What Happens When Bonds Are Defaulted On? Venezuela's Crisis Explained

Last month, ratings agencies declared Venezuela to be in selective default for failing to make $200 million in coupon payments due on global bond issuances. Soon after that announcement, Venezuela entered into a deal with Russia designed to give Venezuela financial flexibility. Venezuela has stated that it will meet its future debt obligations, but the continuing unrest and fiscal strain enveloping Venezuela have left creditors rightfully concerned about the risk of future defaults.

When a sovereign defaults on its debt, holders of defaulted bonds will generally negotiate with the sovereign to restructure the debt. Should those efforts fail, holders can sue the sovereign under the debt instrument and obtain judgment for the default. Now a "judgment creditor," the holder can enforce the judgment entered against the sovereign (now a "judgment debtor") in appropriate and generally international jurisdictions using various enforcement tools.

The first step in the enforcement process is generally the use of expansive post-judgment discovery and other information-gathering methods, such as the use of suitable investigative services, to discover where the sovereign transacts business and may have certain asset classes. Armed with that information, the judgment holder may then take any number of available enforcement steps. For example, the judgment holder can seek liens against the property of the sovereign; obtain orders restraining the sovereign or third parties from transferring assets in which the sovereign has an interest; or obtain an injunction restricting the sovereign debtor or third parties from taking actions that may impede the judgment holder’s ability to collect on its judgment.

Perhaps most critically, a judgment holder can also seek the seizure and turnover of certain categories of the sovereign debtor’s assets. Each of these measures can be used to recoup the judgment amount and provide the incentive to a sovereign debtor to negotiate on terms more favorable to the judgment holder.

Enforcing a judgment effectively and efficiently requires significant technical expertise: specific judgment enforcement procedures and methods vary by country and jurisdiction. Enforcing a judgment against a sovereign demands a deft hand because it involves unique considerations, not the least of which is the Foreign Sovereign Immunities Act, which protects certain classes of a sovereign’s assets from seizure. For that reason, it’s critical that holders of defaulted sovereign debt engage and obtain advice from experienced enforcement counsel.

It’s also imperative that enforcement counsel be engaged as soon as possible after the occurrence of a default: experienced enforcement counsel can be invaluable in helping shape pre-judgment discovery and even the way the judgment itself is drafted. Moreover, negotiating positions can change drastically depending upon actions taken (or not taken) by counsel early on in the dispute. For example, the Republic of Argentina’s historic public offer to holders of its defaulted debt last year gave a preference to bondholders that had obtained a judgment against the Republic; those that waited too long received less favorable offers.

This cannot be gainsaid: Holders of sovereign debt issued by countries like Venezuela would be well-advised to proactively develop a strategy with experienced enforcement counsel. Uninformed inaction and delay can have costly consequences.

Jay Auslander is a Managing Partner at Wilk Auslander focusing his practice in complex, large-scale judgment enforcement and distressed debt litigation.

Anthony Del Giudice is an Associate at Wilk Auslander and concentrates his practice on complex commercial and securities litigation, with a particular focus on the representation of investment banks, hedge funds and other participants in the financial services sector.