so long as all machines operate on the same standards and the

network infrastructure is capable of processing all member communications.”).

By contrast with the telephone, the owner of a particular tea kettle may find great utility in its water

capacity, built-in whistle, or other inherent qualities, but has relatively little interest in the number of other tea

drinkers, let alone users of their particular kettle. The utility derived from a tea kettle thus turns on its inherent

value, while that of a telephone arises from the size of its network of users. See Carmine Di Noia, Competition

and Integration Among Stock Exchanges in Europe: Network Effects, Implicit Mergers and Remote Access, 7

UR. FIN. MGMT. 39, 52 (2001) (“Positive network externalities (the benefit to an individual increases in the

number of others on the system) arise when a good is more valuable to a user the more users adopt the same

good or a compatible one.”); Katz & Shapiro, supra, at 424 (“[T]he utility that a given user derives from the

good depends upon the number of other users who are in the same ‘network.’”).

100

See Kahan & Klausner, supra note 39; Klausner, supra note 39; see also Lucian Arye Bebchuck,

Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law, 105 H

ARV. L.

EV. 1435, 1498-94 (1992); Jeffrey N. Gordon, The Mandatory Structure of Corporate Law, 89 COLUM. L.

EV. 1549, 1567-69 (1989). Initially, Klausner argued that network externalities might be present in corporate

contract terms. See Klausner, supra note 39, at 774-75. Together, Kahan and Klausner elaborated on this

analysis, identifying two important sources of value in standard contract terms: (1) “learning benefits” that

arise when a firm adopts a contract term that has been commonly used in the past, regardless of whether firms

will continue to use it in the future, see Klausner, supra note 39, at 776 n.61, 779, and (2) “network benefits”

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commonly elect to adopt a more widespread contract term

one whose

existing and future user base is larger

because such standardized terms offer

substantial value above and beyond the intrinsic, or inherent, value of the term,

in isolation.

101

Such network benefits of a particular corporate contract term

are analogous to the benefits of conventional network goods, such as personal

computers, which produce greater or lesser value to users depending on

whether they are used commonly or rarely.

102

An IBM-compatible personal

computer thus produces two categories of benefits. First, there are its inherent

benefits, arising from uses unrelated to the number of other individuals that use

a compatible model. The ease of typing a letter on a particular word processor,

for example, might be construed as an inherent benefit of a given computer

system.

103

A computer also offers network benefits, however, which are

dependent “on how many people own [and will own] PCs and thereby create

markets for compatible software, hardware, and repair services.” As a result,

“widespread use of a PC has a value to a user independent of the inherent value

of the product.”

104

that arise when a firm adopts a term that will be simultaneously included in other firms’ contracts and will

consequently be used in the future, see Kahan & Klausner, supra note 39, at 719-25; Klausner, supra note 39,

at 786, 788, regardless of whether it has been widely used in the past. See generally Kahan & Klausner, supra

note 39, at 718.

Although it is not the focus of this Article, a brief explanation of Klausner and Kahan’s learning

benefits is in order. Learning benefits are a component of the inherent value of a term, gained through

previous experience with it. See id.; see also Lemley & McGowan, supra note 98, at 568 (“Learning benefits

refer to the value imbued in a given term through previous experience . . . . [F]or purposes of network theory,

Klausner categorizes these as inherent rather than network benefits, reserving the latter term for those benefits

accruing through contemporaneous use of a term by other firms.”). In essence, a contract term that has been

commonly used in the past may have generated a degree of learning that is valuable to current users of that

term. See Kahan & Klausner, supra note 39, at 719. In Kahan and Klausner’s enumeration, such learning

benefits arise in at least three ways. First, the potential for error is lower, when the present formulation of a

term reflects improvements made in the past, based on implementation in a variety of circumstances, and

examination and reform by many prior users. See id. at 720-21. Second, learning benefits come in the form of

past precedents, which reduce uncertainty over interpretation of a term in the future. See id. at 722-23.

Finally, the familiarity of legal and financial professionals with a given term may reduce the costs and improve

the quality of professional advice. See id. at 723.

101

See Kahan & Klausner, supra note 39, at 730-35; Klausner, supra note 39, at 806-07.

102

See Klausner, supra note 39, at 772.

103

See id.

104

Id. at 763-64. As I describe infra, the preference for standardization in network environments is

relative, not absolute. See infra Part IV.C. Thus, even significant network effects may not produce complete

convergence, as the inherent benefits of the nondominant standard to some users, given their particular utility

preferences, may outweigh the network gains from adopting the common standard. The long coexistence of a

UAC network under New York law and a smaller MAC network under English law is therefore fully

consistent with a network analysis. See infra Part IV.C.

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Corporate contract terms may produce analogous network effects, because

firms that use a particular contract term

like Apple computer usersform a

“network . . . linked together by commonly used complementary products.”

105

Among other possibilities, contractual network benefits include professional

expertise, pricing knowledge, and a body of judicial precedents developed

during the time the firm incorporates the given term in its contracts.

106

described by Russell Korobkin:

Contract terms might become more valuable as more parties adopt

them, for example, because wider use of a term can lead to more

judicial opinions interpreting the term. More interpretations, in turn,

can benefit users of the term by reducing uncertainty over how the

term would be interpreted by a court should the user become

embroiled in litigation in the future. Widespread use of a contract

term can also create benefits for users by making lawyers and other

providers of legal services more facile in drafting, negotiating,

interpreting, and, if need be, litigating the term. Such facility can

create value to term users by increasing . . . [its] value in the capital

markets . . . . In short, widespread use of a contract term can benefit

users of the term by causing complementary goods (such as judicial

precedents or professional services) to become more available,

cheaper or both.

107

Network effects can be predicted in sovereign debt contracting as well.

Much of the study of network effects in corporate contracts, in fact, has

focused on bond indenture terms. Many of the sources of network effects in

corporate contract are thus equally likely to arise in sovereign debt contracts.

Perhaps most importantly, sovereign debt contracts are likely to be shaped by

105

See Klausner, supra note 39, at 774-89. Just as PCs are linked together by complementary software

and hardware, firms that use a common contract term are linked together by complementary goods including

relevant judicial precedents and professional services. See id. at 757-59, 782-84; Russell Korobkin, Inertia

and Preference in Contract Negotiation: The Psychological Power of Default Rules and Form Terms, 51

AND. L. REV. 1583, 1594-95 (1998).

106

See Kahan & Klausner, supra note 39, at 726-27.

107

Korobkin, supra note 105, at 1594-95. As suggested above, in extending a network analysis from its

technological origins to contracting practices, it is important not to overstate the network preference for

standardization. As I describe infra, in Part IV.C, the presence of network effects does not dictate complete

standardization. Rather, the inherent value of a unique term might outweigh the network benefits of the

standard term in any given case. In contracting practices, this may help to explain the value of legal counsel’s

capacity for innovation, and perhaps even the general jockeying between parties for contract advantage. See

Marcel Kahan & Michael Klausner, Path Dependence in Corporate Contracting: Increasing Returns, Herd

Behavior, and Cognitive Biases, 74 W

ASH. U. L.Q. 347, 350 (1996) (describing the benefits of innovation). In

essence, such innovation might constitute an effort to maximize contract value on those terms as to which

network effects do not strongly favor standardization.

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what Klausner terms “marketing” network effects.

108

Such effects arise from

the nature of present-day sovereign debt. Until the late 1980s, sovereign debt

consisted almost entirely of syndicated bank loans.

109

Such loans were subject

to limited prospect of resale or transfer. As such, the terms of the relevant debt

contracts were of importance almost exclusively to the originator of the debt,

and there was little need to conform those terms to any more uniform set of

market standards.

With the shift to sovereign bonds, this pattern was turned on its head.

Bonds are widely dispersed and subject to active trading on secondary markets.

Such trading, in turn, creates a strong preference for standardized terms.

Standard terms, with which the market is familiar, can be expected to

maximize the ease of resale

the tradabilityof a given bond. Selection of

contract terms that are and will be used more widely therefore enhances a

bond’s value on the secondary market.

Klausner and Kahan primarily ground the network effects that naturally

follow from such pressure for standardizationby which the value of a given

term grows with its wider usein the reduced cost of pricing more uniform

corporate securities.

110

Lower cost of pricing, in turn, can reduce a firm’s cost

of capital, creating a “marketing” network effect favoring the standard term.

In slightly broader terms, widespread use of a given term can be expected to

produce more efficient and accurate pricing, by expanding the pool of relevant

financial information and thereby improving price precision.

111

Standardized

terms might also help to enhance bond value, in another iteration of marketing

network effects, by increasing liquidity. This may apply not only to the

particular bond issue involved, but also to later issues by the same sovereign.

While marketing network effects are given slightly less attention by

Klausner and Kahan than some of the other sources of network effects they

identify,

112

marketing effects are arguably the most important source of the

network pattern in sovereign debt contracting. Several factors might produce

relatively stronger marketing network effects in sovereign debt contracts than

in corporate contracts. The first turns on the balance of network and inherent

value in corporate versus sovereign contracts, including bonds. Obligations

108

See Klausner, supra note 39, at 785-86.

109

See supra notes 47-50 and accompanying text.

110

See Klausner, supra note 39, at 785; see also Marcel Kahan, The Qualified Case Against Mandatory

Terms in Bonds, 89 N

W. U. L. REV. 565, 586-87 (1995).

111

See Ahdieh, Making Markets, supra note 5, at 285-88.

112

Cf. Kahan, supra note 9, at 1079-80; Klausner, supra note 39, at 785-86.

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held against a domestic corporation clearly have an inherent value, regardless

of their network value. Even should trading in the given corporation’s bonds

be suspended, or the relevant corporation cease to be a going concern, its

bonds retain value as a residual claim against the corporation’s assets.

113

Such

claims can be asserted in bankruptcy. The inherent value of sovereign bonds,

by contrast, is far more constrained. Given the lack of any institutionalized

system of sovereign bankruptcy, or other form of receivership, debt claims

against a recalcitrant sovereign debtor are only as good as the market for their

resale.

114

This has arguably been evident in the Argentine financial crisis of

recent years.

115

In essence, Argentina has concluded that conciliation and

compromise with its private creditors offers little promise of future reward and

has consequently refused to negotiate.

116

A related factor arises from the significantly greater prospect of default on

sovereign bonds than corporate bonds. Given the greater likelihood of

sovereign default, the tradability of a sovereign bond is necessarily more

important. Such bonds, by comparison with corporate bonds, are relatively

less likely to reach maturity. As such, their inherent value is more limited, and

their network value proportionately greater.

117

Marketing network effects may

thus be essential to the valuation of sovereign bonds than corporate bonds,

given the latter’s inherent value upon maturity.

The proportion of network to inherent value generally, and the significance

of marketing network effects particularly, in sovereign debt versus corporate

debt contracts may also be influenced by the degree of heterogeneity among

borrowers. At least as they come to the debt markets, sovereign debtors may,

as a group, be relatively more homogeneous than corporate debtors.

Minimally, they may disaggregate into a more limited number of debtor

categories. If this is so, then marketing network effects are again likely to be

stronger in sovereign debt contracts. If differences among sovereign debtors

are more limited, their inherent preference for distinct terms should also be

less, and the relative value of participating in a larger network concomitantly

113

Cf. Ahdieh, Making Markets, supra note 5, at 292-96 & n.69.

114

This is not to deny the potential of creditor pressure and threats of future exclusion from the debt

markets to convince sovereign debtors to negotiate. It simply suggests that if the latter are ineffective,

creditors have little recourse.

115

See Michael Casey & Michael M. Phillips, Argentina Finds Middle Ground with IMF, Averts Loan

Default, W

ALL ST. J., Mar. 10, 2004, at A2.

116

See id.

117

Cf. Ahdieh, Making Markets, supra note 5, at 294-95.

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that much greater.

118

In the marketing of more homogeneous sovereign debt,

furthermore, investors are less likely to be seeking eccentric sources of

arbitrage.

A final reason to predict relatively more significant marketing network

effects in sovereign debt contracts turns on the sovereign debt markets’ focus

on the adverse implications of a shift from UACs to CACs, or to any relatively

more liberal CAC formulation.

119

A significant barrier to an emerging market

shift to CACs has been the fear that the latter might be interpreted as a signal

of some greater prospect (or even expectation) of future debt restructuring.

Given as much, network effects are likely to figure prominently in the choice

of any given sovereign to continue to use UACs or to shift to CACs. If a

growing tide of debtors is turning to CACs, any adverse implication for a given

emerging market is likely to be reduced, if not eliminated, and transition

rendered significantly easier.

Beyond marketing network effects, the other sources of network value

Klausner and Kahan identify in corporate contracts are also likely to be present

in sovereign debt contracts.

120

These include the value of future judicial rulings

regarding a contract terman “interpretive network externality”; the value of

tracking “common practices” that are pursued by similarly situated firms using

a given term; and the greater availability of legal services for the interpretation

and implementation of more common terms.

121

Interpretive network effects follow from the increase in relevant judicial

decisions that can be expected to result from wider use of a given term.

122

Such

decisions reduce uncertainty, and hence firms’ cost of capital.

123

Perhaps most

importantly, judicial decisions reduce uncertainty when they clarify ambiguous

118

Cf. Klausner, supra note 39, at 813-14, 817.

119

Cf. id. at 785.

120

It bears restating that I do not mean to offer any firm conclusion on the strength of network effects in

sovereign debt contracting. Choi and Gulati have begun the effort to address this empirical question. See Choi

& Gulati, supra note 5. Kahan and Klausner, among others, have used various empirical measures to explore

the strength of network effects in corporate bond contracts. See Kahan & Klausner, supra note 39, at 740-60

(outlining empirical analysis of network effects in corporate bonds). By contrast, this Article concentrates on

the origins of network effects in sovereign debt contracting, and suggests some of their important implications.

Further, it attempts to theorize what might trigger transition in network environments, including sovereign debt

contracting.

121

See Klausner, supra note 39, at 774-75.

122

See Lemley & McGowan, supra note 98, at 565.

123

See Klausner, supra note 39, at 777.

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or open-ended contract terms.

124

Consequently, the scope of interpretive

network effects in a given contract depends on the proportion of its terms that

require interpretation. If a contract is composed primarily of terms of a self-

explanatory nature, judicial interpretation

and hence the size of the network

of users of those terms

will be less important to the value of the contract, and

network effects will be of less consequence. The greater the proportion of

ambiguous terms, the more significant any network effects.

In sovereign debt contracts, judicial interpretation is likely to offer at least

some network value. Under a UAC contract, for example, it is necessary to

determine whether any given contract change comes within the enumerated list

of changes to basic financial terms that require unanimous consent. Greater

judicial clarity as to that enumeration is likely to reduce uncertainty. Judicial

interpretation of sovereign debt contracts may have become even more

important in recent years, moreover, given the rise of a variety of techniques

by which emerging market countries have attempted to skirt the limitations of

UACs.

125

Interpretive network effects may also have grown in importance

given the sudden emergence of various forms of CACs under New York law.

As these new and untested terms are adopted, judicial interpretation may be

especially valuable. A particular source of interpretive network effects in

sovereign debt contracts, in fact, may be the inevitable issues that newly

adopted CACs raise regarding the majority’s fair treatment of minority

creditors.

126

Thus, intercreditor duties of good faith and fair dealing, which are

essential to the efficacy of any CAC regime, will likely require active judicial

interpretation.

127

At least some interpretive network effects are therefore likely

in sovereign debt contracting.

128

The next type of network effect identified by Klausner and Kahan,

common practice network effects, also has application in the sovereign debt

124

Valuable judicial decisions, however, are not limited to those interpreting the terms themselves, but

might also address how particular terms relate to relevant statutory or regulatory rules. See Klausner, supra

note 39, at 776 n.62.

125

See infra notes 241- 49 and accompanying text.

126

Notably, Klausner references the interpretation of such intercreditor duty provisions as a prime source

of interpretive network effects in corporate contracts. See Klausner, supra note 39, at 775.

