Response by Professor Weisburd

by Mark Weisburd

Odette Lienau’s Who is the “Sovereign” in Sovereign Debt? provocatively argues that Chief Justice Taft’s method of analysis in his 1923 arbitral award in the so-called Tinoco arbitration offers a useful approach to controversies over so-called odious debts owed by states, that is, debts incurred for purposes unrelated to the well-being of the population of the state responsible for the debt. Lienau argues that Taft applied what she calls a “rule of law” approach, making the enforceablility of the obligations in question in that arbitration dependent upon the compliance of the regime incurring the debt with its own law. Such a rule, she argues, would provide some protection of a population against a corrupt government while establishing a relatively objective standard against which lenders could evaluate the risk that any particular debt would not be paid. Lienau contends that such a mode of analysis would avoid the difficulties posed by the two other most common ways of addressing odious debt situations.

One of these approaches, which Lienau labels “statist,” enforces against a state all debts formally attributable to that state. This view is justified as necessary to avoid throwing credit markets into confusion; it is problematic because it would require a state to bear the burden of all debt concluded in its name, even those debts incurred in the name of the state by officials whose intentions to steal the borrowed money were obvious at the time of borrowing. The other approach focuses on the popular legitimacy of the regime incurring the debt, and makes the enforceability of the debt dependent on the purpose for which the debt was incurred and to which the proceeds of the borrowing were applied. The advantage of this view is that the state would not be responsible for debts incurred in its name but conferring no benefit on its population; the disadvantage is that it makes the enforceablility of debt uncertain at the time the debt is concluded, in turn reducing the willingness of lenders to deal with any government not both perfectly democratic and perfectly incorruptible.

Lienau is certainly correct that the binary choice to which she objects is undesirable. It is absurd to impose the burden of the loss from a theft on the victims rather than on the thief, but it is also unreasonable to expect lenders to lend money in the knowledge that they may be denied repayment on the basis of vague standards whose applicability in a particular case may be difficult to determine. Unfortunately, it is not clear that the approach Chief Justice Taft actually took in the Tinoco arbitration will do the work Lienau asks of it.

To explain this conclusion, it is necessary to describe the two claims Taft addressed. One was brought on behalf of a British firm whose oil concession, granted by the Tinoco regime of Costa Rica, was cancelled by the government which was elected to power after Tinoco’s overthrow. The other was brought on behalf of a British bank which had extended credit to the Tinoco regime by honoring checks, totaling $200,000 in American money, drawn on a Costa Rican government account with the bank and payable, in essence, to Tinoco himself and to his brother. The Costa Rican account had been established by the deposit in the British bank of certain notes issued by the Tinoco government; the bank’s claim arose when the successor government refused to pay the notes.

Taft ruled for Costa Rica on both claims. As to the concession agreement, Taft concluded that a crucial provision, exempting the concessionaire from certain taxes, had been entered into in violation of the Costa Rican constitution, and was both unenforceable itself and so central to the agreement as to render the entire agreement unenforceable. As to the notes held by the British bank, Taft concluded that it was so obvious at the time the checks were drawn that the $200,000 was for the personal use of the Tinoco brothers rather than for governmental purposes that the bank simply could not enforce the debt against Costa Rica.

While these determinations at first blush seem to support Lienau’s argument, closer examination renders that conclusion doubtful. In the first place, as Taft noted, the concession agreement itself provided that “disputes in respect to . . . execution of this contract shall be . . . decided according to the laws of Costa Rica.” Taft was therefore not somehow crafting his own approach to resolving this matter. Rather, he was applying the internal law of Costa Rica in a case where the agreement giving rise to the claim expressly made that law applicable. To be sure, Taft did not explicitly state that Costa Rican law governed because of the language of the concession agreement; rather, he stated that “[the concession’s] validity is, as I have already said, to be determined by the law in existence at the time of its granting; and that means the law of the government of Costa Rica under Tinoco.”

Unfortunately, it is not clear where in the preceding portion of his award Taft had taken that position. The most logical explanation is that his reference is to the article of the concession agreement he had quoted earlier. This part of Taft’s award, then, appears to stand for no more than that local law should govern a contact if the contract expressly so provides, a proposition of fairly limited utility.

As to Taft’s disposition of the claim of the British bank, the problem for Lienau’s argument is about the reverse of that just discussed. Whereas the parties’ agreement appears to have been Taft’s basis for relying on Costa Rican law as to the concession agreement, it is not even clear that Costa Rican law was the source of the rule of law Taft applies to the bank’s claim. He states:

[The bank] must make out its case of actual furnishing of money to the government for its legitimate use. It has not done so. The bank knew that this money was to be used by the retiring president, F. Tinoco, for his personal support after he had taken refuge in a foreign country. It could not hold his own government for the money paid to him for this purpose.

What law imposed this obligation on the bank is not stated; certainly, Taft does not explicitly ground this obligation in the internal law of Costa Rica. The result regarding the bank, then, cannot be ascribed to the approach to sovereign debt advocated by Lienau, and the analysis Taft actually employed would not offer the advantage to creditors to which Lienau refers. That is, it is not clear that creditors’ uncertainty would be reduced if other tribunals followed Taft’s method of analysis of the bank’s claim, since it is not clear that Taft relied on a standard that the bank would have realized was applicable at the time of the transaction, even if it had assumed that its rights depended on Costa Rican law.

The bank’s claim provides a problematic precedent for a second reason. As the foregoing quotation indicates, Taft based his determination on his conclusion that the bank knew that it was paying money for Tinoco’s personal use, that is, that he was stealing the money. Indeed, he quotes “an agent of the bank” as stating that it was clear that Tinoco was about to fall at the time of the initial deposit of Costa Rican government notes. The Tinoco case, that is, was an extreme one. The dishonesty of the transaction was obvious as soon as the checks were presented to the bank. It is not at all clear how Taft would have dealt with a case where the matter was not so obvious to a lender at the time of the transaction, and thus not clear how broad the range of application of his rule would really be.

Odette Lienau is to be commended for devising an original approach to the odious debt dilemma. Her proposed solution, however, needs work.

http://opiniojuris.org/2008/06/10/response-by-professor-weisburd/

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