Saddam's evil debts

The bill calls most of Iraq's debt "odious" — a reference to the legal doctrine of odious debts that was outlined by a legal scholar in the 1920s in response to debt repudiations of the day…With respect to past loans, where the regime was dictatorial and oppressive, the creditor knew or ought to have known that to provide money without any questions asked, was to strengthen the regime. No creditors could in good faith defend such loans.

National Post
October 23, 2003

Saddam's evil debts
Iraq's outstanding loans were incurred without the population's consent, as creditors likely were aware, and such 'odious debt' deserves to be forgiven
Jeff King

Western governments and their bilateral financial agencies are congregating in Madrid today to decide how much to contribute to Iraq's reconstruction. Some of the aid may be offered in the form of new grants; others in the form of debt relief. One topic that will be on no Western donor's lips, but on all of their minds, is the possibility that Iraqis decide to aid themselves by repudiating many of the foreign debts Saddam accumulated for the purpose of oppressing them.

At the same time that the donors are meeting, legislation that could aid an Iraqi repudiation is before the U.S. Congress. Last summer, a Democrat and a Republican representative jointly introduced the Iraqi Freedom from Debt Act. The bill calls most of Iraq's debt "odious" — a reference to the legal doctrine of odious debts that was outlined by a legal scholar in the 1920s in response to debt repudiations of the day. It calls upon the Secretary of the Treasury to use U.S. influence at the World Bank and International Monetary Fund to cancel their Iraqi debt.

While helpful, the US$150-million owed to these institutions is a small dent in the overall Iraqi external debt (excluding reparations), estimated at well over US$110-billion. Yet the initiative reflects a surge in recent concern over the legitimacy of Iraqi debt, with articles or editorials in the Washington Post, the Financial Times, and, earlier this week, The Economist. Public calls for cancellation have come from the influential Pentagon advisor Richard Perle, among others.

The international legal doctrine of odious debt deems loans unenforceable when they did not benefit a debtor state, they did not have its population's consent, and the creditors were aware of both of these circumstances. The debtor state has the burden of proving each element. Though the doctrine is contestable under international law, there is certainly enough state practice, domestic law analogy and learned writing to support a strong argument in favour of its application.

With the prevailing view that most Iraqi debt will be restructured or cancelled, potentially in reference to this doctrine, creditors fear the consequences of setting an odious debt precedent. Yesterday's Wall Street Journal expressed this concern in warning that lenders, at a minimum, would demand a higher risk premium. This is based on the assumption that the doctrine would create instability in future lending. However this concern is misleading. Creditors can create "odious-debt proof" loan agreements and bond offerings by following two conditions.

First, the doctrine can only be invoked legitimately by a properly constituted international tribunal and not by governments acting unilaterally. Western nations, using well accepted practices, have commonly employed such tribunals to resolve international disputes. Second, creditors must act diligently to insure that the proceeds of their loans or bond purchases are applied to specific public purposes. The international community and market forces can see to the first condition, while creditors must see to the second. Giving a fair outlet for legitimate protest would likely only diminish the prospect of unilateral repudiation.

In much direct lending and project financing today, the parties have a clear idea of the purpose of the loan and the borrower becomes bound by an elaborate set of representations and warranties. Often, the funds are disbursed periodically according to the fulfilment of these conditions, failing which the loan is cancelled and the debt becomes due immediately. However, much sovereign borrowing today takes place through bond offerings on international capital markets. In these cases, there is a less direct dialogue between borrower and lender. The use of proceeds is still usually identified, but to a less specific level than in earlier syndicated bank lending. The creditor has less control in structuring terms, but just as much reason to inquire after the use of proceeds. The odious debt doctrine provides a market incentive for states and creditors alike to insure valid public purposes for public debt.

With respect to past loans, where the regime was dictatorial and oppressive, the creditor knew or ought to have known that to provide money without any questions asked, was to strengthen the regime. No creditors could in good faith defend such loans. Where they were diligent in ensuring the proceeds were applied to public purposes (Japan's past loans to Iraq to build roads and other infrastructure would be an example), the debtor state could not make out a legitimate argument under the doctrine. If the monies were illicitly redirected, without the creditor's knowledge, the loans would still remain valid.

With debt traded on secondary debt markets, where creditors buy up sovereign debt for a fraction of its value and hope to eventually sue or sell for a much higher amount, establishing a debt's bona fides need not differ. The Economist in April referred admiringly to firms that "specialize in the debt of 'pariah' states." In such cases, buyers walk in with their eyes open; they know or ought to know that such debts were contracted by dictators without the consent and against the interests of the population. Holders of such debt cannot claim good faith; these are called vulture or pariah funds for a reason.

All told, the doctrine of odious debts protects against arbitrary state action and provides creditors with strong security vis-à-vis future loans. If properly applied, the doctrine would discourage lending to dictatorial regimes, and promote creditor scrutiny of loans of an allegedly public nature. This makes financial, moral and legal sense, from whichever perspective you look at it.

Jeff King is a legal research fellow at the Montreal-based Centre for International Sustainable Development Law.

© Copyright 2003 National Post


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