The harsh realities incurred by many African nations following decolonisation in the mid-twentieth century produced violent civil wars, extreme poverty and shortcomings in sustainable development. The strategy of European occupying powers to weaken the civilian population during colonialism in order to sustain control over Africa’s inhabitants, combined with the political posturing of both the West and the East vying for control of the arena during the Cold War, produced a pattern of underdevelopment and a failure by many African governments to provide their people with even the basic necessities.⁽²⁾ The effects of these practices by outsiders have left many nations across the continent reeling from a lack of stability, or racked with a difficult transition after long periods of civil war.⁽³⁾ Even today, these countries represent some of the poorest places on earth. The 26 countries, including the bottom 10, found among the bottom 30 in global economic indexes by posting the lowest figures for per capita gross domestic product (purchasing power parity (PPP), are all located on the continent.⁽⁴⁾ The average African lives on less than US$ 5 per day.⁽⁵⁾

These states are spread across the continent from West Africa to the Horn of Africa, and from Zimbabwe up to Mali.⁽⁶⁾ Despite certain individual nation’s recent economic success, no region of Africa has been spared from poverty and economic strife, which transcended the decolonisation and post-colonial periods. Many of the nations which possess such low earnings for the average citizen are also the recipients of large amounts of foreign aid, which constitutes over 10% of gross national income (GNI) in many African nations.⁽⁷⁾ These countries have been categorised as Highly Indebted Poor Countries (HIPC) by the International Monetary Fund (IMF) and the World Bank as part of an initiative for debt relief launched in 1996.⁽⁸⁾

Given the dire economic circumstances that many states face despite receiving large amounts of donor funding, alternative sources of income are required for governments to provide basic necessities as well as to further their long-term development strategies to alleviate citizens’ ongoing economic hardship. Some of these secondary forms of revenue are provided by international credit, loaned by one country to another.⁽⁹⁾ Often the debtors are unable to pay the balance within the allotted time, thus defaulting on the loans. This has created a secondary market in which these debts are bought and sold by various entities.⁽¹⁰⁾ Due to the inability to collect the funds, the creditor nation must attempt to salvage some return. They do this by selling the debt on the secondary market for pennies on the dollar.⁽¹¹⁾ This unfortunate circumstance has generated a new type of niche investment labelled a ‘vulture fund’, a financial conglomerate that preys on the poorest of nations for massive financial returns during a time when the state is most vulnerable. This practice is crippling many of the HIPCs globally, especially in the heart of Africa.⁽¹²⁾

This CAI article explores the history and logistics of vulture funds and exposes the harsh realities and scrutiny that accompany the actions of these investment organisations that prey on the world’s poorest nations. Finally, the piece briefly describes measures that have been taken by some countries and recommendations from various organisations to prevent these states from slipping further into debt, handicapping any efforts for sustainable long-term development that will help pull their citizens out of poverty by creating a strong middle class.

The history of vulture funds

A secondary debt market is not a new phenomenon, tracing its origins back to the early 1960s.⁽¹³⁾ The idea was to provide financial relief to lending institutions from bad debt - or loans that have defaulted. Initially the development of the secondary debt market was restricted to consumer accounts, namely bad credit card debt, but, by the 1980s, this market expanded to include corporate debt as well.⁽¹⁴⁾ Around the same time a small market between lending institutions arose to exchange sovereign debt in an ‘as is’ condition.⁽¹⁵⁾ As more countries requested bridge-loans or began defaulting on their debt, the market evolved to sell the debt to third-party investors at reduced costs to generate cash.⁽¹⁶⁾ This created the modern secondary sovereign debt market.

