The Coroner's Inquest: Ecuador's Default and Sovereign Bond Documentation
Conventional wisdom is that sovereigns will rarely, if ever, default on their external debts in circumstances where it is clear that they have the capacity to pay. The first line of defense against the errant sovereign is its concern about reputation. It may have to tap the external debt markets again in the future; and there is the fear that the markets will extract revenge. But reputational constraints do not always work because some governments heavily discount future costs in favor of current benefits. When reputational constraints fail, however, a second line of defense is supposed to come into play. That line of defense is comprised of contractual and legal remedies. Both lines of defense broke down in the case of Ecuador’s default in late 2008. The breakdown of the second line of defense is significant because this was the first time that the modern theory of supermajority creditor control of sovereign debt problems was tested in practice. This Article begins the coroner’s inquest into the reasons for this breakdown and how similar situations might be averted in the future.