127

See Bratton & Gulati, supra note 7; cf. Lemley & McGowan, supra note 98, at 573-74 (discussing

interpretive network effects regarding good faith obligations in corporate contracts). As any interpretive

network effects arising from the adoption of CACs obviously postdate the transition to CACs, they do not help

to explain the longevity of UACs or the rapid shift to CACs. They may nonetheless be important in the

ongoing evolution of CAC terms and in any future contract transition.

128

Some features that make judicial decisions valuable in corporate contracts, however, may be less

common in sovereign debt contracts. See, e.g., Klausner, supra note 39, at 778 & nn.66-68.

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context. These network effects arise from contract terms tied to the practices

of contracting parties’ peers; “reasonable notice” requirements provide an

obvious example. Issues of intercreditor good faith under CACs may be the

most relevant example. The obligations of sovereign debtors under certain

collective action clauses, including provisions mandating disclosure,

engagement, and the like, might also give rise to common practice network

effects. In these cases, questions regarding any particular course of conduct in

debt restructuring, whether with reference to disclosure, notice, or other

procedural obligations, or with reference to the substantive terms of the

restructuring, can best be assessed with an eye to others’ practices regarding

the same procedural or substantive obligation under identical contractual

terms. Additionally, the existence of some common practice among a network

of users of the same term may also help to insulate a debtor’s or creditor’s

decision from adverse judicial review.

Legal services network effects, finally, also likely exist in sovereign debt

contracts, given the complexity of bond indentures, the foundational contract

of bond issues.

129

Legal services network effects may also have grown in

significance in sovereign debt contracting in recent years, as sovereign debtors

have pursued alternative avenues of restructuring.

130

Thus, Ecuador’s ability to

use exit consents to avoid the constraints of its UAC bonds

131

was grounded in

the availability of effective legal counsel to advise it how to do so. Such

opportunities are likely to be caseor contractspecific, and therefore

dependent on the availability of legal counsel to assist in the assessment and

application of a particular term.

132

Legal services network effects can therefore

be predicted in sovereign debt contracts. The more standard a given clause is,

the cheaper and better quality the legal services regarding its interpretation

may be.

Another increasingly important source of legal services network effects in

sovereign debt contracts is the need for legal counsel on the aforementioned

questions of intercreditor duty. Majority action under CACs creates a risk of

minority creditor abuse, against which courts and other regulators may act.

133

Yet the scope and nature of intercreditor duties remain unclear, creating an

129

See Klausner, supra note 39, at 784 n.87.

130

See infra Part III.B.2. But see supra note 127.

131

See infra notes 243-44 and accompanying text.

132

Thus, not every UAC or CAC contract’s terms are identical. See Stephen Choi & G. Mitu Gulati, Why

Lawyers Need to Take a Closer Look at Exit Consents, I

NT’L FIN. L. REV., Sept. 2003, at 15.

133

See supra notes 126-27 and accompanying text .

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essential need for effective counsel, and an important source of legal services

network effects, at least in the near future.

Finally, Klausner points to the benefits arising from the promptness of legal

advice in certain circumstances, including mergers and acquisitions.

134

The

same may be true in the sovereign debt context, given the transition process

often underway, and the exigent dynamic that often attends a debt

restructuring.

135

Given this need for speed, legal services network effects can

also be predicted.

Interpretive, common practices, and legal services network effects may,

like marketing network effects, be more significant in sovereign debt contracts

than in corporate contracts for at least two reasons. Most importantly, it is

relatively less likely that the demand for a given term will extend beyond the

reach of network effects in sovereign debt contracting. To clarify, the welfare

consequences of network effects are only significant if they encompass much

of the demand curve for a given product or term. If network gains taper off

early in the demand curveif only a few additional users are enough to

produce any and all network gainsthen network effects become incon-

sequential. They are, in the terms of the network literature, “inframarginal.”

136

By comparison, the extent of sovereign debt contract term usage and

interpretation is nowhere near the “consumption” of corporate contract

terms.

137

Consequently, network effects are relatively less likely to have

tapered off below the requisite level of demand in sovereign debt contracts

than in corporate contracts.

138

As compared with corporate charters in particular, network effects may

also be stronger in sovereign debt contracts because of the greater recurrence

of the latter. Thus, sovereign debt contracts are issued by sovereigns with

some regularity, sometimes as often as several times a year. Corporate

134

See Klausner, supra note 39, at 783.

135

With the transition to CACs, additional legal service efficiencies might be expected in the drafting

context. Just as UACs may have come to dominate sovereign debt contracts under New York law, on account

of the existing expertise of New York counsel with corporate debt contracts, in which UACs were mandatory,

see infra note 173, as drafting expertise increasingly shifts to the preparation of CACs, the relative cost of

drafting UACs may grow, strengthening the preference for CACs in new sovereign debt issues. These effects

are more in the nature of learning benefits, however, than network effects.

136

See Lemley & McGowan, supra note 98, at 573 n.403.

137

Cf. Ahdieh, Making Markets, supra note 5, at 288 n.40; Klausner, supra note 39, at 778-79.

Furthermore, there is a less vigorous legislative check on adverse, or even erroneous, judicial interpretations in

the sovereign debt context. Cf. id. at 778.

138

See Ribstein & Kobayashi, supra note 98, at 112.

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charters, by contrast, are by nature a rare occurrence.

139

Thus, one might

expect relatively less attention to be given to the drafting of sovereign debt

contracts.

140

Boilerplate, and resulting standardization, is that much more

likely, and more significant network effects can be expected to follow.

Of course, some features might be expected to reduce the significance of

network effects in sovereign debt, versus corporate, contracts. To begin with,

the population of relevant participants in sovereign debt contracting is smaller

than in corporate contracting, increasing the possibility of effective

communication or internalization of any network externalities.

141

Specific to

the latter possibility, the more select universe of attorneys involved in the

sovereign debt markets may serve as “norm entrepreneurs” of a sort,

142

internalizing network benefits and hence facilitating efficient contract

transition.

143

This, in essence, is the pattern Choi and Gulati describe, with

reference to the role of Cleary, Gottlieb, Steen & Hamilton in facilitating

sovereign debt contract transition.

144

There may also be relatively fewer open-ended or ambiguous terms in

sovereign debt contracts than in corporate contracts.

145

As a result of this lack

of ambiguity, and because there are fewer sovereign debt contracts generally,

there are relatively fewer judicial interpretations of them.

146

Interpretive

139

Even amendments to corporate charters are relatively rare.

140

At the Georgetown Conference on Sovereign Debt Restructuring at which this Article was presented, a

participating banker commented that sovereign debt contracts are rarely read. Rather, in his view, bankers’

priority is the standardization of terms, not their actual content.

141

See Ribstein & Kobayashi, supra note 98, at 112-13.

142

See Cass R. Sunstein, Social Norms and Social Roles, 96 COLUM. L. REV. 903, 968 (1996).

143

See Ribstein & Kobayashi, supra note 98, at 12-13; see also Lemley & McGowan, supra note 98, at

578. On the other hand, there may be relatively less competition for legal services in sovereign debt

contracting than corporate contracting, reducing the degree of “entrepreneurship.”

144

See Choi & Gulati, supra note 5, at 951 tbl.2. If the relevant universe of sovereign debt participants is

construed not as the universe of sovereign debt debtors and creditors, but as the rather limited collection of

(mostly New York) law firms and banks that stand behind sovereign bond issues—one potential way of

thinking about Choi and Gulati’s analysis—network effects may remain significant, but have far fewer welfare

consequences than suggested below. See infra Part II.B. Further, the barriers to effective communication, and

resulting coordination, that are identified below will also present far more limited obstacles to efficient

contract transition.

145

Cf. Kahan, supra note 110, at 586-87 (enumerating categories of variation in corporate bond

contracts); Lemley & McGowan, supra note 98, at 571-72 (describing lesser importance of network effects in

contracts consisting primarily of specific terms). Sovereign debt contracts might also be argued to contain

relatively fewer specific, or non-open-ended, terms than corporate contracts.

146

Cf. Lemley & McGowan, supra note 98, at 572-73; Ribstein & Kobayashi, supra note 98, at 112.

Relatively less litigation of sovereign debt contracts may help to explain the smaller number of judicial

decisions. See Lemley & McGowan, supra note 98, at 572-73. The more “domestic” nature of corporate

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network effects may therefore be less important in sovereign debt contracts.

Finally, given the sovereign character of one party to a sovereign debt contract,

courts may hew more rigidly to contract language, again reducing the

importance of any interpretive network effects.

On the whole, then, the present analysis cannot support strong conclusions

regarding the significance of network effects in sovereign debt contracting.

147

Such conclusions must rest on empirical analysis and study.

148

However, the

foregoing suggests good reasons to predict the presence of network value in

sovereign debt contracts, including the importance of secondary trading in

sovereign bonds and resulting marketing network effects, and the importance

of legal counsel in sovereign debt contracting and resulting legal services

network effects. Likewise, what empirical evidence we have indicates the

presence of network effects.

149

Given as much, it is worth considering the

compatibility of a network theory of sovereign debt contracting with the

observed reality of longstanding stasis and rapid change in sovereign debt

contracting, as described above. As we shall see, a network theory of

sovereign debt contracting offers a compelling explanation of both patterns.

B. Network Effects, Stasis, and Change in Sovereign Debt Contracting

A network theory of sovereign debt contracting, and perhaps contract

boilerplate more generally, offers a persuasive explanation of the observed

pattern of development in the sovereign debt market in recent years. Network

effects can first explain the stasis of market utilization of UACs,

notwithstanding their seeming inefficiency and the substantial pressure to

abandon their use. Yet, network effects can also explain the rapid shift to

CACs in 2003, as well as the wholesale nature of that transition. These

explanations will be considered in turn.

As articulated in an array of economic and legal analysis, network effects

have the potential to produce Pareto inferior consumption patterns and welfare

consequences. Among the efficiency concerns that have been identified in

contracts and differences in repeat player characteristics may, in turn, help explain the diminished volume of

litigation of sovereign debt contracts.

147

See Ribstein & Kobayashi, supra note 98, at 114-15.

148

To this effect, Steve Choi and Mitu Gulati have analyzed the existence of network effects in sovereign

debt contracting and found evidence of their presence. See Choi & Gulati, supra note 5, at 931, 936, 938; see

also Kahan & Klausner, supra note 39, at 740-60 (outlining empirical evidence of network effects in corporate

bonds).

149

See Choi & Gulati, supra note 5, at 931, 936, 938.

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network industries is the prospect of strong lock-in of existing technologies or

standards.

150

As Klausner and Kahan have put it, “when network externalities

are present . . . the outcome of decentralized individual maximizing decision in

the market will be path dependent.”

151

Thus, once a given network standard

has secured a dominant or even exclusive position, it may be difficult to shake

it from that position, no matter how inefficient it becomes.

152

This follows

from the unwillingness of market participants to move to a smaller network,

even given potential improvements in (inherent) product quality.

153

Network

environments thus exhibit “excess inertia.”

154

150

See Di Noia, supra note 99, at 43 (“The model shows that network externalities may lock-in exchanges

into inefficient outcomes, due to a lack of coordination, even in perfect competition.”); Sean P. Gates,

Standards, Innovation, and Antitrust: Integrating Innovation Concerns into the Analysis of Collaborative

Standard Setting, 47 E

MORY L.J. 583, 609-10 (1998); Klausner, supra note 39, at 791; see also Ahdieh,

Making Markets, supra note 5, at 317-18. Other potential network inefficiencies have also been identified.

See

Lemley & McGowan, supra note 98, at 567; Ribstein & Kobayashi, supra note 98, at 110.

151

Kahan & Klausner, supra note 100, at 763-64.

152

See Nicholas Economides, Network Economics with Application to Finance, 2 FIN. MARKETS, INST. &

NSTR., Dec. 1993, at 89, 93 (“Lock-in is particularly important in the presence of market power in sponsored

networks. In general, firms may be very reluctant to change their way of operation, especially if they have to

pay the costs of transition. The self-reinforcing nature of networks creates switching costs for the existing

customers. The existence of positive critical mass often means that in the presence of one network, a

differently organized one may not even exist. These facts give market power to firms that sponsor networks,

and may impede technological innovation.”).

153

See Catherine Fazio & Scott Stern, Innovation Incentives, Compatibility, and Expropriation as an

Antitrust Remedy: The Legacy of the Borland/Ashton-Tate Consent Decree, 68 A

NTITRUST L.J. 45, 52 (2000)

(discussing lock-in effects resulting “[w]hen marginal consumers weigh the network externality more heavily

than the intrinsic value of each technology”).

[C]onsumers might have difficulty moving to a new standard—even if they all agreed that the

adopted standard was suboptimal—because of collective action problems. The value of any

alternative system would depend on the number of users adopting it; the rational consumer might

well choose to wait until an alternative had been adopted by others who incurred the costs of

shifting to the new standard but reaped fewer benefits relative to later adopters.

Lemley & McGowan, supra note 98, at 497 (citation omitted); see also Lewis M. Branscomb & Brian Kahin,

Standards Processes and Objectives for the National Information Infrastructure, in S

TANDARDS POLICY FOR

INFORMATION INFRASTRUCTURE 5-6 (Brian Kahin & Janet Abbate eds., 1995); Shelanski & Sidak, supra note

98, at 5 (“As the benefits offered by one network grow, so too do the costs to consumers of choosing, or

switching to, a rival offering.”). Pirrong argues that:

Successful entry requires the new [network] to attract a sufficient number of traders from the

incumbent simultaneously. If this does not occur, the new [network] is very costly to [operate]

because it is illiquid . . . . Given the difficulty of coordinating the simultaneous defection of large

numbers of traders, it is quite costly for an entrant [network] to survive, even if its terms and . . .

policies [are preferable].

Stephen Craig Pirrong, The Self-Regulation of Commodity Exchanges: The Case of Market Manipulation, 38

J.L. & E

CON. 141, 155 n.24 (1995).

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In this path-dependent dynamic,

155

an early standard may determine the

shape of the market long after it has grown inefficient.

156

A dominant

technology may thus neither evolve with the dictates of efficiency nor be

susceptible to displacement, given significant network effects. Such a pattern

has been suggested to explain the continued dominance of the Microsoft

Windows operating system, in spite of the asserted superiority of its

competitors.

157

Slightly further afield, I have suggested that network lock-in

may explain the persistent dominance of the New York Stock Exchange,

notwithstanding its limited adoption of electronic enhancements of its trading

Such network lock-in assumes a dispersed market, in which direct communication is not a viable

mechanism for network participants to share a preference for transition. A small community of readily

identifiable network participants might thus be able to transition effectively, by communicating among

themselves an intention to elect a nondominant, but otherwise preferable, standard. Network barriers to

transition are therefore limited—at least in the ordinary case—to those network markets in which size,

dispersion, anonymity, and the like prevent effective communication. Thus, as noted above, if the network of

sovereign debt contracting consists not of debtors and creditors, but of sovereign debtors’ counsel and

underwriters, network lock-in becomes easy to avoid, through direct communication among the latter groups.

See supra note 144.

154

See James B. Speta, Handicapping the Race for the Last Mile?: A Critique of Open Access Rules for

Broadband Platforms, 17 Y

ALE. J. ON REG. 39, 80 (2000) (describing potential “excess inertia” in network

industries); see also Joseph Farrell & Garth Saloner, Standardization, Compatibility, and Innovation, 16

RAND J. E

CON. 70, 71 (1985) (indicating that “it is plausible that the industry, once firmly bound together by

the benefits of compatibility or standardization, will be inclined to move extremely reluctantly to a new and

better standard because of the coordination problems involved”). But see Michael L. Katz & Carl Shapiro,

Product Introduction with Network Externalities, J. I

NDUS. ECON., Mar. 1992, at 55, 73 (suggesting potential

for “insufficient friction” in some network markets and resulting stranding of earlier purchasers).

155

Note that network effects produce a different form of lock-in than “path dependence” as formally

defined. Path dependence is grounded in historical patterns, while network lock-in is tied to the present

composition of the market. See Lemley & McGowan, supra note 98, at 495.

156

See Ahdieh, Making Markets, supra note 5, at 317-21. Of course, this does not mean that a new

network can never displace an established first-mover. If the new standard is sufficiently advantageous, its

inherent value might be able to overcome the network effects favoring the dominant standard. See Dwight R.