According to Sandoval (2002)⁽¹⁷⁾ the concept of vulture funds - originally labelled holdout creditors - was introduced to the secondary sovereign market in the mid-1990s, when the architecture for sovereign borrowing changed from bank loans to bonds, thus opening the market to previously restricted investors. This shift in the sovereign debt paradigm created a loophole in which newly established bondholders were not obliged to work with the country on a restructuring plan. A major player on the current vulture fund market, Paul Singer and his investment firm, Elliott Management, purchased US$ 20 million in Peruvian bank debt in the form of bonds in 1995 at approximately half of the original value. Elliott then sued the country and was awarded US$ 56 million by a New York Appeals Court. In order to obtain the funds awarded in the judgement, Elliott pursued several restraining orders blocking Peru from satisfying other debts to creditors while ignoring its obligations to Elliott Management. A court in Brussels ruled that, “Peru was attempting to make payments in violation of a principle of equal treatment (pari passu clause) among foreign creditors.”⁽¹⁸⁾ This meant that Peru could not distinguish between creditors, but that it had to pay each creditor pro rata. Peru was forced to pay the debt to Elliott so they would not default on other outstanding loans, or be held hostage by the decision achieved by Elliott Management. This pioneer case opened the door for vulture funds to emerge as a genuine threat to the sovereign secondary debt market and poor indebted states worldwide.

During the time of the first vulture fund case, the IMF and World Bank laid the groundwork for a revolutionary programme to assist in debt relief for poor nations. In 1996, the Heavily Indebted Poor Country Initiative was launched, and then enhanced in 1999.⁽¹⁹⁾ This agenda reduced the global debt-burden threshold, opening the door for more nations to reap the benefits of debt relief.⁽²⁰⁾ By reducing the cost of debt service and providing earlier assistance for debt alleviation, the initiative consequently raised the funds available for the state’s poverty reduction strategy (PRS).⁽²¹⁾ This cooperation between lenders and international economic organisations created a scenario in which HIPCs could direct funds normally appropriated for debt service payments towards development programmes that would reduce poverty and increase long-term developmental infrastructure projects.⁽²²⁾ However, many of the achievements of the HIPC Initiative were undone through vulture fund litigation after the Elliott case opened the door for other investment conglomerates to enter the fray in the secondary sovereign debt market.⁽²³⁾ In addition, the case also outlined the steps and strategies that new vulture fund companies would follow to achieve massive gains at the expense of poor nations.

The logistics and harm of vulture funds

A vulture fund is a label given to a firm that makes money from purchasing debt on the secondary market for pennies on the dollar. Contrary to other lending agreements, vulture funds refuse to enter into any bilateral restructuring negotiations.⁽²⁴⁾ Instead, the company sues the sovereign debtor for the full value of the loan, plus interest, arrears and the cost of litigation, which in total equals 3-20 times the original purchase price of the loan. The lawsuits are generally held in European or United States (US) courts and take years to officially settle.⁽²⁵⁾ The amounts awarded by the court can be crippling to the sovereign nation, at times composing 13% of the country’s gross domestic product (GDP).⁽²⁶⁾

Once the judgement is handed down by a court, the debtor country is literally held hostage by the vulture fund creditor.⁽²⁷⁾ The ruling in the Elliott Management versus Peru case by the Brussels court is crucial to the process as it set a precedent for vulture fund collection and hampered the normal process of sovereign loan restructuring. Due to the vulture funds’ unwillingness to enter into restructuring or alleviation negotiations to reduce loan payments or prevent default, money that would normally be redirected towards development projects and poverty reduction strategies are now mandated, through the clause of pari passu, to be distributed among all creditors pro rata, or else the debtor country is prevented from restructuring loans with other creditors.⁽²⁸⁾

This process has granted these investment firms a great deal of success. Since this lucrative process began, vulture funds have won 25 settlements against debtor countries, yielding nearly US$ 1 billion in returns.⁽²⁹⁾ And since many of these organisations operate in tax-friendly havens such as the British Virgin Islands, returns on investments grow even larger.⁽³⁰⁾ Although many of these investment firms are owned by hedge funds, often there is little-to-no information on their umbrella group.⁽³¹⁾ Sometimes organisations are established simply to pursue one case and then they are shut down upon completion.⁽³²⁾

The effect on Africa

As of mid-2011, African countries dominated the HIPC list, making it by far the most vulnerable continent to vulture fund suits. African countries made up 26 of the 32 post-completion-point HIPCs, three of the four pre-decision-point HIPCs and all four interim HIPCs.⁽³³⁾ By constituting 33 of the 40 HIPCs, Africa makes up over 80% of the countries either eligible for debt relief or vying to become eligible under the joint IMF and World Bank initiative. Unfortunately, this situation puts these nations in a position to be preyed upon by vulture funds. Three particularly devastating cases of vulture fund litigation will be examined to show the negative impact this has had on development and poverty reduction.

