The emerging-markets hedge fund Gramercy Funds Management LLC has filed a Notice of Intent to pursue an international arbitration claim for $1.3bn damages against Peru. The claim relates to Gramercy’s holdings of Peruvian Agrarian Land Reform Bonds (“Land Bonds”), the value of which Peru has written down to near-zero. Gramercy’s legal representative describes Peru’s revaluation of these bonds as “deplorable conduct” and claims that it violates the terms of the US-Peru Trade Promotion Agreement (TPA).
The history of these bonds is rather colorful. In 1969, the leftist Government of Peru did a Zimbabwe, passing a Land Reform Act that allowed it to expropriate the land holdings of wealthy families and redistribute them to small farmers and laborers. Over the next ten years it expropriated and redistributed an area about the size of Portugal.
The Peruvian government agreed to compensate the landowners for the expropriation of their property by issuing bonds at 4-6% annual interest, to be repaid over 20-30 years. These are the Land Bonds that are the subject of Gramercy’s claim.
Such forcible interventions in land ownership rarely end well. Peru’s economy collapsed in the late 1970s, just as Zimbabwe’s did twenty years later. Despite (or, in part, because of)
And there matters rested for twenty years. But Peru’s economy did not stand still. From 1991 onwards, the Peruvian government enacted a series of reforms designed to lower trade barriers and encourage inward foreign investment. It entered into numerous bilateral trade treaties, including the US-Peru TPA, which was signed in 2006 and came into force in 2009. It is this treaty that Gramercy alleges Peru has violated.
As part of its reforms aimed at attracting foreign investment, in 2001 Peru revitalised the Land Bonds, revaluing them to current value and agreeing to honor them in full, a decision endorsed by the Peruvian Congress in 2006 and 2011. Foreign investors including Gramercy bought these bonds, attracted by the stable interest rate and evidence of Peru’s intention to repay them.
But in 2013, Peru decided to change the basis on which the revaluation of the bonds was done. And the new basis wiped out virtually all of their value.
In 2001, the revaluation was achieved by deflating with the prevailing rate of CPI over the lifetime of the bond. This effectively restored the original value of the bonds, wiping out the effects of the 1980s hyperinflation. But in 2013, Peru decided this would be too expensive, and instead opted for a “dollarization” method. Gramercy’s Notice of Intent explains how this worked:
The Government was directed to calculate the adjusted value of the Land Bonds by first indexing the existing obligations to the equivalent in U.S. Dollars at a so-called “parity exchange rate”, and second applying to that dollar-equivalent value the interest rate for United States Treasury Bonds.
In effect, Peru converted the bonds to the equivalent of US Treasuries.
That would have been fine if the exchange rate used had accurately reflected the improvement in the Peruvian economy since the currency conversion of 1991. But according to Gramercy, the formula used to calculate the parity exchange rate amplified rather than eliminating the effects of hyperinflation, and the resultant dollar value was less than one percent of the value of the bonds when deflated with CPI. And the interest rate applied to the dollarized bonds was that of the 1-year US Treasury – less than 1% - even though the bonds are of twenty to thirty years’ duration and originally carried 4-6% interest. The end result amounted to a 99.5% haircut.
The way in which the change in revaluation approach was approved is described by Gramercy as “shockingly tainted”. The decision was made by the Peruvian Constitutional Court or “Congressional Tribunal”, which is made up of senior members of the Peruvian judiciary. According to one of their number, Justice Carlos Mesía, the Tribunal originally decided to retain the CPI valuation method. But a few days later, the head of the Tribunal, Chief Justice Urviola, was visited out-of-hours by an emissary of President Humala. Gramercy’s description of what happened next is worth reproducing in full:
Everything changed after that visit. The following Tuesday, July 16, 2013, Chief Justice Urviola suddenly offered a new decision, one that rejected CPI in favour of dollarization. Chief Justice Urviola instructed Judge Eto to sign the new draft and falsely present it to the other Justices as if Justice Eto had been its author. Justice Mesía was stunned by this last-minute about-face. He refused to sign the new decision and demanded that Chief Justice Urviola afford him at least forty-eight hours to review the new draft and write his dissent, as the Congressional Tribunal’s internal rules required. However, Chief Justice Urviola did not allow Justice Mesia the time he was legally allowed to receive. Instead, that afternoon someone used significant amounts of white-out and a typewriter to transform the original majority opinion endorsing CPI into Justice Mesia’s dissent, erasing Justice Eto’s signature and the signature blocks for Justices Urviola and Alvarez.
Gramercy goes on to explain how the forged dissent allegedly allowed Chief Justice Urviola to use his casting vote to force through a decision in favor of dollarization. Corruption in the judiciary, eh?
Gramercy admits that the allegation of forgery appears far-fetched. But it then goes on to say that it is corroborated by sworn witness statements and by a forensic report from the Institute of Legal Medicine and Forensic Sciences, which includes multiple images of the “dissent” showing it to be “liberally splattered” with white-out. In December 2015, the secretary to the Congressional Tribunal, Oscar Diaz, was charged with falsification of court documents. The matter is now sub judice.
However, the dollarization decision stands. It was confirmed by Supreme Decrees in 2014. Unsurprisingly, attempts to persuade the Congressional Tribunal to overturn the Supreme Decrees failed. Gramercy and the other Land Bond holders have effectively been wiped.
But why does this (allegedly) constitute a breach of the US-Peru TPA?
Gramercy claims that the revaluation violates Peru’s international law obligations under the TPA on these grounds:
- It constitutes expropriation, in violation of Article 10.7;
- It fails to afford Gramercy the “minimum standard of treatment”, in violation of Article 10.5;
- It treats Gramercy less favorably than domestic investors, in violation of Article 10.3.
I am quite used to the legal representatives of creditors being extremely critical of the behavior of those who wish to impose losses upon their clients. After all, I have been following the HETA soap opera. But this statement from the Notice of Intent is pretty strong even by HETA standards:
Responsible States do not try to make US$5 billion of public debt – itself compensation for the expropriation of approximately US$42.4 billion of land – simply vanish by politically motivated court decisions adulterated with white-out, and executive decrees that falsely promise to pay the debt but in reality wipe it out.
Ouch.
This is, of course, merely the opening salvo in what promises to be a long-running and horrendously expensive legal battle. Peru will no doubt claim that it can’t afford to pay these bonds without terrible social costs: the creditors will equally argue that as one of the best-performing Latin American economies, it can and should. But as we have seen with Argentina, winning a case in the US courts and getting paid by a Latin American country are entirely different matters anyway. Stock up your popcorn now.