Lee & Richard B. McKenzie, A Case for Letting a Firm Take Advantage of “Locked-In” Customers, 52

ASTINGS L.J. 795, 796-98 (2001) (noting that “if the gains from switching are greater than the costs of doing

so, incentives exist for entrepreneurs—so-called ‘network sponsors’—to overcome the built-in resistance to

change”). In such circumstances, the new technology “leapfrogs” the established one. See Michael H. Knight

& Nicholas A. Widnell, Dark Clouds in the Distance? Network Effects and the Approaching B2B Storm, 9

EO. MASON L. REV. 599, 619 (2001) (describing how Sega gained substantial share from Nintendo through

“leapfrog technology”); Lemley & McGowan, supra note 98, at 517; Melonie L. McKenzie, How Should

Competing Software Programs Marry? The Antitrust Ramifications of Private Standard-Setting Consortia in

the Software Industry, 52 S

YRACUSE L. REV. 139, 155 (2002). In the presence of network effects, however,

this result cannot be assumed, and requires not merely a somewhat more advanced, or cheaper, standard, but

one offering significant improvements or cost-savings. See McKenzie, supra, at 155.

157

See W. Brian Arthur, Increasing Returns and the New World of Business, 74 HARV. BUS. REV. 100,

102 (1996).

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mechanism.

158

In these cases, competing technologies that cannot offer

substantial efficiency gains have been unable to displace the network standard.

The dominant players, meanwhile, have exhibited inadequate receptivity to

technological upgrading or other forms of modernization.

159

A pattern of network lock-in readily captures the state of sovereign debt

contracting for much of the last century.

160

Notwithstanding apparent

efficiency gains to be had by a shift to CACs,

161

most sovereign debt issuers

were unwilling to choose the latter alternative.

162

Instead, bond issue after

bond issue under New York law relied on the dominant network standard of

unanimous action.

163

The lock-in of UACs should come as no surprise,

however, if network effects are significant in the selection of sovereign debt

restructuring terms.

164

Rather, lock-in of the UAC standard is precisely what a

158

See Ahdieh, Law’s Signal, supra note 5, at 222-23; Ahdieh, Making Markets, supra note 5, at 316-21.

159

From a slightly different perspective, network lock-in can be conceived as a form of barrier to entry.

In essence, new producers are excluded from the market, absent their identification of a substantially more

efficient technology. Assessing network effects as such, I have previously suggested that new markets,

standards, or technologies may not emerge in the first place, even absent any dominant producer. See Ahdieh,

Making Markets, supra note 5, at 308–09; see also Ribstein & Kobayashi, supra note 98, at 110; Amitai

Aviram, Regulation by Networks 13 (2003) (unpublished manuscript), available at http://www.law.uchicago.

edu/Lawecon. In essence, the network-driven expectation that a dominant producer will emerge, see infra

notes 174-77 and accompanying text, may cause producers not to enter, for fear they will be unable to recover

their sunk costs if they do not ultimately emerge as the dominant network. See William J. Baumol et al.,

Parity Pricing and Its Critics: A Necessary Condition for Efficiency in the Provision of Bottleneck Services to

Competitors, 14 Y

ALE J. ON REG. 145, 160 (1997).

160

Cf. Kahan, supra note 9, at 1078-79; Kahan, supra note 110, at 587 (describing lock-in of corporate

bond contract terms). Other explanations have been offered for this pattern, including one by Lee Buchheit

and Mitu Gulati. See Buchheit & Gulati, supra note 12, at 1359-60; see also Choi & Gulati, supra note 5, at

931. At a minimum, a network interpretation may supplement any alternative explanation, such as the

pos sibility that the holdout concerns that CACs address were simply not a priority for market participants. See

Roubini & Setser, supra note 14, at 19.

161

See supra notes 8-13 and accompanying text.

162

See Eichengreen, Crisis Resolution, supra note 54, at 10; EICHENGREEN ET AL., supra note 14, at 7 &

tbl.1. It bears noting that scholars have flagged reservations about CACs. See Portes, supra note 16, at 48, 67,

69; see also Bratton & Gulati, supra note 7 (citing sources); Buchheit & Gulati, supra note 12, at 1358 n.88;

Gulati & Skeel, supra note 4, at 1.

163

As a further sovereign debt contract puzzle, Choi and Gulati cite the failure of recent sovereign debt

contracts to resolve the ambiguity of the pari passu clause, notwithstanding the attention called to this obscure

provision by Elliott Associates’ predatory claim again Peru’s assets. See Choi & Gulati, supra note 5, at 992-

93. Strong network lock -in can readily explain this pattern. In essence, sovereign debtors might fear that any

shift from existing contract norms—even toward seemingly greater clarity—would reduce the marketability of

their bonds. More difficult to explain from a network perspective, thus, is the increase in the percentage

requirement for amendment of the pari passu clause in several of the recent sovereign bond contracts. See id.

164

Besides explaining lock-in of the UAC standard, network effects may also help to explain the

widespread usage of UACs. This is simply the flip side of the same coin. By preventing displacement of the

existing standard, network effects favor continued, and increasingly universalized, use of that standard.

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network theory of sovereign debt contracting would predict. Given the pattern

of dispersed ownership of sovereign bonds by anonymous holders,

communication among creditors and debtors of an intent to transition to CACs

was essentially impossible.

165

Without such communication, however, no party

to a sovereign debt contract would be willing to shift away from the dominant

network of UACs, even to the superior, but non-network, CAC standard.

Favoring this characterization, Barry Eichengreen, Kenneth Kletzer, and

Ashoka Mody offer an explanation of UACs’ persistence that overlaps with a

network analysis, describing the pattern as one of inertia.

166

Admittedly, the extent of network lock-in of UACs was likely reduced by

the presence of the competing MAC network under English law.

167

Thus, a

shift from the network dominant UAC standard to CACs did not require

adoption of a completely new and untested standard. Rather, MACs were

included in a significant portion of the universe of sovereign bonds.

168

While

the extent of network value would therefore be diminished by a shift to

collective action, it would not be completely lost. First-movers to CACs

would not be starting a new network, but would rather be joining a smaller, but

still significant, MAC network under English law. The presence of such a

competing network, even if smaller, might be expected to diminish the extent

of network lock-in.

169

On the other hand, it is not entirely clear that the New York law UAC and

the English law MAC networks represented true competitors for the business

of emerging markets for several reasons. Until the recent transition,

developing countries issued predominantly UAC bonds under New York

law.

170

Eichengreen, Kletzer, and Mody have grounded this pattern in those

nations’ relatively greater need to exhibit the “commitment” implicit in UACs,

than to maintain the “flexibility” facilitated by CACs.

171

Emerging market

issuers may therefore have faced less of a choice of networks (i.e., New York

law UACs versus English law MACs) than the existence and even size of the

minority MAC network might nominally suggest.

165

See supra notes 50- 53 and accompanying text.

166

See EICHENGREEN ET AL., supra note 14, at 17, 33-36; Eichengreen, supra note 16, at 86 -87.

167

See supra Part I.A.

168

See Mody, supra note 17, at 14, tbl.1.

169

The seeming ease of the ultimate transition to CACs might thus be explained, at least in part, by the

presence of the CAC-style English law network of MAC bond contracts.

170

See Mody, supra note 17, at 14.

171

See, e.g., id. at 13-14.

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Sovereign debt contracts, furthermore, consist of more than an election of

unanimous versus collective action provisions. Bond contracts encompass an

array of provisions, largely standardized within the New York and the English

debt markets, but distinct as between the two jurisdictions.

172

The body of New

York versus English law case precedent is also a point of distinction in a

sovereign’s choice to issue under New York or English law. For these reasons,

the choice to shift to English law MACs would have involved substantially

more than a choice between competing networks distinguished only by their

use of UACs instead of MACs. Rather, other network—as well as inherent—

utility might be sacrificed by such a shift. Network lock-in may have remained

significant for this reason as well.

A final network-related source of lock-in for emerging markets, which

might further obviate the nominal availability of the competing network of

English law MACs, turns on the signaling effect of such a shift.

173

Thus,

regardless of its rationale, the decision of a given emerging market, which has

ordinarily issued its debt with UACs, to make a unitary shift to MACs might

have been interpreted by the market to suggest nonpublic information

regarding the stability or creditworthiness of the issuer. For these reasons,

network lock-in of UACs likely remained significant in the sovereign debt

markets, notwithstanding the presence of English law MACs.

If a network conception of sovereign debt contracting offers a compelling

theory of the long persistence of UACs, notwithstanding widespread

challenges to their efficiency, what of UACs’ ultimate demise in the rapid and

wholesale transition to CACs over the course of 2003? Notably, network

effects also explain this pattern with relative ease. The network effects

literature predicts market “tipping” in the presence of strong network effects.

174

As described above, in network environments, consumers prefer to participate

172

Cf. Choi & Gulati, supra note 5, at 932.

173

See ERIC A. POSNER, LAW AND SOCIAL NORMS 18-19 (2000). One among many potential non-

network explanations for lock-in of the UAC standard is the strong reliance on form or model terms in drafting

bond contracts. Mitu Gulati and Ralph Brubaker have separately opined to the author that this tendency may

be especially strong in sovereign debt and other public finance groups at large law firms. See also supra note

39 and accompanying text.

174

See Shelanski & Sidak, supra note 98, at 5; see also Ahdieh, Law’s Signal, supra note 5, at 226-27;

Ahdieh, Making Markets, supra note 5, at 305 n.114 (characterizing network markets as “tippy,” such that “the

coexistence of incompatible products may be unstable, with a single winning standard dominating the market”)

(quoting Stanley L. Besen & Joseph Farrell, Choosing How to Compete: Strategies and Tactics in

Standardization, J. E

CON. PERSP., Spring 1994, at 117, 118); Michael L. Katz & Carl Shapiro, Systems

Competition and Network Effects, J. E

CON. PERSP., Spring 1994, at 93, 105–06; Lemley & McGowan, supra

note 98, at 496–97; cf. Bratton & Gulati, supra note 7 (noting potential for tipping from UACs to CACs).

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in what is or will be the largest network. This preference arises from the

“positive externality conferred upon users of a term . . . that [is and] will be

widely used.”

175

A larger network, in essence, offers greater network utility to

its participants. Because of this preference to participate in the largest

network, however, network industries can be expected to move rapidly

towardand tip toa dominant, if not singular, network, as each new

participant, hoping to maximize its own network gains, jumps on the prevailing

network’s bandwagon.

176

A pattern of network tipping can readily explain the rapid shift from UACs

to CACs in 2003. In essence, as various signals suggested a likely shift to

CACs, and as a handful of countries took the plunge, the market tipped to

CACs. As each sovereign bond issuer made the decision to restructure existing

debt or issue new debt, it identified some widely recognized, or idiosyncratic,

reason to expect that future contract norms would favor CACs. It therefore

chose to adopt collective action terms itself, to avoid being stranded with the

non-network-dominant choice of termUACs. Assuming significant network

effects, moreover, the speed of this process should not be surprising. To the

contrary, once the process is underway, network theory would predict it to be

both rapid and wholesale, as each and every new issuer rationally adopts the

new standard. That CACs have emerged as the new norm, and not simply a

competing alternative to UACs, falls well within the expectations of network

theory.

177

175

Kahan & Klausner, supra note 100, at 729.

176

See Katz & Shapiro, supra note 174, at 105–06 (explaining “tipping” as the tendency of one system to

pull away from its rivals in popularity once it has gained an initial edge).

177

It bears noting that Klausner and Kahan’s “learning benefits,” see supra note 100, have the potential to

reduce a tipping effect tendency toward transition. See Klausner, supra note 39, at 789 n.102 (noting that

learning benefits encourage lock-in). By contrast with network effects, future gains that result from the

num ber of present and future users of a given good, standard, or term, learning benefits are products of the past

user base of a given good, standard, or term. Thus, unlike the future judicial decisions that produce

interpretive network effects, the learning benefits encompassed in the existing universe of judicial precedent

regarding a given term will persist, even if all users were now to abandon that term. Learning benefits thus

favor retention of an existing standard, regardless of its existing pool of users, so as not to sacrifice the benefits

of past learning. See id.

For any given user, it is entirely plausible that the learning benefits of the historic standard may

outweigh the network benefits of joining a larger, but newer network. Over time, this should be increasingly

less true, but at least at the outset, learning benefits may outweigh network effects. Ultimately, this will

depend on the balance of inherent value (including learning benefits) and network value in a given good. See

supra notes 99-104 and accompanying text. In the battle between the Betamax and VHS standard for

videocassette players, for example, the Betamax standard’s inherent benefits, including its existing base of

players and programs, would seem to have been inadequate to prevent a relatively rapid tipping of the market

to VHS. The growing network favoring the DVD standard, by contrast, would seem to be insufficiently strong

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A network theory of sovereign debt contracting can therefore help to

explain much of what we have observed in the sovereign debt markets over the

last several years. Perhaps more importantly, such a theory discourages any

rote assumption that contract standards will naturally evolve in the face of

efficiency demands. Yet, a major gap remains in our understanding of the

pattern of recent developments in sovereign debt markets. Network theory

may explain why there was little change in sovereign debt restructuring terms

for many years, and why the change was both rapid and wholesale when it

came. But network analysis alone cannot explain why the change occurred

when it did. More specifically, it does not address what might trigger the shift

from network stasis to network transition. In the following Part, I suggest a

role for state action in that shift.

III. C

OORDINATION GAMES, FOCAL POINTS, AND A CUEING THEORY OF

SOVEREIGN DEBT TRANSITION

If a network theory of sovereign debt contracts can explain both the long

persistence of UACs and the alacrity with which they were abandoned, how

might we explain the timing of that shift? After decades of seeming resilience,

why were UACs replaced by CACs at the moment they were? While external

pressure in 2002 and 2003 might offer a partial explanation, it cannot alone

suffice. Pressure to shift to CACs had been in place since the 1990s, yet did

not make a dent in the widespread use of UACs. Something more must have

been added to the mix.

Applying a relatively unfamiliar corner of game theory to the network

dynamic of sovereign debt contracting, this Article posits that the driving force

behind the recent shift to CACs was a change in expectations, brought about

through what I term “regulatory cues.” The following begins with an

explication of a “coordination game” theory of sovereign debt contracting and

the identification of regulatory cues as a critical mode of state action in

facilitating coordination around alternative equilibria. I then identify potential

cues in the transition from UACs to CACs and use these examples to explore

the nature of regulatory cues in contract transition. In sum, the transition from

UACs to CACs in sovereign debt contracts suggests the role of regulatory cues

as an important, if inadequately appreciated, mechanism of state action.

to overcome the inherent benefits of the now-longstanding VHS network. In sovereign debt contract terms, for

the reasons outlined above, I would predict network effects to be of reasonable significance. Choi and Gulati’s

empirical analysis would seem to lend some support to this view. See Choi and Gulati, supra note 5.

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A. A Game Theoretic Account of Sovereign Debt Contracting

While game theory has found widespread application in the literature of

sovereign debt restructuring, the latter analysis has relied almost exclusively on

the familiar paradigm of the Prisoner’s Dilemma. Given an orientation to the

challenge of debt restructuring under unanimous action provisions, the

strategic dynamic of the Prisoner’s Dilemma is an appropriate frame of

reference. This strategic pattern arises in sovereign debt restructuring from the

incentive of each creditor to demand side payments for their participation in

any collective decision to restructure. In this way, each creditor attempts to

maximize its individual payoff.

178

This is the precise pattern of the Prisoner’s

Dilemma, in which each prisoner’s individual payoff favors defection

confession, or a refusal to participate in any agreed restructuring. Yet the

resulting outcome, in which both players defect, produces inferior payoffs for

both players than if they had kept to the agreement.

179

Coordination is

therefore at the heart of the Prisoner’s Dilemma of sovereign debt restructuring

under UACs.

Yet the Prisoner’s Dilemma actually involves a form of second-order

coordination, within the game of sovereign debt restructuring. With the terms

of the game defined by unanimous action contract provisions, the Prisoner’s

Dilemma necessarily plays itself out. In the present analysis, however, our

subject is the first-order coordination required to define the rules, or standards,

of the relevant game.

