Sovereign Immunity and Sovereign Debt

Abstract

The law of foreign sovereign immunity changed dramatically over the course of the 20th century. The United States abandoned the doctrine of absolute immunity and opened its courts to lawsuits by private claimants against foreign governments and officials. It also pursued a range of other policies designed to shift such disputes into litigation or arbitration (and thus relieve political actors of pressure to intervene on behalf of disappointed creditors). This article explores how international financial contracts responded to these legal and policy initiatives and presents findings with implications for our understanding of sovereign immunity law, for debates about the role of litigation in the current financial crisis, and for contract theory.First, although the decision to abandon the doctrine of absolute immunity was a major legal and policy shift - one that has rightly captured the attention of legal scholars - it had little practical significance for investors. Indeed, investors seemingly dismissed these developments as irrelevant to their prospects for enforcing the government’s promise to pay. Second, and relatedly, worries that litigation may disrupt efforts to restructure government debt may be overblown, especially to the extent these fears center around the ability of creditors to enforce judgments through seizure of sovereign assets. The findings presented here suggest that such fears are overstated and lend support to theories that discount the relevance of legal enforcement in the sovereign debt markets. Finally, contract theory posits that sovereign bonds and other boilerplate financial contracts will rarely change in the absence of a financial crisis or other exogenous shock. This article, however, demonstrates that the Foreign Sovereign Immunities Act of 1976 prompted a large but seemingly symbolic shift in contracting practices, as bond contracts adjusted to incorporate largely-ineffectual sovereign immunity waivers. The episode suggests that contract theory should recognize that a wider range of forces may prompt standardized contracts to change.