U.S Corporate Bond Default: Do American Bond-Holders Have an Advantage Over Foreign Bond-Holders?

When a U.S corporate bond defaults, the question often arises: do American bond-holders have an advantage over foreign bond-holders, given their U.S. citizenship status? This article explores this issue and sheds light on the factors that truly matter in the recovery process.

Legality and Bond Holdings

The legal principle of pari passu (eleven Latin for "equal per step") ensures that bond-holders of the same class have the same standing in the event of a company default. This fairness in treatment can be traced back to international conventions and national laws, ensuring that bond-holders, regardless of their nationality, are treated equally under the law.

Collective Bondholder Actions

Typically, bond-holders, whether they are foreign or domestic, form groups to hire lawyers to negotiate with the company and even pressure it into bankruptcy. This collective action is a crucial aspect of the recovery process. Even if you were not part of the initial group, you can still participate in the bankruptcy settlement. Foreign bond-holders, in particular, can easily hire local attorneys to represent their interests. In fact, it is relatively common for foreign investors to be substantial bond-holders in many issuances, as evidenced by significant foreign institutional involvement in the 2008 Sub-Prime Mortgage Bond crisis.

Proportional Recovery

After a company defaults and goes into bankruptcy, the assets are sold off to pay off the banks and any remaining funds are distributed to the bond-holders proportionally. This means that all bond-holders, regardless of nationality, receive the same recovery rate. Whether a provider of 55 cents on the dollar or a more generous offer, it is the same for everyone.

Examples and Evidence

Some of the biggest bond-holders in the 2008 Sub-Prime Mortgage Bond crisis were foreign institutions, yet they received the same recoveries as American or other non-U.S. bond-holders. This reality illustrates that U.S. citizenship does not confer any legal advantage in the recovery process. The assets are sold and the funds are distributed according to the legal structures in place, without bias towards a particular nationality.

The Bottom Line

While it is true that American bond-holders may have more familiarity with the legal and regulatory environment of the United States, this advantage is often offset by the fact that foreign bond-holders can quickly and easily hire local legal representation. Regardless of nationality, bond-holders are legally entitled to the same treatment and recovery under the pari passu principle. The key to successful recovery in a default is often the strength of the bond-holders' collective action and legal representation, rather than their nationality.

For foreign bond-holders, understanding and leveraging the local legal landscape can be just as effective as for American bond-holders. This includes forming coalitions, hiring reputable local attorneys, and engaging in constructive dialogue with debtors.

Ultimately, the recovery process is fundamentally based on legal equality and the proportional distribution of assets, making the U.S. citizenship of bond-holders less relevant than commonly perceived.

Key Takeaways: U.S. corporate bond-holders share the same legal standing as foreign bond-holders in the event of a default. Collective action and legal representation are key factors in the recovery process. Proportional recovery applies to all bond-holders, regardless of their nationality. Foreign bond-holders can effectively participate in the recovery process through local legal expertise.