180

As with the restructuring of distressed foreign debt,

such coordination is not easy to achieve. The strategic dynamic at work,

however, is not characterized by the Prisoner’s Dilemma game, but by the less

familiar, yet no less prevalent, “coordination game” dynamic.

181

178

Buchheit & Gulati describe a slightly broader coordination dilemma than the conventional account, but

continue to focus on coordinated action among creditors; thus, they emphasize the prospect of acceleration or

litigation by holdout creditors, and consequently arrive at an iteration of the familiar Prisoner’s Dilemma. See

Buchheit & Gulati, supra note 12, at 1320. A distinct inquiry regarding application of the Prisoner’s Dilemma

in sovereign debt restructuring suggests that the strategic dynamic at work in sovereign debt markets may not

be nearly as dire as the conventional analysis would suggest. See Arturo C. Porzecanski, The Constructive

Role of Private Creditors, E

THICS & INT’L AFF., Fall 2003, at 18, 19.

179

See Ahdieh, Law’s Signal, supra note 5, at 229-30.

180

See Charles J. Goetz & Robert F. Scott, The Limits of Expanded Choice: An Analysis of the

Interactions Between Express and Implied Contract Terms, 73 C

AL. L. REV. 261, 292-93 (1985) (highlighting

need for coordination in facilitating change in contract norms). In slightly different terms, one might think of

most game theory analysis in the sovereign debt literature to be about resolving sovereign debt crises, while

the present analysis considers how to avoid them.

181

See Ahdieh, Law’s Signal, supra note 5, at 234. Coordination games have not received much attention

among legal scholars. See Steven Hetcher, Creating Safe Social Norms in a Dangerous World, 73 S. C

AL. L.

EV. 1, 7, 42 n.160 (1999). While various explanations for such neglect might be suggested, one possibility is

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Coordination games involve the same challenge found in the network

context of the transition from UACs to CACs and analogous standard-setting

contexts: the need to coordinate and align player expectations.

182

This need is

readily apparent in the most basic model of coordination

the Meeting Place

game

in which a husband and wife who have become separated seek to find

each other.

183

In this situation, aligned interests and a resulting preference for

coordination

the hallmarks of network environments, in which market

participants gain from selection of a common network standard

are the

dominant features.

184

In graphical terms, with the added feature of one

potential equilibrium that is Pareto superior to the other, this dynamic is

captured in Figure 1.

the erroneous assumption that where interests are aligned, as in coordination games, efficient outcomes will

occur without legal intervention. See id. at 47 & n.47 (citing examples). A related argument posits that true

coordination game social dynamics are rare, as compared with Prisoner’s Dilemma-type social interactions.

To the contrary, however, “[e]veryday life is full of situations where we have to coordinate our actions with

those of other people.” See Karl Warneryd, Conventions and Transaction Costs, in 1 T

HE NEW PALGRAVE

DICTIONARY OF ECONOMICS AND THE LAW 460 (Peter Newman ed., 1998). Coordination games capture many

of the most funda mental forms of human interaction. Experimental evidence would appear to support the view

that coordination failures are more than a “theoretical curiosity.” See RUSSELL W. COOPER, COORDINATION

GAMES: COMPLEMENTARITIES AND MACROECONOMICS 1 (1999).

182

See Richard H. McAdams, A Focal Point Theory of Expressive Law, 86 VA. L. REV. 1649, 1679, 1680

(2000) (describing the capacity of a judge to achieve an outcome merely by altering the parties’ expectations).

183

In Thomas Schelling’s original Meeting Place game, a husband and wife were to determine where and

when they would attempt to find each other if they were separated at a department store. See id. at 1656

(describing Schelling’s original game). In simplest terms, this can be modeled as such:

Husband

Entrance

Information

Desk

Wife

Entrance 5,5 0,0

Information

Desk

0,0 5,5

Schelling also conducted other “matching game” experiments. See Robert Sugden, A Theory of Focal Points,

105 E

CON. J. 533, 543 (1995) (noting “Schelling’s New York game, Choose a Disc, Choose a Letter, and

Coloured Disks”). For more examples of coordination games, see McAdams, supra note 182, at 1654–58.

184

See Ahdieh, Law’s Signal, supra note 5, at 233-37. In coordination games such as the Meeting Place

game, interests and incentives are aligned, but the players lack the necessary information—specifically,

accurate expectations of one another—to “find each other” and solve the game.

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FIGURE 1

Sovereign Debt Contracting as a Meeting Place Coordination Game

185

This game, like coordination games generally, is characterized by multiple

Nash equilibriahere, in the northwest and southeast quadrants.

186

At these

points, players cannot enhance their welfare by a unilateral change in

strategy.

187

Nash equilibria are consequently quite stable. Neither party can be

expected to diverge from them, absent some expectation that their counterpart

will do likewise. Even if players are at the suboptimal coordination point of

the southeast quadrant, thus, they may not move to the Pareto superior

northwest one.

188

If the northwest quadrant is the Pareto optimal coordination norm of CACs

and the southeast represents the longstanding use of UACs, then, what might

produce a shift from the latter to the former? At heart, the shift among Nash

equilibria is an issue of expectations.

189

If they are to move among Nash

equilibria, market participants need some mechanism by which they can

develop accurate expectations of the future behavior of other market

participants, and make resulting adjustments to their own behavior. In the

185

I demarcate the game participants as Mexico and Brazil. In its broader form, however, the game of

sovereign debt contracting I describe herein includes the entire array of sovereign debtors, as well as the

universe of institutional and individual lenders. As such, iterations of the same game would be expected to

play out between Mexico and the United States, between Mexico and any given lender, between Mexico and

the IMF, between the IMF and other lenders, between the IMF and the United States, and so on.

186

Notably, Bratton and Gulati also identify a multiple equilibrium issue in sovereign debt contracting,

but one directed to the prospect of defection underlying the Prisoner’s Dilemma. See Bratton & Gulati, supra

note 7.

187

See Ahdieh, Law’s Signal, supra note 5, at 232, 235-36.

188

See id. at 236-37.

189

See id. at 230-33; Ahdieh, Making Markets, supra note 5, at 308-10.

Brazil

CACs UACs

Mexico

CACs 10,10 0,0

UACs 0,0 5,5

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simple terms of the Meeting Place game, I need to develop accurate

expectations of where you are likely to expect me, to expect you to go, and so

on.

190

Once such expectations are developed, one can predict a common shift

to the Pareto superior choice—here, CACs.

How do such expectations develop, then? How might the array of

participants in a stable coordination game develop the common set of

expectations necessary to trigger abandonment of the existing (Pareto inferior)

Nash equilibrium, for a more efficient alternative? Most obviously, they might

communicate with one another. In sovereign debt contracting, for example, a

creditor conference might be convened, market analysis of competing contract

terms might be developed and widely circulated, or debtors might organize

themselves into political groupings. In a variety of circumstances, however,

communication may not be an available, or effective, source of common

expectations.

191

To begin with, the greater the heterogeneity of participants in the relevant

game, the less effective communication is likely to be. Heterogeneous parties

are less likely to come together, or to be able to reach common understandings,

if they do. In sovereign debt contracting, the relevant community consists,

most significantly, of competing populations of creditors and debtors.

192

Even

within these groups, the extent of heterogeneity is substantial, with debtors

ranging from the United States to the least-developed countries, and creditors

ranging from banks and other institutional holders of sovereign debt to

individual bondholders.

193

Moreover, the efficacy of communication in sovereign debt contracting is

likely to be further diminished by the number of relevant participants. This

follows from the shift from syndicated bank loans to bonds, as described

above.

194

With this shift, the community of sovereign debt creditors went from

a small collection of large banks, who could easily come together or otherwise

consult, to a massive number of dispersed and anonymous bondholders, among

whom communication is all but impossible. As noted above, this obstacle is

further aggravated by the tradability of bonds on the secondary markets.

190

See Ahdieh, Law’s Signal, supra note 5, at 236 n.94.

191

See id. at 239-41.

192

But see supra note 144.

193

Among the relevant creditors, moreover, are so-called “vulture funds,” which purchase bonds of

distressed sovereigns with the specific intent to hold out from any agreed restructuring. A greater

heterogeneity of interests among coordination game participants is difficult to imagine.

194

See supra notes 47-50 and accompanying text.

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Consequently, the universe of participants in the coordination game of

sovereign debt contract transition is in near constant flux.

But the tradability of sovereign bonds is actually even more problematic for

coordinating expectations than this suggests. Given the relatively extended

term of sovereign bonds and their tradability on the secondary markets, the

network of sovereign debt lenders actually has an even broader character than

the present pool of bondholders. Instead, it encompasses the universe of

potential purchasers of such bonds.

195

Among this broad group, it is even

clearer that communication cannot be relied on to achieve efficient

coordination.

Lastly, cheap talk

the devaluation of nonbinding speechmay also limit

the efficacy of communication as a means of creating common expectations

and thereby facilitating the shift to a Pareto superior coordination point.

196

sovereign debt contracting, this may be an especially acute difficulty, given the

need for effective communication among debtors and creditors. Even given

the existence of some significant coordination dynamic, driving both parties to

the relevant communication to seek convergence on a common standard, the

strategic interaction of debtors and creditors must necessarily also involve

some strong divergence of interest. Given as much, distortive cheap talk is

likely to be unavoidable.

197

195

Cf. Ahdieh, Making Markets, supra note 5, at 291.

196

See Ahdieh, Law’s Signal, supra note 5, at 239-41.

197

See id. at 240-41. For this reason, something akin to a “Battle of the Sexes” coordination game is

likely most appropriate to the sovereign debt contracting strategic environment.

Husband

Ballet Boxing Match

Wife

Ballet 10,5 3,3

Boxing Match -3,-3 5,10

In this conflictual coordination game, wife and husband wish to spend the evening together (hence, the need

for coordination), but have distinct preferences as to where to go—a boxing match or the ballet (hence, the

element of conflict). See id. at 240 n.102.

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In the face of this dilemma, in which coordination is desirable, but

communication is difficult or impossible, Thomas Schelling famously offered

“focal points” as a mechanism by which coordination games might be solved.

In Schelling’s approach, focal points are those equilibrium choices in

coordination games “that, for cultural or psychological reasons, [are] more

‘salient’ and therefore seem[] more natural.”

198

A focal point analysis thus asks

whether a particular solution stands out or is more prominent

199

and suggests

that such solutions can be expected to be chosen by any given coordination

game player and, therefore, to be the preferred choice of players collectively.

200

While useful as an explanation of players’ preliminary choice of one Nash

equilibrium over another, however, Schelling’s analysis cannot alone resolve

dilemma of transition. Where the parties have already arrived at a given

equilibrium, thus, a focal point theory cannot explain subsequent transition.

The most focal point in a coordination game already played is thus the

equilibrium at which the players have arrived, whether it be efficient or

otherwise.

For focal points to facilitate a shift among Nash equilibria, then, what is

needed is some mechanism to render an alternative solution focal. While

various agents might contribute to this end,

201

I would propose that there is an

important public, or official, role to play in this function, by means of what I

have previously termed “regulatory cues.”

202

Such cues are a form of state

198

David A. Strauss, Common Law Constitutional Interpretation, 63 U. CHI. L. REV. 877, 910 (1996).

On focal points generally, see Ahdieh, Law’s Signal, supra note 5, at 129-30, and McAdams, supra note 182,

at 1659-63.

199

See DOUGLAS G. BAIRD ET AL., GAME THEORY AND THE LAW 39 (1994); ROBERT SUGDEN, THE

ECONOMICS OF RIGHTS, CO-OPERATION AND WELFARE 49 (1986); EDNA ULLMANN-MARGALIT, THE

EMERGENCE OF NORMS 83-84 (1977); McAdams, supra note 182, at 1659. The term “salience” is commonly

used in the coordination game literature as an alternative characterization of focal points. See Gerald J.

Postema, Conventions at the Foundation of Law, in 1 D

ICTIONARY OF ECONOMICS AND THE LAW, supra note

181, at 469-70 (describing the regularity of behavior as a source of salience because it makes “one particular

combination of actions stand out as uniquely eligible among a number of possible combinations”); see also

UGDEN, supra, at 89- 90 (noting the interchangeable terminology of prominence, salience, and focal points).

200

See Ahdieh, Law’s Signal, supra note 5, at 244-45.

201

Private sources of focal points can thus be identified. Schelling refers to a picture of the Empire State

Building on the cover of The New York Times as a privately created focal point, which might help solve his

New York game, in which two friends become separated in New York City without having previously

identified a meeting place. Choi and Gulati’s emphasis on the role of the law firm of Cleary, Gottlieb, Steen &

Hamilton, which serves as counsel to a substantial number of sovereign debt issuers, in facilitating the

transition to new terms might also be characterized to constitute a privately created focal point. See Choi &

Gulati, supra note 5, at 951 tbl.2, 975, 977.

202

See Ahdieh, Law’s Signal, supra note 5, at 245-47.

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action, but are not mandates in any conventional regulatory sense.

203

They

involve no threat of sanction, or even the existence of such sanction.

204

The

role of regulatory cues in the coordination game dynamic of network

industries, including contract transition, is to help shape expectations in a way

that permits efficient private transition.

205

Coercion

whether in the form of

threatened sanction or promised reward

is unnecessary for this adjustment of

expectations (rather than incentives), the key to the efficient resolution of

coordination games.

206

Thus, regulatory cues play an informational, a facilitative, and an

encouragement role, not a coercive one. In a variety of forms, regulatory cues

encourage the emergence of common expectations around a particular

equilibrium outcome, thereby facilitating coordination around that equilibrium

and resolution of the relevant coordination game.

207

In the terms of the

coordination game of sovereign debt contracting, regulatory cues might serve

to make alternative contract terms focal and thus facilitate transition to the

Pareto superior coordination equilibria of CACs.

Notably, such an intermediate public role in sovereign debt contracting is

not without precedent. In fact, just this pattern is evident in the English and

U.S. governments’ role in organizing dispersed foreign bondholders during the

interwar period. In England, Parliament granted the Corporation of Foreign

Bondholders a royal charter, while in the United States, the Foreign

Bondholders Protective Council arose out of a working party sponsored in

1932-33 by the State Department.

208

In each case, coordination among

creditors was facilitated through indirect state action. Today, as in the 1930s,

changes in sovereign debt contract norms may again “require moral suasion by

203

See id. at 255-59.

204

See id.

205

See id. at 229-33; Ahdieh, Making Markets, supra note 5, at 308-09.

206

See Ahdieh, Law’s Signal, supra note 5, at 229-33. It is important to note, in this view, that the

“coercive” nature of conventional regulation can come in two guises. Whether carrot or stick, reward or

punishment, these are perfect substitutes for one another. In some sense, then, government “persuasion” is no

different from government “mandate.” In each case, the incentives of the regulated entity are altered by public

action.

207

In an earlier article, I describe the nature and function of such cues in extended detail. See id. at 245-

68. Arguably, the debt restructuring strategy of the Brady Plan exhibited some cueing dimensionc in its

pressure on developing countries to make the shift to Brady Bonds. See Eichengreen & Portes, supra note 48,

at 15-16.

208

See Portes, supra note 16, at 59-60. The SEC also played a role in the evolution of the Foreign

Bondholders Protective Council in the United States. See id. at 60.

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G-7 governments, central banks, and the IMF to overcome the markets’

reluctance” to change.

209

B. Regulatory Cues in Sovereign Debt Contract Transition

In the recent transition from UACs to CACs in sovereign debt contracts,

several important regulatory cues can be identified. Each of these likely

helped to influence both debtor and creditor expectations of a shift to CACs;

collectively, they helped to tip the market to the latter. By rendering the use of

CACs as focal, such cues helped to break the lock-in of the Pareto inferior

Nash equilibrium of UACs, in the southeast quadrant, and facilitate a shift to

the Pareto superior Nash equilibrium of CACs, in the northwest quadrant.