The case of the Republic of Congo

Building on the success of his case against Peru, Paul Singer and Elliott Management purchased US$ 30 million of debt owed by the Republic of Congo from the 1980s at an undisclosed price.⁽³⁴⁾ Elliott then sued the country for the full debt plus interest, and was awarded more than U$ 100 million in 2002.⁽³⁵⁾ Since then Elliott has managed to wrangle US$ 39 million of the country’s oil sales, as the money that is raised through oil profits can be seized by Elliott until the debt is repaid, thus  directing the profits away from the state.⁽³⁶⁾ Elliot seems poised to continue to control oil profits until the awarded sum is made whole. This means that the country’s most profitable industry will continue to be hampered by the negative investment judgement as it prevents a very profitable industry from having any impact on development.

The case of Zambia

In 1979, the government of Zambia bought agricultural equipment from Romania on credit.⁽³⁷⁾ When it became clear that Zambia would be unable to fulfil the terms of the debt, the two countries agreed to liquidate it in 1999 as part of a debt relief programme.⁽³⁸⁾ However, at the eleventh hour, a third-party investment firm, Donegal International, purchased the debt for the purpose of vulture litigation. The original value of the debt was US$ 15 million.⁽³⁹⁾ Donegal managed to buy the debt for approximately US$ 3 million and immediately sued Zambia, seeking a total settlement of US$ 55 million.⁽⁴⁰⁾ In 2006, the British High Court ruled in favour of Donegal and ordered Zambia to pay US$ 15.4 million to the investment firm, or 65% of the total relief under the Multilateral Debt Relief Initiative (MDRI), a 2005 enhancement of the HIPC Initiative.⁽⁴¹⁾ This means that a large portion of the funds designated by world financial institutes for poverty reduction strategies now has to be paid to an outside investment entity. This is a prime example of how progress made by an HIPC can be erased by vulture funds. Donegal was established in the British Virgin Islands with the sole purpose of handling the suit against Zambia.⁽⁴²⁾ The owner of Donegal, Michael Sheehan, is also the owner of the Washington-based company Debt Advisory International (DAI), a firm that was instrumental in setting up the conditions for the vulture fund claim against the Democratic Republic of Congo (DRC).⁽⁴³⁾

The case of the DRC

Throughout his tenure, the former leader of the DRC (then known as Zaire), Joseph Mobutu Sese Seko, created a system that would be forever be known as ‘kleptocracy’, as he pillaged the country’s coffers, redirecting the funds to his own personal finances, amassing a wealth that once was estimated to range between US$ 8 billion and US$ 10 billion.⁽⁴⁴⁾ In the 1980s, Zaire borrowed US$ 30 million from a Bosnian energy company for a development project that never came to fruition.⁽⁴⁵⁾ With the help of DAI, an American-based vulture fund called FG Hemisphere, run by former Morgan Stanley consultant Peter Grossman, purchased the debt for US$ 3 million.⁽⁴⁶⁾ FG sued the DRC for US$ 100 million in 2010.⁽⁴⁷⁾ Using a loophole in the legal system on the tiny channel island of Jersey, FG was awarded the full sum to be paid by the state-owned mining company Gécamines.⁽⁴⁸⁾ However, in 2012, the Judicial Committee of the Privy Council - the final court of appeals for all British dependencies, including Jersey - blocked the judgement, ruling that the mining company was not responsible for the debts of the DRC.⁽⁴⁹⁾ The sale of the debt to DAI and FG has recently come under further scrutiny as the former Bosnian Prime Minister, Nedzad Brankovic, has been charged with corruption for negotiating and approving the sale with Sheehan without authorisation from the Bosnian government.⁽⁵⁰⁾ FG Hemisphere has now attempted to pursue the debt through other avenues and legal systems from those of the US to Hong Kong.⁽⁵¹⁾ The outcome is still pending.