210

The range of relevant cues can be divided into two broad categories, based on

the relevant actor. The first set encompasses the range of regulatory cues

offered by the United States and other developed economies, the official sector

(e.g., the IMF and the World Bank), and international groupings of these

actors. The second includes those cues offered by emerging market sovereign

debtors. Both categories of regulatory cues, furthermore, can be graded along

a pair of independent axes, which I define in the following section as the extent

to which the relevant cue has a coercive potentiality beyond its cueing

function, and the extent to which its coordinative role arises from its provision

of information.

1. Regulatory Cues of Creditor States and the Official Sector

In the first category, perhaps the most significant regulatory cue was the

U.S. Department of Treasury’s strong encouragement of a shift to CACs.

211

Before 2003, “[t]he U.S. Treasury and leading investment bankers [had] been

searching for at least one reputable emerging-market sovereign willing to

volunteer to issue a benchmark bond with new collective-action clauses

facilitating an eventual restructuring.”

212

Roubini and Setser have implicitly

209

Id. at 65.

210

See supra notes 184-88 and accompanying text.

211

See Choi & Gulati, supra note 5, at 973; Dealing with Default, supra note 81; Porzecanski, supra note

178, at 24. Although there is no evidence of it to date, pressure on investment banks could also serve a cueing

role in contract transition. See Roubini & Setser, supra note 14, at 23 (“A handful of investment banks

dominate the emerging market bond business. These investment banks could be summoned by the Treasury

and the Federal Reserve and it could be made clear that the authorities expect them to follow the lead of [those

banks that are using CACs] and to bring to market a new generation of bonds that have clauses. If not, the

authorities would ‘name and shame’ the investment banks that refuse to cooperate.”).

212

Porzecanski, supra note 15, at 41. Similarly, Under Secretary of Treasury John Taylor suggested the

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suggested the value of such encouragement by the United States and other

developed countries in facilitating sovereign debt contract transition.

213

course, such strong encouragement

or mild pressure, as it might be seen in

the eyes of the beholder

may have contributed to the shift to CACs as much,

if not more, because of its coercive force, as its cueing function. As I describe

below, these functions are not exclusive of one another.

214

Rather, a given

public act may both coerce and cue transition. For present purposes, however,

I focus particularly on the cueing function of such pressure.

The cueing function of U.S. encouragement of a shift to CACs is readily

apparent in the case of Mexico, which became the first investment-grade issuer

of New York law bonds to include CACs, under pressure from the United

States.

215

Notably, Mexico announced its issue

unexpected given earlier

indications that it had no plans for a new issuance

216

immediately before the

April 2003 IMF meeting at which the final SDRM proposal was to be

presented for approval.

217

In doing so, it effectively cut the legs out from under

the SDRM, as the United States had long sought to do.

218

Mexico has seemed

to acknowledge the external role in its decision.

219

As put by one Mexican

finance official: “This is more about sending a signal to the international

markets than it is about reducing our borrowing costs.”

220

The immediate

praise of Mexico by the United States and the G-7 may also be suggestive: “As

a solid investment-grade borrower, Mexico is making an important

contribution to strengthening the international financial system.”

221

U.S. expectation that new European Union members would soon adopt CACs. See Taylor, Using Clauses,

supra note 15.

213

See Roubini & Setser, supra note 14, at 23 (“Issuers that continue to use the old boilerplate should at a

minimum expect that their unwillingness to use collective action clauses will be publicly noted in the course of

IMF surveillance and that they will have unpleasant conversations with U.S. authorities.”).

214

See infra note 264-65 and accompanying text.

215

See Skeel, supra note 25, at 418 n.3.

216

See Mexico Pioneers Plan to Ease Debt, supra note 1.

217

See Gulati & Skeel, supra note 4, at 3.

218

See Taylor, Using Clauses, supra note 15.

219

See Eichengreen, supra note 16, at 87 n.6.

220

Mexico Pioneers Plan to Ease Debt, supra note 1.

221

Id. I elaborate infra why this pattern is not best understood as U.S. coercion of Mexico. See infra Part

III.C.1. Such coercion might encompass both the possibility I emphasize herein—what might be characterized

as the “negative coercion” of threatened sanctions—and the “positive coercion” of promised rewards. In either

case, Mexico’s strategy is altered based on changed incentives, as opposed to expectations. A cueing theory,

however, emphasizes the role of U.S. action in shaping Mexican expectations. See infra Part III.C.1.

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A related regulatory cue was the decision of many developed economies to

incorporate CACs into their own debt instruments.

222

Such “leadership by

example” was actively encouraged by the IMF and others.

223

Responding to

this encouragement, in September 2002, the membership of the European

Union, including Italy, Spain, and Sweden, which regularly issue debt in

foreign jurisdictions, announced plans to incorporate CACs into their bond

contracts.

224

Canada and Switzerland followed suit.

225

Collectively, these

choices encouraged an expectation that generalized transition might be

imminent.

226

The clearly articulated goal of the G-7 to minimize IMF bailouts was

another important cue behind the shift to CACs. Beginning with a proposal

from the Council on Foreign Relations in 1999, scholars and policymakers

increasingly insisted that the IMF should hew more closely to the constraints

of its bylaws on the provision of bailout funds.

227

In the period immediately

preceding the shift to CACs, several countries, as well as the official sector,

began to sound an even more forceful note on this issue. John Taylor, the U.S.

Under Secretary of Treasury, offered the clearest example of this pattern in an

April 2002 address regarding CACs and the SDRM initiative.

228

This was far from cheap talk, meanwhile, given the actual limitation of

official sector relief in the recent cases of Argentina, Ukraine, and Ecuador.

229

222

See Boorman, supra note 15, at 67.

223

See Portes, supra note 16, at 47 (quoting 1999 IMF Report); see also Eichengreen, Crisis Resolution,

supra note 54, at 15; Taylor, Using Clauses, supra note 15.

224

See Taylor, Using Clauses, supra note 15.

225

See EICHENGREEN ET AL., supra note 14, at 9; Eichengreen, supra note 16, at 87; Portes, supra note 16,

at 70.

226

The nature of any cueing effect of the developed countries’ choice of CACs warrants careful

definition. Such shifts do not serve, at least in primary part, to facilitate transition by enhancing the returns on

the now-larger CAC network. Given the miniscule possibility that Canada, Switzerland, Italy, or Sweden will

ever seek to restructure their debt, it is not obvious that they can be meaningfully included in the CAC network

encompassing Mexico, Brazil, and Uruguay. Admittedly, the use of CACs by Canada, Switzerland, Italy, and

Sweden may enhance awareness and improve the pricing of CACs, indirectly enhancing value. See supra Part

II.A. Yet this is not the primary cueing function of that choice. Rather, developed countries’ use of CACs acts

as a cue for any given emerging market because they signal a greater likelihood that other emerging markets

will follow the lead of Canada, Switzerland, and the others, and also adopt CACs.

227

See EICHENGREEN ET AL., supra note 14, at 8. In addition to the Council on Foreign Relations, the

Bank of Canada and the Bank of England jointly proposed as much, as did the Meltzer Commission. See id.

228

See Taylor, Sovereign Debt Restructuring, supra note 15; see also Barry Eichengreen, Crisis

Prevention and Management: Any New Lessons from Argentina and Turkey?, G

LOBAL DEV. FIN., Oct. 2001, at

20- 21; Porzecanski, supra note 15, at 40; Porzecanski, supra note 178, at 24.

229

See Bratton & Gulati, supra note 7; Eichengreen, supra note 228, at 21-22, 22 n.42; cf. EICHENGREEN

ET AL., supra note 14, at 8.

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Even more important for the adjustment of market expectations regarding the

use of CACs was the willingness of the international community to allow

several nations to fall into default, notwithstanding longstanding talk of the

risks of “contagion.”

230

This included Russia in 1998,

231

Ecuador in 1999, and

Argentina, arguably, in 2002.

232

Following directly from the latter set of regulatory cues, the IMF’s serious

consideration of an SDRM

which suggested its growing reticence to pay a

hundred cents on the dollar in emerging market bailouts

233

and even more so,

the actual prospect that an SDRM might come into being, were important cues

for the transition from UACs to CACs. “Why have borrowers changed their

minds? One reason is fear. Once the SDRM was mooteda far worse idea

than collective-action clauses in borrowers’ eyes

the thought that it might be

put into effect focused minds on the search for a market-based alternative.”

234

Yet IMF interest in an SDRM might not have been enough to alter

longstanding expectations. The United States’s apparent wavering on the

SDRM, however, greatly strengthened the force of the SDRM cue to the

markets.

235

“The [U.S.] Treasury, apparently annoyed by bondholders’ failure

to embrace its contractarian accommodation of their interests, responded with a

public tilt in the direction of the IMF proposal.”

236

If this was the United

States’s gambit, it was an effective cue. In the aftermath of the U.S.

expression of interest in the SDRM, the Institute of International Finance,

representative of the interests of sovereign debt creditors and long opposed to

the adoption of CACs, suddenly embraced them. Other creditor groups also

came to identify CACs as an alternative approach and even proposed

boilerplate language for such clauses.

237

230

See Frank Partnoy, Why Markets Crash and What Law Can Do About It, 61 U. PITT. L. REV. 741, 753

(2000).

231

See Eichengreen, supra note 16, at 80 n.3.

232

See Bratton & Gulati, supra note 7; Eichengreen, supra note 228, at 21-22, 22 n.42; Portes, supra note

16, at 70-71; Porzecanski, supra note 15, at 42.

233

See Eichengreen, Crisis Resolution, supra note 54, at 12.

234

Dealing with Default, supra note 81.

235

See Bratton & Gulati, supra note 7; Eichengreen, supra note 228, at 32; Taylor, Using Clauses, supra

note 15; see also Christopher Bowe & James Harding, Wall Street Wants Fiscal Prudence, Voters Want Money

in Their Pockets, F

IN. TIMES, Dec. 10, 2002, at 23; Gulati & Skeel, supra note 4, at 3.

236

Bratton & Gulati, supra note 7. This was as likely a strategic feint as anything else: “The U.S., which

is still formulating its tactics for the [April IMF] meetings, may decide to leave the threat of the SDRM alive

as an incentive for emerging market countries to follow its alternative proposal . . . .” Beattie, supra note 76,

at 13.

237

See EICHENGREEN ET AL., supra note 14, at 9.

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A final cue that may prove important in the further evolution of sovereign

debt contract standards is creation of the mechanisms necessary for the

efficacy of a CAC regime. Most particularly, this calls to mind Bratton and

Gulati’s proposed judicialization of the development of intercreditor duties in

sovereign debt contracts.

238

The emergence of such a regime, in essence, might

serve to raise expectations that a strong CAC arrangement might realistically

be chosen by sovereign debtors and accepted by creditor markets.

239

Collectively, these nearly simultaneous acts, decrees, and pronouncements

of the United States, the G-7, the IMF, and others helped to facilitate the

transition from UACs to CACs, without ever mandating as much. They might

be said to have done no more than create some “constructive ambiguity” with

regard to future action (or inaction) by the official sector.

240

Given resulting

adjustments in debtor and creditor expectations, the need to minimize the costs

of restructuring may have come to loom larger for both groups, creating wider

expectations of a shift to the more efficient CACs, and thereby inducing that

shift.

2. Emerging Market Regulatory Cues

By contrast with the foregoing regulatory cues, several important cues

behind the recent shift to CACs were signaled by developing countries

themselves. Perhaps most importantly, the transition to CACs may have been

encountered by emerging markets’ growing willingness to press forward with

restructuring, regardless of creditor or official sector opposition.

241

Essentially,

recent events may have signaled that debtor nations would find a way to

restructure their debt, without regard to the conventional “stick” of reputational

harm in the capital markets.

242

If such willingness was becoming the norm,

then more efficient mechanisms of restructuring, such as CACs, would

increasingly be preferred by creditors and debtors alike, and a shift to CACs

might be expected.

238

See generally Bratton & Gulati, supra note 7.

239

A related cue that deserves note was the encouragement of CACs through the preparation of draft CAC

language by the G-7, as well as several groups of creditors. See E

ICHENGREEN ET AL., supra note 14, at 35;

Choi & Gulati, supra note 5, at 997. Such language may reduce the cost of developing CACs, and therefore

heighten expectations of their adoption.

240

See Bratton & Gulati, supra note 7.

241

See Eichengreen, Crisis Resolution, supra note 54, at 15 (noting the example of Russia in 1998).

242

After Ecuador’s use of New York law amendment clauses to modify the nonfinancial terms of its

Brady Bonds and Eurobonds, and thereby induce participation by holdout creditors, “[e]xpressions of praise

and outrage, depending on the source, inevitably followed.” See Buchheit & Gulati, supra note 12, at 1334.

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Ecuador was perhaps the greatest contributor to this particular cue.

243

2000, in the face of expected repayment difficulties on its outstanding debt,

Ecuador proposed to restructure its debt, by exchanging it for new bonds with

longer terms, but reduced interest rates. To minimize the potential for costly

holdouts, Ecuador made use of so-called “exit consents.” Under this scheme,

creditors who agreed to the exchange simultaneously gave Ecuador their proxy

for changes to the nonfinancial terms of the existing bonds. Because such

changes required only a majority vote, even in UAC contracts, Ecuador was

able to secure the authority to amend the nonfinancial terms of the old debt,

without regard to any dissenters from the exchange itself.

244

Yet through

selective changes to the nonfinancial terms of the bond issue (including choice

of law), Ecuador could dramatically reduce the liquidity and overall value of

the old bonds. As a result, potential holdouts had little incentive to refuse the

exchange, as evident in their nearly universal agreement to what was

nominally a “voluntary” exchange.

Other debtor states followed Ecuador’s lead toward more aggressive forms

of restructuring, whether through exit consents or other techniques. This

included Russia, which offered a unilateral exchange in 2000, and Pakistan and

Ukraine, which likewise took a “take-it-or-leave-it” approach.

245

In the case of

Uruguay, meanwhile, separate negotiations with private creditors permitted

restructuring to occur, notwithstanding the limited support of the IMF, which

had previously been considered a precondition to any attempt at

restructuring.

246

Collectively, these aggressive moves by emerging markets to

restructure their debt between 2000 and 2002 may have served as an important

cue in changing prevailing expectations. If these countries could do it, so

could others.

247

Their ability to force a restructuring of their debt, and the fact

that the IMF had essentially let them get away with it,

248

made clear that “the

era of bondholder immunity from restructuring” was over.

249

As such, creditors

might be expected to increasingly favor a shift to CACs.

243

See id. at 1331, 1334; Silverman & Deveno, supra note 51, at 184; see also Choi & Gulati, supra note

5, at 933-35 (describing role of Ecuador exit consent in subsequent contractual shifts). On Ecuador, see also

Felix Salmon, The Buy Side Starts to Bite Back, EUROMONEY, Apr. 2001, at 46, 58-59.

244

See Choi & Gulati, supra note 5, at 933; Choi & Gulati, supra note 132, at 15; see also Lee C.

Buchheit & G. Mitu Gulati, Exit Consents in Sovereign Bond Exchanges, 48 UCLA L. R

EV. 59 (2000).

245

See Buchheit & Gulati, supra note 12, at 1346.

246

See Porzecanski, supra note 178, at 20; see also EICHENGREEN ET AL., supra note 14, at 29-30.

247

See Porzecanski, supra note 178, at 20.

248

See Boorman, supra note 15, at 61.

249

See Bratton & Gulati, supra note 7; Choi & Gulati, supra note 5, at 934, 939. In fact, the period from

2000 to 2002 was characterized by growing talk of ways in which emerging markets might achieve their

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Another emerging market cue of importance, at least for the later phases of

the transition to CACs, was Mexico’s successful issuance of a New York law

bond with CACs. By avoiding the imposition of any substantial discount,

Mexico undermined the claim that CACs would be costly for developing

economies.

250

This signal arguably began to take shape even earlier, in fact,

with Lebanon’s and Qatar’s placement of CAC bonds in 2000, and Egypt’s

similar issue in 2001.

251

While these were private placements,

252

the fact that

they did not register with the markets as aberrational may have been an

important cue that CACs would not be unwelcome on the market.

In coordination game terms, the collection of cues outlined above helped to

encourage an expectation among debtors and creditors that their peers were

increasingly more likely to shift to CACs. This allowed some to make the

shift, which in turn caused others to do so. In network terms, these regulatory

cues helped to tip the market to CACs. They did so not by means of coercion,

whether dictating or affirmatively rewarding the use of CACs, but instead by

signaling expectations of a transition to them.

C. The Nature and Role of Regulatory Cues

From the enumeration of potential regulatory cues in the prior section, it is

readily apparent that the particular character and form of such cues may vary

widely. Nonetheless, one might analyze regulatory cues along the paired

dimensions of relative coerciveness and information provision. Along the first

axis, of coercion, public intervention in sovereign debt contracting may range

from acts that are purely cues and have little potential for coercion, to more

coercive acts, approximating law or regulation as ordinarily conceived. Along

the second axis, cues might be plotted based on how much information they

provide to coordination game participants, whether regarding the benefits of

coordination generally, or the likely return on particular coordination

equilibria. These twin scales, which do not posit competing characterizations

of cues as either coercive or informational, but rather acknowledge the

restructuring goals, without recourse to conventional, negotiated workouts. In particular, one might note J.P.

Morgan’s “two-step” process, see Roubini & Setser, supra note 14, at 25, by which outstanding debt would be

exchanged for new debt with CACs, which would then be restructured. See Boorman, supra note 15, at 59, 60,

68- 69; see also Choi & Gulati, supra note 5, at 934.

250

See Choi & Gulati, supra note 5, at 969-70.

251

See Eichengreen et al., supra note 14, at 3 n.3; Anthony Richards & Mark Gugiatti, The Use of

Collective Action Clauses in New York Law Bonds, 35 G

EO. J. INT’L L. (forthcoming 2004); see also Choi &

Gulati, supra note 5, at 962.

252

See EICHENGREEN ET AL., supra note 14, at 22.

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possibility of cues that are at once coercive in tenor and information-rich, or

vice-versa, can be considered in turn.

1. Cues and Coercion in Sovereign Debt Contract Transition

Among the most important characteristics of regulatory cues is their

noncoercive nature.

253

In essence, they can be distinguished from public

regulation as conventionally conceived, because their efficacy does not depend

on the threat, imposition, or even existence of any public sanction. As I have

elaborated elsewhere, regulatory cues may resolve even intractable

coordination problems, without restraints on parties’ behavior

the ordinary

mechanism of legal regulation.

254

Given the strategic dynamic of coordination

games, in which players’ expectations, rather than incentives, require

adjustment, cues function by offering information, facilitating inter-action, and

encouraging common understandings.

Notwithstanding their noncoercive nature, however, regulatory cues can be

defined along some continuum of relative “coerciveness.” This is evident in

the examples above. The United States’s pressure on Mexico and other

investment-grade markets to incorporate CACs into new bond issues falls at

the relatively coercive end of the spectrum.

255

As suggested above, such

pressure may serve a cueing function, but maywhether by design or

inadvertencealso coerce a change in behavior. Mexico may have had great

confidence that U.S. pressure to shift to CACs was toothless and may

consequently have adjusted its contract standards based only on the cueing

effect of U.S. policy. Yet even a small possibility of U.S. sanction may have

been enough to have altered Mexico’s incentive to use UACs instead of CACs,

and thus have coerced the transition to CACs.

256

Besides U.S. encouragement

of CACs, other relatively more coercive cues might be the IMF’s insistence on

the seemingly unrealistic SDRM, and the United States’s abrupt expression of

potential interest in that proposal in mid-2002, notwithstanding its prior strong

resistance to it.

257

253

See Ahdieh, Law’s Signal, supra note 5, at 255-59. Other important features of regulatory cues

include their complex intertwining of public and private functions and their fundamentally expressive

character. See id. at 259-65.

254

See id. at 255-56.

255

See supra notes 215-21 and accompanying text.

256

Although I highlight the threat of sanctions as coercion, it is important to note that the provision of

rewards is no less coercive, as the latter concept is used here. In both cases, behavior is modified based on

altered incentives, and not simply altered expectations.

257

See supra Part III.B.1.

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At the opposite end of the continuum of coercion, meanwhile, are various

patently noncoercive cues, including most, though not all, of the cues

originating from debtor states themselves. Ecuador’s use of exit consents is

one example. Mexico’s successful issuance with CACs is another. Developed

countries’ promised and actual use of CACs in their own bonds also lacked any

coercive dimension and was a pure cue.

Falling somewhere in the middle, finally, are cues such as the growing

emphasis on the IMF’s obligation to limit bailouts and the imposition of such

limits in several important cases. Speculatively, a possible intermediate cue

might be a speech by Alan Greenspan favoring a transition to CACs. While

more coercive than the foregoing emerging market cues enumerated above,

these examples fall far short of the near-regulatory character of U.S. pressure

on emerging markets to use CACs and the IMF’s threat of an SDRM.

It bears emphasizing, however, that even seemingly coercive cues are not

coercive at heart.

258

Rather, debtors and creditors may choose to reject an

inefficient coordination equilibrium signaled by public authorities, whether it

be the United States or the IMF.

259

They can be expected to do so, moreover,

in any case where the inherent inefficiency of the proposed solution outweighs

any resulting coordination, or network, benefits.

260

If the “costs” of CACs to

Mexico were sufficiently high, for example, Mexican authorities would be

expected to have more forcefully resisted any U.S. pressure to adopt them.

Stating the point slightly differently, even the most coercive-seeming

regulatory cues are not meant to dictate coordination, at least in the first

258

See Ahdieh, Law’s Signal, supra note 5, at 256-59. To this effect, Edna Ullmann-Margalit has

suggested that coordination norms are “used” or “conformed to” by private parties, rather than complied with.

See ULLMANN-MARGALIT, supra note 199, at 98.

259

See LEMLEY & MCGOWAN, supra note 98, at 545.

260

See Randal C. Picker, Simple Games in a Complex World: A Generative Approach to the Adoption of

Norms, 64 U. C

HI. L. REV. 1225, 1285 (1997). A somewhat parallel dynamic can be observed in experimental

analyses of what have been termed “Ultimatum” games. See generally Werner Guth et al., An Experimental

Analysis of Ultimatum Bargaining, 3 J. E

CON. BEHAV. & ORG. 367 (1982). In this situation, an allocator (or

proposer) proposes how to divide a sum of money. The receiver (or responder) must then choose to accept or

to refuse the proposal. If the receiver refuses it, however, neither player will receive any payoff. In this

dynamic, as little as a penny should be accepted by a rational receiver. Economists have observed a tendency

toward a breakpoint, however, below which receivers reject the proposal, notwithstanding the consequent loss

to themselves. See, e.g., Colin Camerer & Richard H. Thaler, Anomalies: Ultimatums, Dictators and

Manners, J. E

CON. PERSP., Spring 1995, at 209, 210; Elizabeth Hoffman et al., On Expectations and the

Monetary Stakes in Ultimatum Games, 25 I

NT’L J. GAME THEORY 289, 291-92, 295-96, 299-300 (1996); Peter

H. Huang, Dangers of Monetary Commensurability: A Psychological Game Model of Contagion, 146 U. P

L. R

EV. 1701, 1711-12 (1998).

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instance. Instead, they seek to encourage efficient coordination, by influencing

the expectations of coordination game participants.

261

In the transition from

UACs to CACs, thus, a shift was never dictated. Rather, the array of cues

outlined above collectively pointed to a likely adjustment of individual debtor

and creditor strategies to favor the incorporation of CACs. In this way,

expectations

and ultimately behaviorschanged. Had the relevant debtors

and creditors found the benefits of the use of CACs, including both their

inherent value and network value, to be sufficiently less than the existing

benefits of UACs, no individual cue, or even collection of them, would have

been effective in prompting a transition.

262

Even if regulatory cues have the capacity to accomplish efficient transition

without need for coercion, however, the category of most coercive-seeming

cues



U.S. pressure for the adoption of CACs, the IMF’s SDRM proposal, and

the like

would seem to beg the question of what dynamic actually triggered

the shift to CACs. Perhaps a coercive story offers a better, or at least a

simpler, account of the transition? This sharper narrative of the recent

transition in sovereign debt contracting, one favored by the maxim of Occam’s

Razor,

263

would acknowledge the presence of network effects and the resulting

tendencies toward lock-in and tipping in sovereign debt contracting practice. It

would not identify noncoercive regulatory cues as the trigger behind the

ultimate transition, however, but transnational coercion by the United States,

other developed countries, and the IMF. In this view, pressure from the United

States to abandon UACs and to choose CACs over the SDRM can fully explain

the observed patterns of transition. Such a theory, in fact, could point to the

very same collection of public acts that I label as only seemingly coercive and

suggest that appearances may not be deceiving in this case. Rather, seeming

coercion by the United States may have actually coerced the shift to CACs.

The present account does not entirely dispute this version of events.

Rather, a cueing theory of the transition from UACs to CACs acknowledges

the potential for multiple triggering events, including some element of

coercion.

264

An accounting grounded exclusively in coercion, however, sits

uneasily with the delay between the onset of external pressure to move to

261

See Ahdieh, Law’s Signal, supra note 5, at 258-59.

262

See id. at 256.

263

See Tracey E. George & Robert J. Pushaw, Jr., How Is Constitutional Law Made?, 100 MICH. L. REV.

1265, 1275 n.38 (2002).

264

Similarly, it acknowledges that various non-network factors may have contributed to the long pattern

of UAC lock-in in New York law bonds. See supra Part I.A.

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CACs, and the ultimate decision of Mexico and others to make that shift. With

an eye to this delay, the present analysis posits that something additional may

have been at worknamely, the effect of the collection of regulatory cues

enumerated above, all pointing toward the likely, but not mandatory, shift to

CACs by an array of autonomous sovereign debt creditors and debtors.

Yet if at least some of what I identify as regulatory cues

including U.S.

pressure on emerging market debtors

are likewise tools of coercion, does the

distinction between cueing and coercion not become mere semantics? What

distinguishes the most coercive-seeming cues from coercion? In essence, the

answer lies in the particular motivation to change strategy in coordination

games, including network environments such as the transition of contract

boilerplate. In the Prisoner’s Dilemma and other noncooperative strategic

situations to which conventional legal regulation seems to respond, players

shift their behavior to socially preferred alternatives in the face of changes in

their incentives to choose a particular strategy. Law and regulation facilitate

efficient outcomes by altering parties incentives. In coordination games, by

contrast, players change strategies not because of any change in incentives, but

because their expectations regarding the strategy of their counterpart have

changed. As described above, thus, regulatory cues are directed to

expectations, not incentives.

What might this mean in practice? How is the cue of U.S. encouragement

of a shift to CACs any different than the coercion of U.S. pressure to shift?

The coercive account posits that Mexico’s incentives to use UACs instead of

CACs in its bond contracts, and the analogous incentives of other emerging

markets, were altered by U.S. pressure. The costs of utilizing UACs increased,

thus, once the threat of direct or indirect U.S. sanctionsbroadly defined, of

coursebecame clear.

A cueing analysis, observing the same U.S. behavior, suggests that a

different mechanism might have been at work. U.S. pressure may have

primarily served to alter Mexico’s expectations regarding emerging markets

use of UACs versus CACs in the years ahead. In combination with the other

cues enumerated above, the cueing theory posits that U.S. pressure may have

simply signaled to Mexican authorities that other debtors, as well as creditors,

were likely to shift to CACs. Given as much, a transition to the latter by

Mexico became appropriate as well.

Far from mere semantics, this difference has important implications for the

conception and design of state action. It suggests, for example, that even if

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Mexico knew it would face no sanction for its failure to respond to U.S.

demandsimagine, for example, that it had been offered clear guarantees to

that effect, or even that it was strong enough to resist such pressure

265

it might

nonetheless have made the shift to CACs. It would do so not based on U.S.

coercion, at least of Mexico itself, but based on its expectation that other

nations would respond to U.S. pressure

or the perception of U.S.

pressure

by shifting to CACs. In this view, Mexico might even shift to

CACs in the absence of any pressure from the United States, but instead in

response to real or perceived pressure on Brazil, Russia, or other emerging

markets.

Perhaps most importantly, a cueing model of the transition from UACs to

CACs offers the lesson that coercion may not be necessary to achieve efficient

transition. Thus, regardless of whether Mexico’s decision to shift to CACs,

and the ensuing decisions of other emerging markets, were driven more by

coercion or cueing, ensuing changes in sovereign debt contracting practices

may not require coercion. More generally, cueing theory suggests that public

authorities may be able to rely on a cueing function of law in a number of areas

in which coercive regulation has conventionally been the norm. Policy goals

vis-à-vis a given subject of regulation (whether a nation-state or domestic

private actor), finally, may be achieved without need for sanction, or any

action regarding that particular subject, as opposed to other, similarly situated

subjects of regulation.

2. Regulatory Cues as Sources of Information

A second continuum in the characterization of regulatory cues is the

amount of information provided by the relevant cue. To what extent does it

serve its coordination function by enhancing the quality, and perhaps simply

the commonality, of the information available to coordination game

participants? Expectations regarding the likely choices of other playersthe

key to any shift among Nash equilibria in the coordination game of contract

boilerplate transitionare ultimately a question of information.

266

265

Even if Mexico was politically or economically strong enough to resist U.S. pressure to adopt CACs,

thus it might nonetheless shift to CACs, based on its expectations regarding other countries’ ability (or

inability, to be more precise) to resist U.S. pressure.

266

See Ahdieh, Law’s Signal, supra note 5, at 258-59. To related effect, Anne-Marie Slaughter speaks of

“regulation by information.” See A

NNE-MARIE SLAUGHTER, A NEW WORLD ORDER 24 (2004).

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Information regarding the value of an alternative equilibrium, as well as the

costs of transition to that equilibrium, will thus enhance or diminish

expectations regarding the occurrence of a transition.

267

In essence, information

may render a given coordination point more focal and thereby encourage

coordination around that point.

268

This information function is apparent in the

regulatory cues enumerated above, as is the gradation of its importance in the

operation of various cues.

Mexico’s nondiscounted bond issuance, notwithstanding its inclusion of

CACs, is perhaps the best example of a regulatory cue serving as a source of

information

in that case, to other potential issuers. Other information-

oriented cues in sovereign debt contracting might include the willingness of the

IMF and G-7 to allow several important sovereign debtors to go into default

and the ability of several developing countries to go at it alone in their

restructuring.

269

The Greenspan testimony imagined above might be construed

as an important informational regulatory cue, as would a publicly com-

missioned study of the efficiency gains from a shift to CACs and the potential

debtor premiums for such a shift.

270

By contrast, the seemingly feigned interest

of the United States in the SDRM and the U.S. pressure on Mexico to issue

debt with collective action provisions were relatively less directed to

information provision, at least in any meaningful sense.

271

Ultimately, then, along the twin axes of relative coerciveness and the extent

of information offered by a regulatory cue, we can plot an array of cueing

behaviors of public authorities. U.S. pressure on Mexico was relatively more

coercive, and less information-intense. Mexico’s successful issuance, by

contrast, was primarily important as a source of information, and had little or

no coercive dimension. Finally, the IMF’s failure to prevent several countries

from falling into default may have been both relatively coercive, and an

267

Elsewhere, I have described the respective role of regulatory cues in facilitating coordination outcomes

generally, and in facilitating the Pareto efficient Nash equilibrium particularly. See Ahdieh, Law’s Signal,

supra note 5, at 247-48. Cues’ provision of information might be conceived as directed to these same two

ends. Some information points to coordination generally as optimal, while other information favors a

particular coordination outcome.

268

Besides offering information regarding the value of a particular equilibrium, regulatory cues might

also, by providing information, be seen to be enhancing that value. I am grateful to Steve Choi for noting this

point.

269

See Choi & Gulati, supra note 5, at 934 (describing Ecuador’s exit consents as source of information

for other sovereign debtors).

270

The IMF, in fact, has supported several such studies.

271

See supra Part III.B.1.

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important source of information to participants in the coordination game of

sovereign debt contracting.

3. The Shifting Role of Regulatory Cues in Sovereign Debt Contract

Transition

A final point regarding the role of regulatory cues in facilitating change in

boilerplate contract terms concerns the application of such cues in distinct

circumstances and contexts. The need for greater or lesser coerciveness, as

well as the nature and extent of information offered by cues in facilitating

contract transition, can be expected to vary, depending on the particular

dynamic within which the relevant cue is meant to operate. Thus, different

demographic and transitional dynamics among participants in distinct cases of

boilerplate contract transition may demand different forms of regulatory cues.