While there has been no definitive damage done to the DRC yet, if the full sum of the Jersey ruling can be obtained elsewhere, coupled with the Belgium judgement, the DRC - the world’s poorest country in terms of per capita GDP - will take a substantial economic hit that can reroute funds that can be used for development projects or poverty reduction strategies under the HIPC Initiative.

Conclusion

Vulture funds are the lowest form of capitalist greed. The investment firms were designed to prey on the weakest states across the globe for their own financial gain by seizing funds intended for development. Their methods of hiding ownership, functioning in offshore tax havens and establishing ‘fly-by-night’ operations to carry out their suits clearly show that they recognise that their goals are less than reputable. In addition to preying on economically weak states, they rob the taxpayers of donor countries by refusing to pay taxes on gains and forcing developing countries to pay aid money given to them by donor nations and intended for future development projects.

Advocates of vulture funds claim that they are only stealing from corrupt Third World political elites and that the money taken from the countries’ coffers would never actually reach the people who truly need it.⁽⁵²⁾ While corruption remains a harsh reality in many HIPCs, the idea that the money should instead be redirected to wealthy investors is myopic. How will these countries emerge from the dregs of the least-developed if their funds are greedily confiscated by foreign investors? Also, given the case of the DRC, it seems the investment firms can be party to corruption and false dealings during their transactions in order to hoard large profits. The vulture funds undermine everything that the multilateral financial organisations have accomplished to assist countries in their goal to create strong economies.

The threat to Africa that these suits pose is indeed grim. African nations populate the HIPC lists and many are among the world’s poorest nations, making them vulnerable to vulture suits. With a reported US$ 1.47 billion in outstanding lawsuits against African nations, the fight has just begun. Furthermore, with the success of previous cases, the potential for more vulture fund cases lingers. While the United Kingdom has passed legislation limiting the amount a creditor can recover from an HIPC, in order to stop the practice, the international community must unite in similar actions to prevent investors from further undermining global development.⁽⁵³⁾

In an attempt to hamper or discourage vulture fund activity, Jubilee USA has outlined a seven-step process to change global policy. This includes limiting profits, increased vulture fund transparency, the introduction of an international bankruptcy framework and obtaining commitments from creditors to refuse sale of HIPC claims to entities that will not provide debt relief.⁽⁵⁴⁾ While these efforts would be effective strategies to curb vulture funds, places like the US and Europe must commit to such manoeuvres in order to prevent sovereign debt litigation for HIPCs within their borders. The quickest way to eliminate the threat is to remove the forum for investment firms to profit from vulture fund activity, and hence to adjust the court system they so easily exploit. Vulture funds are a very real threat to the developing world, and their greedy ambitions should be prevented before they harm another adolescent economy, undermining vital debt relief practices.

Written by Daniel R. Donovan ⁽¹⁾

NOTES:

(1) Contact Daniel R. Donovan through Consultancy Africa Intelligence’s Africa Watch Unit ( africa.watch@consultancyafrica.com). This CAI discussion paper was developed with the assistance of Claire Furphy and was edited by Nicky Berg.
(2) Talton, B., ‘The challenge of decolonization in Africa’, The Schomberg Center for Research in Black Culture, 2011, http://exhibitions.nypl.org.
(3) Ibid.
(4) ‘Country comparison: GDP per capita (PPP)’, CIA World Factbook, 1 July 2012, https://www.cia.gov. 
(5) Ibid.
(6) Ibid.
(7) ‘Geographical distribution of ODA: ODA receipts and selected indicators for developing countries and territories’, OECD, 20 December 2012, http://www.oecd.org.
(8) ‘Debt relief under the heavily indebted poor countries (HIPC) initiative’, The International Monetary Fund, 10 January 2013, http://www.imf.org.
(9) ‘Vulture funds in the sovereign debt context’, African Development Bank Group, 2013, http://www.afdb.org.
(10) Ibid.
(11) Ibid.
(12) Ibid.
(13) Gerety, V., ‘Bad debt marketplace: The emerging secondary market’, VGA Advisors working paper, 2009 http://vgadvisors.com.
(14) Ibid.
(15) Power, P.J., 1996. Sovereign debt: The rise of the secondary market and its implications for future restructurings. Fordham Law Review, 64(6), pp. 2701-2772.
(16) Ibid.
(17) Sandoval, E.L.L., ‘Sovereign debt restructuring: Should we be worried about Elliott?’, Harvard Law School International Finance Seminar, May 2002, http://www.law.harvard.edu.
(18) Ibid.
(19) ‘The enhanced HIPC Initiative - overview’, The World Bank, 2013, http://web.worldbank.org.
(20) Ibid.
(21) Ibid.
(22) Ibid.
(23) The World Bank estimates that more than one third of the states that qualify for debt relief have likewise been targeted by vulture funds for litigation. ‘Vulture funds in the sovereign debt context’, African Development Bank Group, 2013, http://www.afdb.org.
(24) Ibid.
(25) Ibid.
(26) Ibid.
(27) Fukuda, K., ‘What is a vulture fund?’, The University of Iowa Center for International Finance and Development, May 2008, http://ebook.law.uiowa.edu.
(28) Ibid.
(29) ‘Vulture funds in the sovereign debt context’, African Development Bank Group, 2013, http://www.afdb.org.
(30) ‘Vulture funds and poor country debt: Recent developments and policy responses’, Jubilee USA, 2008, http://www.jubileeusa.org.
(31) Ibid.
(32) Ibid.
(33) Canuto, O. and Moghadam, R., ‘Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiative (MDRI) – Status of implementation and proposals for the future of the HIPC Initiative’, The International Development Organization and the International Monetary Fund, 8 November 2011, http://www.imf.org.
(34) Polgreen, L., ‘Unlikely ally against Congo Republic graft’, The New York Times, 10 December 2007, http://www.nytimes.com.
(35) ‘Vulture funds - the key players’, The Guardian, 15 November 2011, http://www.guardian.co.uk.
(36) Ibid.
(37) ‘Vulture funds and poor country debt: Recent developments and policy responses’, Jubilee USA, 2008, http://www.jubileeusa.org.
(38) Ibid.
(39) ‘Vulture funds - the key players’, The Guardian, 15 November 2011, http://www.guardian.co.uk.
(40) ‘Vulture funds and poor country debt: Recent developments and policy responses’, Jubilee USA, 2008, http://www.jubileeusa.org.
(41) Ibid.
(42) Ibid.
(43) ‘Vulture funds - the key players’, The Guardian, 15 November 2011, http://www.guardian.co.uk.
(44) Maykuth, A., ‘A kleptocracy collapses - years of looting by Zaire’s Mobutu coming to an end’, The Seattle Times, 11 May 1997, http://community.seattletimes.nwsource.com.
(45) ‘Vulture fund case studies’, Jubilee USA, 2007, http://www.jubileeusa.org.
(46) Ibid.
(47) Ibid.
(48) Neate, R., ‘Privy council blocks 'vulture fund' from collecting $100m DRC debt’, The Guardian, 18 July 2012, http://www.guardian.co.uk.
(49) Ibid.
(50) ‘Vulture fund case studies’, Jubilee USA, 2007, http://www.jubileeusa.org.
(51) ‘Vulture funds - the key players’, The Guardian, 15 November 2011, http://www.guardian.co.uk.
(52) Joyce, E., ‘Congo's victory against a “vulture fund”' is hollow’, The Guardian, 19 July 2012, http://www.guardian.co.uk.
(53) Tran, M., ‘Can vulture funds be prevented from preying on poor countries?’, The Guardian, 16 November 2011, http://www.guardian.co.uk.
(54) ‘Vulture funds and poor country debt: Recent developments and policy responses’, Jubilee USA, 2008, http://www.jubileeusa.org.