Perhaps most importantly, this variable nature of cueing forms might be

expected to turn on the stability of the status quo equilibrium.

272

The longer

Nash equilibrium has been in place, the relatively greater the coercive tenor or

amount of information contained in any cue may have to be, in order to

achieve the desired change in player expectations. Additonally, the greater the

number of players who operate at the status quo equilibrium, and the

consequently greater the network value of that equilibrium, the greater the

potential need for coercion or information. In essence, shared expectations

may be more difficult to achieve across a larger and/or more heterogeneous

population. Across a wider universe of more diverse participants, information

may be more difficult to share, absent the public intervention of regulatory

cues.

273

Conflicting cues may also increase the need for more coercive-style

cues. Amidst the noise of various cues favoring an expectation of alternative,

and even competing, outcomes, cues of a coercive tenor may be particularly

focal, and hence effective.

Finally, even partial displacement of the dominant equilibrium may allow

relatively less coercive cues to facilitate efficient transition. Choi and Gulati’s

analysis of network effects in sovereign debt contracting would seem to

suggest as much.

274

Thus, as long as the dynamics of the market involved

272

Cf. Ahdieh, Law’s Signal, supra note 5, at 243.

273

It bears reiterating, in this regard, that regulatory cues’ degree of coerciveness and information-

provision are not competing characteristics. Rather, a given cue might be quite coercive in tenor, yet also

provide substantial coordination-related information.

274

See Choi & Gulati, supra note 5, at 936-38.

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solely a choice between longstanding and widely adopted UACs and less

familiar CACs, existing cues were inadequate to trigger transition. In the

aftermath of Ecuador’s use of exit consents, however, this dynamic changed.

With Ecuador’s decision, the equilibrium choice of UACs was bifurcated into

two strategies, offering UACs as conventionally understood and applied or the

prospect of their circumvention through the use of exit consents.

275

Now, with

the focal character of UACs somewhat diminished, regulatory cues could

effectively shift the market to the CAC alternative.

276

As this analysis suggests, regulatory cues are not a panacea. While cues

may be as effective as regulatory coercion in the presence of network effects

and a resulting coordination dynamic, they will not always be so. While strong

network effects can enhance the efficacy of regulatory cues, they may also

raise too high a barrier to the effective operation of cues. In such

circumstances, ordinary regulation may be needed to at least displace the

inefficient status quo equilibrium, even if not necessarily to replace it.

Likewise, too great an array of conflicting cues, unlike the relative unanimity

of the signals identified above, may limit the efficacy of a cueing approach. At

least in sovereign debt contracting, however, noncoercive cues would appear to

have been sufficient to facilitate transition to the Pareto superior Nash

equilibrium of CACs.

IV. R

EGULATORY CUES IN THE INTERNATIONAL FINANCIAL ARCHITECTURE

Having identified the role of regulatory cues in the recent transition from

UACs to CACs and described important aspects of the nature of such cues, a

few comments on the potential importance of cues in the ongoing transition in

sovereign debt contract standards deserve note. A role for cues remains

essential, but its precise scope and limitations must be appreciated as well.

A. Between Mandate and Market: Cueing Transition in Sovereign Debt

Contracting

This Article’s analysis has direct implications for the appropriate role of

national authorities and the IMF in facilitating more efficient sovereign debt

275

Choi and Gulati describe a similar conception of the consequence of Ecuador’s decision for the

existing equilibrium, and suggest it created additional axes along which sovereign debt contracts might vary.

See id. at 933.

276

Additional Nash equilibria might also reduce the prospects of displacement, however, by diminishing

the focal force of a singular alternative equilibrium, such as CACs.

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restructuring. Until now, the debate around this issue has been posed as a

choice between the IMF’s institutional approach

the creation of an

SDRM

and the contractual approach favored by the United States, which

hoped the increased use of CACs would reduce delays and other inefficiencies

in debt restructuring. As between these stark alternatives, cueing theory stands

somewhat closer to a contractual approach. It suggests that an efficient scheme

for sovereign debt restructuring can emerge without the need for the complex

mandates and institutions of the SDRM.

Yet cueing theory goes further in its challenge to the need for regulatory

mandate in sovereign debt contract transition. Before the recent shift to CACs,

many proponents of the contractual approach could be heard to encourage

regulators to dictate the universal adoption of CACs. Many thus argued for

IMF conditionality to be used to mandate sovereign debtors’ use of CACs.

277

Cueing theory would deny the need for such regulation, a view seemingly

affirmed by the noncoerced shift of the market in 2003. Yet even as CACs

have become the norm, notwithstanding the lack of regulatory mandate, calls

for coercive regulation have not abated, including among contractarians. A

strong chorus has thus called for regulatory intervention to dictate

standardization in the terms of collective action utilized in sovereign debt

contracts.

278

New debt contracts have adopted varying percentage requirements

for majority action (as well as distinct definitions of a qualified majority), and

have applied those requirements to different sets of enumerated contract

changes. In the face of such divergence, many have proposed that the IMF and

national authorities mandate specific CAC provisions, in order to facilitate

ultimate convergence around those provisions: “[The international community]

needs to do more than examine, encourage and consider. Without the

introduction of actual legislation and regulation in the creditor countries,

progress on this front is unlikely.”

279

277

See Boorman, supra note 15, at 67-68. Others proposed that domestic authorities, such as the SEC, act

to dictate transition to CACs. See Roubini & Setser, supra note 14, at 13 -14 (describing potential regulatory

interventions by the SEC and various international institutions); see also Bratton & Gulati, supra note 7. A

cueing theory of contract transition, however, denies the need for the SEC to mandate CACs in SEC-registered

bonds, see Roubini & Setser, supra note 14, at 23 -24, or to make CACs a legal requirement for enforcement of

bonds in U.S. courts (in an inversion of the Trust Indenture Act, see E

ICHENGREEN ET AL., supra note 14, at

36), or for the IMF to amend its Articles of Agreement or offer preferred interest rates based on the use of

CACs. See Eichengreen, Crisis Resolution, supra note 54, at 15.

278

Even Under Secretary of Treasury John Taylor has suggested a potential need to mandate adoption of

standardized CACs. See E

ICHENGREEN ET AL., supra note 14, at 36-37.

279

Portes, supra note 16, at 71; Eichengreen, Crisis Resolution, supra note 54, at 15.

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Cueing theory, by contrast, suggests that network effects can be expected to

achieve desirable standardization, without the need for coercive public

intervention. Again, recollection of the coordination game dynamic at work in

sovereign debt contracting is helpful: In this environment, players hope to

agree

to convergein order to tap beneficial network effects, and simply

require the information necessary to develop accurate expectations of one

another. This, of course, is adequately offered by noncoercive regulatory

cues.

280

This is not to suggest that there may not be other reasons to mandate

transition, or subsequent standardization, in sovereign debt contracting. Barry

Eichengreen suggests the need to adopt CACs as a matter of law, given the

risks of litigation

281

and other potential difficulties.

282

While there may be

numerous reasons to mandate the adoption of CACs, and particular forms

thereof, cueing theory counsels that neither the goal of adoption generally, nor

a desire for rapid adoption or even uniform CAC standards, requires

mandate.

283

With the careful use of regulatory cues, rapid and widespread

adoption of standardized terms can be predicted.

Notwithstanding the challenge of cueing theory to the imposition of

regulatory mandate, however, it does not favor a purely contractual approach

to sovereign debt restructuring standards either. While cueing theory

challenges the argument for mandate, it likewise recognizes limits on the

capacity of the market to facilitate efficient transition on its own. As we have

already seen, in the network environment of sovereign debt contracts,

unanimous action standards were locked-in and difficult to displace, despite

their relative inefficiency.

284

280

See Ahdieh, Law’s Signal, supra note 5, at 255-59 (describing capacity of cues to function without

need for public sanction). Thus, while I agree with Choi and Gulati that contract standardization may require

some extra-contractual process or regime, I offer the possibility that it may not. See Choi & Gulati, supra note

5, at 932.

281

See Eichengreen, Crisis Resolution, supra note 54, at 9-10.

282

See id. at 11-12. Because Eichengreen highlights adverse selection as a central obstacle to efficient

transition, he argues for greater intervention than the present analysis suggests, including proposals for IMF

conditionality and favorable interest rates for CAC users. See id. at 15. In subsequent analyses, in fact,

Eichengreen has suggested even more aggressive forms of regulatory intervention, given questions of the

legality of the foregoing approaches, as well as questions of time consistency.

283

See id. at 12-13 (proposing amendment of IMF Articles or domestic law to encourage adoption of

CACs).

284

See supra notes 150-73 and accompanying text.

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Even with the prevailing standard of UACs now eliminated, there is no

guarantee that the standard that emerges will be optimal. Notwithstanding the

capacity of network effects to produce desirable standardization, as described

above, the pattern of tipping in network environments also means that there is

no guarantee of efficient outcomes.

285

Rather, in network environments, a first-

mover is likely to prevail.

286

If network size matters, each new entrant can be

expected to elect the largest available network, producing a bandwagon effect

leading to the initial entrant. This will be true, at least at the margin, regardless

of the efficiency of the preliminary standard.

287

The dominant first-mover is

unlikely to be displaced, moreover, once it establishes itself. With network

effects, thus, a suboptimal standard will not necessarily fail or quickly be

replaced.

288

Rather, in network environments, “[i]nefficient institutions that are

not conducive to economic growth and development can emerge and

survive.”

289

As a result, a network effects and coordination game theory of sovereign

debt contracting cannot endorse a purely contractual approach to the evolution

of contracting norms and standards, whether it be the choice of UACs or

CACs, the election of a particular form of CAC, or the determination of other

standard-setting issues.

290

Instead, cueing theory suggests that some public

impetus may be needed for efficient sovereign debt contract transition.

291

“The

285

See Ahdieh, Making Markets, supra note 5, at 316-17; see also Katz & Shapiro, supra note 174, at 94

(noting first-mover advantages arising from sunk costs of particular computer systems). This outcome, of

course, assumes exclusivity—that is, an inability to join multiple networks at once. Cf. Bratton & Gulati,

supra note 7 (noting first-mover issues).

286

See Joseph F. Brodley & Ching-to Albert Ma, Contract Penalties, Monopolizing Strategies, and

Antitrust Policy, 45 S

TAN. L. REV. 1161, 1163-64 (1993) (noting that new entrants into a market often find

themselves handicapped by their late arrival); cf. Nicholas Economides, The Economics of Networks, 14 I

NT’L

J. INDUS. ORG. 673, 694 (1996); Katz & Shapiro, supra note 174, at 107.

287

See Karl Warneryd, Network Externality and Convention, in 2 DICTIONARY OF ECONOMICS AND THE

LAW, supra note 181, at 676 (noting decisive character of initial player’s strategy in sequential coordination

game). Conversely, potential first-mover advantages and tipping-related monopoly rents might also serve to

spur competition and industry growth, as some believe has occurred in Silicon Valley.

288

See Daniel R. Fischel & Sanford J. Grossman, Customer Protection in Futures and Securities Markets,

4 J. F

UTURES MKTS. 273, 292 (1984).

289

Stefan Voigt & Hella Engerer, Institutions and Transformation—Possible Policy Implications of the

New Institutional Economics, in F

RONTIERS IN ECONOMICS 131, 139 (Klaus F. Zimmermann ed., 2002); see

Shelanski & Sidak, supra note 98, at 9 (“The market leaders will set the technological standard . . . even if

other technological standards are superior in some economic or engineering sense.”).

290

The persistence of pari passu clauses may also evidence network lock-in. See Choi & Gulati, supra

note 5, at 998.

291

See Roubini & Setser, supra note 14, at 13, 24. As noted above, even the U.S. Department of the

Treasury seems to have acknowledged the need for some public intervention in the sovereign debt markets,

suggesting a need for collective agreement on the contractual approach as the preferred model and the

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historical evidenceand developments since the Mexican crisis

indicate that

the markets will not spontaneously achieve [efficient] outcomes. The

equivalent of law is required, although not the kind of law that would be

needed to establish an international bankruptcy court.”

292

The kind of “law”

that is needed, I would suggest, is regulatory cueing.

Choi and Gulati’s analysis of the patterns of transition in sovereign debt

contracts resonates with this conclusion. To this effect, they speak of small

changes that may help lead to even larger later changes.

293

Likewise, they

describe a role for the official sector grounded in the exact tasks of

encouragement, education, and facilitation that regulatory cues are meant to

achieve.

294

Bratton and Gulati also echo the notion of an initial cueing-like role for the

official and public sector, followed by a more limited (but still essential, I

suggest below) role thereafter:

Under this view, a sovereign bankruptcy regime need do little more

than trump UACs with CACs and then leave the parties free to

renegotiate their contracts. With CACs in place (however imposed),

the parties simply can be remitted to the law governing their

contracts—the law of the State of New York in most cases—without

needing the adjudicatory or administrative assistance of a bankruptcy

infrastructure.

295

Yet cueing theory differs slightly at both ends. Bratton and Gulati hint at

greater dictation of CACs at the outset than a cueing approach would suggest.

Thus, in their view, “[i]f the contractarian strategy is to accomplish anything,

the IMF, the U.S. Treasury, and the other G-7 nations will have to use financial

threats to induce the move.”

296

Further, from the perspective of cueing theory,

development of “incentives to encourage borrowers and lenders to incorporate such terms.” See Taylor,

Sovereign Debt Restructuring, supra note 15. In fact, John Taylor has suggested the potential for even

stronger measures, including an IMF requirement of CACs, as well as preferential IMF interest rates for bonds

incorporating such clauses. See id. While cueing theory rejects this position, earlier Treasury assertions that

no official action was necessary to achieve a transition to CACs. See Portes, supra note 16, at 67 (quoting

Larry Summers, the former Under Secretary of Treasury for International Affairs, that the official sector

should not “mandate the terms of debt contracts” or even adopt policies to induce borrowers to include them).

292

Portes, supra note 16, at 50-51.

293

See Choi & Gulati, supra note 5, at 934.

294

See id. at 998; see also id. at 998, n.110 (“In the sovereign context, it is likely that the many official

sector efforts at supporting research on new contract terms, in organizing conferences, and setting up drafting

committees, all played an important role in producing change.”).

295

Bratton & Gulati, supra note 7.

296

Id. at 67.

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their analysis downplays the role of state action in the ensuing evolution of

contract standards.

Ultimately, a cueing approach offers the benefit of efficient transition,

without dictation. It leaves the final determination of efficient outcomes to the

market itself, which can decline to follow any relevant cues, and can

circumvent the outcomes they lead to, should efficiency dictate as much.

297

Thus might a cueing model, finally, be analogized to Randal Picker’s notion of

“seeding norm clusters,” by which public authorities selectively encourage

certain norms, and see what happens.

298

Norm seeding is a low-risk strategy. If the government seeds an

inefficient cluster, it will die, and little will be lost. If the new norm

is superior to the old norm, however, the artificially created norm

cluster will thrive and spread. This analysis suggests that the

government should embrace test policies or norms or take steps to

foster social meanings in particular local contexts as a way of testing

whether a superior approach can take root and spread.

299

Like norm seeding, a cueing model of state action in sovereign debt

contracting does what is necessary to break network-driven coordination

logjams at the outset, and at successive stages of the transition to new contract

standards, but does not dictate the results of that transition. Ultimate outcomes

are left to the sovereign debt market itself.

B. The Continuing Role of Regulatory Cues in Sovereign Debt Contract

Transition

As suggested above, beyond their preliminary role in facilitating the shift

from UACs to CACs, regulatory cues continue to have an important, if limited,

role in sovereign debt contracting. A variety of significant issues in the design

and standardization of CACs remain unresolved.

300

Perhaps most important is

the risk of minority creditor abuse under CACs.

301

With the adoption of CACs,

there is an urgent need for the development of norms of good faith and fair

dealing, to prevent the exploitation of minority creditors by newly empowered

majorities.

302

This need has triggered discussion of a “code of conduct” for

297

See Ahdieh, Law’s Signal, supra note 5, at 256; Eichengreen, supra note 16, at 94 -95.

298

See Picker, supra note 260, at 1284-85; see also Choi & Gulati, supra note 5, at 998.

299

Picker, supra note 260, at 1285.

300

See EICHENGREEN ET AL., supra note 14, at 39-40.

301

See Bratton & Gulati, supra note 7; Gulati & Skeel, supra note 4, at 5.

302

See Buchheit & Gulati, supra note 12, at 1336-42.

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sovereign debt restructuring.

303

Yet the development of such a code will

require ongoing coordination to define its terms. As a preliminary matter, in

fact, debtors and creditors will need to coordinate their choice of a code or

various competing possibilities, including Bratton and Gulati’s preference for

common law adjudication of intercreditor duties in U.S. courts,

304

the IMF’s

proposal to require that all creditors receive the same settlement offer (or menu

of offers),

305

and the possible use of trust deeds.

306

Another outstanding issue of some importance concerns the aggregation of

debt restructuring across classes of bonds, especially in those cases where the

relevant sovereign has a wide array of bonds outstanding.

307

To address such

aggregation problems, there is a continuing need to develop some form of

“super-CAC,” a norm on the use of bondholder committees, or a relevant code

of creditor conduct.

308

Again, the market itself has begun this process, as

suggested by the use of super-CACs in Uruguay’s 2003 bonds,

309

but cues may

be important in facilitating a transition to such terms.

Finally, a variety of more specific standardization issues are still

outstanding.

310

Thus, it remains unclear whether the relevant percentage

required for majority action should be tied to attendance at a meeting with

quorum, as in English law majority action clauses, or should be a percentage of

outstanding debt.

311

Likewise, the exact percentage required for majority

action remains to be determined, with Brazil having set a rate of eighty-five

percent,

312

rather than the conventional seventy-five percent. There also

303

See EICHENGREEN ET AL., supra note 14, at 5, 30-32. On the value of such a code, see id. at 32. Much

of the general discussion of codes of conduct, has been directed to the conduct of debtors. See Roubini &

Setser, supra note 14, at 10-11. With the adoption of CACs, however, the conduct of majority creditors

toward minority creditors, in the exercise of their majority action rights, is a newly significant concern.

304

See Bratton & Gulati, supra note 7.

305

See INT’L MONETARY FUND, THE RESTRUCTURING OF SOVEREIGN DEBT—ASSESSING THE BENEFITS,

ISKS, AND FEASIBILITY OF AGGREGATING CLAIMS 14 (Sept. 3, 2003), available at http://www.imf.org/

external/np.pdr/sdrm/2003/090303.pdf.

306

See INT’L MONETARY FUND, THE DESIGN AND EFFECTIVENESS OF COLLECTION ACTION CLAUSES 10

(June 6, 2002), available at http://www.imf.org/external/np/psi/2002/eng/060602.pdf.

307

See Buchheit & Gulati, supra note 12, at 1344; Skeel, supra note 25, at 422-23; see also EICHENGREEN

ET AL., supra note 14, at 4, 15; Boorman, supra note 15, at 66.

308

See EICHENGREEN ET AL., supra note 14, at 5.

309

See Gulati & Skeel, supra note 4, at 4; see also EICHENGREEN ET AL., supra note 14, at 29-30. On the

array of innovations in the Uruguay issue, see Choi & Gulati, supra note 5, at 946-47.

310

See Choi & Gulati, supra note 5, at 947-49 (identifying variety of issues on which a standard has not

emerged to date); Porzecanski, supra note 178, at 24.

311

Cf. Buchheit & Gulati, supra note 12, at 1324-25.

312

See Gulati & Skeel, supra note 4, at 5. Guatemala’s bonds also set an eighty-five percent level. See

Choi & Gulati, supra note 5, at 981.

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continues to be a need to reconcile various contractual provisions indirectly

related to the potential for collective action.

313

These provisions include

requirements for information sharing and disclosure,

314

as well as potential

“engagement” requirements.

315

As competing approaches and proposals emerge, regulatory cues can help

to encourage particular standards, to avoid premature lock-in, and, perhaps

more importantly, to offer valuable information on various alternatives. In this

way, cues can help to facilitate the emergence of an efficient regime of CACs,

just as they have already contributed to the preliminary shift from UACs to

CACs.

C. Convergence and Fragmentation in Sovereign Debt Contracting

While I have emphasized the network tendency toward standardization, it

bears noting in conclusion that the proposed network conception of sovereign

debt contracting does not necessitate complete convergence to a network

standard.

316

Rather, network effects in sovereign debt may favor beneficial

standardization, yet permit some persistent diversity. A network theory of

sovereign debt is thus readily reconciled with both the long persistence of

MACs in English law bonds, notwithstanding the network predominance of

UACs,

317

and with the continued use of UACs by a very small group of issuers

under New York law, even today.

318

313

See Boorman, supra note 15, at 67.

314

See Gulati & Skeel, supra note 4, at 4-5.

315

See EICHENGREEN ET AL., supra note 14, at 30-31. Cueing theory also has implications for the so-

called “transition problem,” which concerns the large pool of existing sovereign debt without CACs. See id. at

25. From a network/coordination game perspective, this is not an especially significant concern. While the

transition problem has been asserted to favor creation of an SDRM, see Boorman, supra note 15, at 66;

Roubini & Setser, supra note 14, at 11, if a network effects analysis is warranted, transition should not be

unduly difficult. Rather, market participants can be expected to voluntarily switch to CACs in due course.

A related concern has been the potential for a regression to UACs. See E

ICHENGREEN ET AL., supra note

14, at 4, 17-18; Bratton & Gulati, supra note 7. A network analysis suggests that is unlikely to occur. Given

the network tendency toward lock-in, such regression would require overcoming the network size benefits of

remaining with the newly dominant CAC standard.

316

Nor does it entirely obviate the benefits of innovation. See Kahan & Klausner, supra note 107, at 350

(describing benefits of innovation).

317

The same is true of the persistence of different forms of UACs and CACs, both in the past and today.

This diversity is described by Choi & Gulati, supra note 5, at 963-65.

318

These include Israel, China, and the Philippines. See id. at 970. Ribstein and Kobayashi have

critiqued the network theory of corporate contracting along such lines. See Ribstein & Kobayashi, supra note

98, at 117-18. For the reasons outlined above, this criticism is inapposite.

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Both the long persistence of UACs and MACs in sovereign debt contracts

and the continued use of various forms of each

319

are consistent with the

network dynamic described above, because of the existence of both network

and inherent value in any contract term (or other network good).

320

Depending

on the particular balance of network and inherent utility that a given user

derives from the relevant good or service

that is, the blend of value

dependent on, and independent of, network size

321

some users may find that

the inherent benefits of the non-network dominant choice outweigh the

network gains of its more widely used competitor.

322

Such is the claim, for

example, of insistent users of Apple personal computers.

323

In the eyes of the

latter, greater ease of use, fewer crashes, and other perceived benefits are worth

more than the greater access to software and repair services and other network

gains that would follow from their use of the dominant Microsoft Windows

operating system.

With sovereign debt contracts, this pattern may be manifest in some

preference for UACs among higher credit risk sovereign debtors.

324

Empirical

analysis has thus suggested that high-risk sovereigns may be forced to pay a

premium by shifting to CACs (in the form of a wider spread), while low-risk

borrowers will enjoy a savings from that shift.

325

It is at least possible, then,

that the inherent benefits of UACs for high-risk debtors might outweigh any

network benefit of being on the dominant network of CACs. That this was an

important explanatory variable in the failure of the pre-2003 market to

converge completely around the network-dominant UAC standard is suggested

319

See Choi & Gulati, supra note 5, at 961-63. Choi and Gulati develop a theory of such persistence,

based on the costs of larger, versus smaller, innovations. See id. at 945-46.

320

See supra notes 100-04 and accompanying text.

321

See supra notes 100-04 and accompanying text.

322

See Lemley & McGowan, supra note 98, at 592.

323

See Pamela Samuelson & Suzanne Scotchmer, The Law and Economics of Reverse Engineering, 111

ALE L.J. 1575, 1617-18 (2002).

324

See Choi & Gulati, supra note 5, at 965 (“Indeed, we expect that a range of preferences may exist

among countries for collective-action oriented modification terms. Some countries may desire UACs without

possibility of modification as a means of convincing investors of the countries’ low-risk of default.”).

325

See Portes, supra note 16, at 68-69; see also EICHENGREEN ET AL., supra note 14, at 4. At first glance,

this result may appear counterintuitive. The shift of lower-risk sovereign debtors to CACs ought to mean little

to the market, given the low risk of their default. High-risk debtors, on the other hand, ought to be rewarded

for their shift to CACs, given the consequently greater ease of handling their much more likely future debt

restructuring. Yet low-risk debtors gain, and high-risk debtors lose. The key to this puzzle lies in the central

emphasis of the sovereign debt markets on moral hazard. From the latter perspective, the high-risk debtors

with CAC bonds may be more prone to pursue restructuring, given its greater ease. The low-risk sovereign, by

contrast, is expected to be adequately constrained by the reputational harm attendant to any restructuring, and

will therefore avoid it, regardless of its greater or lesser ease, under CACs or UACs, respectively.

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by the relatively strong tendency of emerging market issuers to issue UAC

bonds under New York law, rather than MAC bonds under English law.

326

The persistence of a small network of UACs after the transition to CACs

may also be explained by diminishing or even declining network returns to

scale, beyond some point in the demand curve.

327

Thus, network gains may

accrue up to some level of use of a given term. At that point, sufficient use

may exist to produce the desired degree of interpretive network effects,

common practice network effects, and legal services network effects.

Additional adoptions beyond that point may offer little added network utility to

existing users.

328

In that case, users on a smaller, yet sufficiently large, network

would not be expected to shift to the dominant network. Even more

significantly, one might imagine a point beyond which use of a given term

begins to produce negative externalities. For example, a scarce supply of legal

or financial services may become more difficult or costly to access. Excessive

judicial review might also potentially produce too great a diversity of

interpretation, and hence an increase rather than decrease in uncertainty.

329

Given as much, the benefits of flexible regulatory cues becomes especially

evident, as compared with the public mandate of a particular majority standard

for collective action, a specific enumeration of good faith obligations, or the

transition to CACs generally. In essence, regulatory cues offer sovereign

debtors and their creditors freedom to define their preferred terms, and thereby

maximize efficiency gains. While some standardization can be predicted to

result from this process, given the presence of network effects, debtors and

creditors who find sufficient inherent value in preserving the non-network

standard can do so in a regulatory scheme characterized by cues rather than

coercion.

326

See Mody, supra note 17, at 14.

327

See Robert B. Ahdieh, Playing Games: Chicken, Battle of the Sexes, and the Model of Securities

Market Transition 13 (unpublished manuscript, on file with author).

328

See id. at 19.

329

See id. at 23; Klausner, supra note 39, at 777 n.65. Besides these network-specific points, it bears

noting that network tipping need not entail instantaneous change. Rather, a progressive transition is also

consistent with the presence of network effects. The present phase of transition may therefore exhibit a greater

degree of diversity than is likely to exist in the near future. This, in fact, comports with the pattern of

transition described by Choi and Gulati. See Choi & Gulati, supra note 5, at 969-71 (analyzing “big shift”

hypothesis).

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CONCLUSION

Freedom of contract is among the foundational features of the U.S. legal

system. Yet network-driven lock-in of contract boilerplate

and the

potentially related reliance on standard-form contracts

present some

challenge to contractual autonomy, broadly defined. If network effects

significantly restrain contracting parties in their selection of Pareto efficient

contract terms, their contractual freedom might fairly be seen as constrained.

In this Article, I have considered the potential lock-in of contract

boilerplate, and how such lock-in might be overcome, using the shift from

stasis to change in sovereign debt contracting as a salient example. But the

implications of the present analysis extend beyond the natural experiment of

sovereign debt contract transition. If network effects constitute an important

explanation of contract term lock-in, whether in sovereign debt contracts,

corporate or real estate contracts, or other standardized agreements, it is

important to consider whether there might be a broader regulatory role in

preserving contractual choice than is ordinarily acknowledged.

330

Public intervention may help to overcome network barriers to efficient

contracting, yet not create its own obstacles to freedom of contract, through the

noncoercive intervention of regulatory cues. At a minimum, such cues may

serve to displacebut not precludestatus quo equilibrium, and thereby

facilitate contracting parties’ election of efficient alternatives. Cues may also

offer beneficial information on the relative utility of preserving an existing

coordination equilibrium versus adopting an alternative. In these and other

ways outlined above, regulatory cues can serve to facilitate coordination

around efficient contracting norms.

It might be questioned, however, whether the lessons of sovereign debt

contracting emphasized in this Article can be applied outside the peculiar

330

Freedom of contract has long been a theme in the study of standard-form contracts and boilerplate

contract terms. Most commonly, it has been invoked to enforce boilerplate and other terms incorporated by

the drafter, in recognition of a “duty to read.” Llewellyn, conversely, cites freedom of contract for just the

opposite conclusion, arguing that rote enforcement of boilerplate terms eviscerates the freedom of the party

bound, who has not, in any meaningful sense, assented to the relevant terms. See K

ARL N. LLEWELLYN, THE

COMMON LAW TRADITION: DECIDING APPEALS 365-67 (1960). The network effects-driven pattern described

herein likewise challenges the freedom of contract, not of one party or the other, but arguably of both.

Network lock-in, and the resulting constraint on parties’ ability to avoid inefficient constructions, or to elect an

efficient alternative, is a distinct sort of challenge—but not an unimportant one—to freedom of contract in the

broadest sense.

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2004] BETWEEN MANDATE AND MARKET 761

institutional context of the international financial architecture. In particular,

official action would seem to stand more in the foreground of sovereign debt

contracting than it does in conventional contracting, in which public actors

would appear to play a lesser role. Yet this may be just the point: State action

may deserve a more prominent place in contracting environments



whether

international or domestic

in which standard terms are widely used.

It is not

evident, thus, that the relative prominence of official action in sovereign debt

contracting rests on any difference in kind with domestic contracting.

Relevant regulatory cues will surely have a distinct character and form in

different contracting environments, including international versus domestic

settings. When a coordination dynamic exists, however, regulatory cues may

still have an important role to play.

Just as the normative values of the freedom of contract favor a cueing

approach to public intervention in private contracting, the dynamics of

transnational regulation may also favor a reliance on regulatory cues. As

evident in the case of sovereign debt contracting, cross-border regulation is of

growing importance in today’s increasingly globalized marketplace. In areas

from antitrust to securities law, transnational coordination has become

essential to regulatory success. Regulatory cuesas a mechanism of

coordinationmay constitute a valuable implement in the toolkit of national

and international regulators. Through noncoercive cues, transnational policy

ends may be effectively pursued, while preserving norms of national

sovereignty and avoiding the extraterritorial application of law.

331

Regulatory cues, in this vein, may be a particularly useful tool in the hands

of constrained public regulators. Weak regulatory authoritywhether born of

normative design, as in the desire to maximize the freedom of contract; of

institutional constraints, as in the international regime; or of the recency of

national development, as in many transitional statesmay prevent reliance on

ordinary command-and-control regulation. In the presence of a coordination

dynamic, however, noncoercive cues may be an effective regulatory

alternative.

A cueing theory of law might thus be said to offer both negative and

positive lessons for theories of contract and transnational regulation. In the

negative, cueing theory posits that ordinary regulationwith its mandate and

331

To this effect, Anne-Marie Slaughter has suggested the growing importance of soft power in

international law and regulation given the inevitable limitations of hard power in the international sphere. See

LAUGHTER, supra note 266, at 4.

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762 EMORY LAW JOURNAL [Vol. 53

coercionmay not be necessary to overcome barriers to efficiency and

achieve efficient outcomes. In the positive, cueing theory offers an alternative

mode of public regulation. In the realm between the conventional poles of

mandate and the market, cueing theory suggests a pattern of regulation that is

at once adequate to achieve desired policy ends, yet restrained in its

interference with contractual and national autonomy.

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