Edited by Jürgen Basedow, Giesela Rühl, Franco Ferrari and Pedro de Miguel Asensio
Chapter B.10: Bonds and loans
I. Definition and concept
1. Content and parties
Bonds and loans are means of enterprises and states to raise capital. Repayment is limited to fixed periods in which interest accrues. Differences between bonds and loans are based on how capital is raised. Bonds tap directly into the financial market. Prospective financiers are individual investors who buy the bond. Loans are offered by banks. They function as intermediaries between investors and borrowers.
2. Legal nature
Bonds and loans are basically contracts. They may be characterized more specifically as p. 215credit agreements. Their structures are highly complex. A bond issuance generally involves a group of banks known as the ‘underwriting syndicate’. It places the bond onto the financial market. Syndicate members usually rely upon a sophisticated network of branches to facilitate the bond issue. Similarly, a cross-border loan transaction also involves a group of banks known as the ‘loan syndicate’. Its members typically work together to supply the loan and to offset risk.
Relations between syndicate members are generally defined by proportional commitments. Each bank benefits from and is liable up to its own contribution. They may also assume other responsibilities like acting as facility agents for instance. Additional parties may also be involved, eg a trustee, a fiscal agent, a paying agent or a calculation agent. It follows that a bond or loan is less a single contract and more a contractual network of parties linked together by a number of agreements.
Characterizing bonds is further complicated by the fact that they are traded on so-called secondary markets where holders sell their bonds to other individual investors. Bonds are therefore not only agreements (negotium) but also instruments (instrumentum), ie assets valued in commerce. In many legal systems they are characterized as ‘negotiable instruments’ or ‘financial instruments’. In this capacity they are subject to particular rules (→Financial instruments).
3. Domination by standard terms
Techniques used to structure bonds and loans are elaborate. Extensive documentation is necessary in order to determine the rights and obligations of the parties, but also to determine the rights and obligations of the parties, but also to fulfil regulatory requirements. An international bond issue for example usually involves: a prospectus; a subscription agreement; an invitation telex; a paying agency/fiscal agency agreement; a trust deed; a deed of covenant; an agent bank agreement or calculation agency agreement; and the form of the global bond or definitive bonds containing the terms and conditions of the issue (see Agasha Mugasha, The Law of Multi-Bank Financing: Syndicated Loans and the Secondary Loan Market (OUP 2007) 402). These documents are provided by large international law firms that support clients who execute such financial transactions. They rely mostly upon templates or standard agreements that are supplied by professional and industry bodies. The International Capital Market Association (ICMA) for example offers industry standard documentation for bonds. The Loan Market Association (LMA) offers similar standardized terms for loans. Through standard models, financiers voluntarily adopt the legal regime that supports the object of their investment. The uniformity achieved is crucial for reducing transaction costs and increases the marketability of the loan or bond.
Standard terms describe the parties’ rights and obligations with a high degree of precision and detail in order to avoid uncertainty in meaning and to reduce risk in interpretation. Professional and industry bodies continually update the respective texts in order to respond to new economic and legal developments. These terms have noticeably evolved over time. Many of the clauses are innovative. Modern government bonds for example frequently include so-called collective action clauses (CACs). They allow creditors to take concerted action to restructure debt and to modify terms when a debtor is unable to meet his or her obligations. So-called index or gold clauses serve to secure repayment obligations against inflation. Another typical term is the pari passu clause. It aims to ensure that all bondholders are placed on an equal footing. Among the many covenants included in a loan agreement are clauses relating to the consequences of a default, payment procedures and permissibility of →set-off (for an overview, see eg Charles Proctor, The Law and Practice of International Banking (OUP 2010) paras 20.12–20.47). They also contain so-called acceleration clauses under which the lender has a right to terminate the agreement and demand repayment as soon as a certain event occurs such as when the borrower threatens to become insolvent. This type of clause is designed to protect the lender from the risk of non-performance.
The practice of lending money has existed as long as money itself (→Money and currency). Syndicated loans, which now dominate modern cross-border lending, are however a more recent phenomenon (on history, see Yener Altunbas, Blaise Gadanecz and Alper Kara, Syndicated Loans: A Hybrid of Relationship Lending and p. 216Publicly Traded Debt (Palgrave Macmillan 2006); Edwin Borchard, ‘International Loans and International Law’ (1932) 26 ASIL PROC 135).
Bonds emerged from commercial practices that originated in Northern →Italy during the 16th century when debt was securitized. In common law countries, bills of exchange (→Bill of exchange) were used to make debt tradable. This led to them being originally labelled as ‘negotiable instruments’ by legal doctrine. The same characterization has been applied to bonds.
Bonds have played a particularly important role in state financing. Since 1698, the then newly founded Bank of England issued so-called Exchequer Bills, which were an early type of tradable debt. Bonds were also used in →France to repay state debt left by Louis XIV. They have also been instrumental in financing wars (eg the so-called Kriegsanleihen in Germany).
Three major recent developments have transformed bonds: ‘centralization’, ‘immobilization’ and ‘dematerialization’ (→Financial instruments). Bonds are now largely documented in so-called jumbo certificates that do not circulate, but instead remain locked away at deposit institutions that serve as custodians. They are thus centralized and immobilized. Some jurisdictions have abandoned jumbo certificates altogether and instead register the bondholders’ rights electronically, thereby taking the route to ‘dematerialization’.
Bonds are particularly useful for raising foreign currency (→Money and currency). So-called Eurobonds were introduced to raise US dollars from European investors. This practice is now also used for other currencies and other regional markets, while the bonds are still called ‘Eurobonds’.
III. Rules of private international law
1. The dominant role of party autonomy
Bonds and loans are instruments of transnational finance. They are designed so as to avoid conflicts of laws as much as possible. Detailed drafting of their terms serve precisely to make recourse to local law superfluous.
To strengthen legal certainty further, bonds and loans almost always contain choice-of-law and choice-of-forum clauses. The latter typically point to the law and courts of one of the world’s financial centres, ie to English law (→United Kingdom) or the law of the State of New York (→USA). Drafters generally trust the legal systems in these places because their judiciary, legislators and attorneys possess particular experience and knowledge in international financial issues.
The dominance of choice-of-law and choice-of-forum clauses can be hailed as a victory for the principle of →party autonomy. One must not forget, however, that loan borrowers typically have little leverage against lenders regarding choice of applicable law and competent jurisdiction. Bondholders have no influence on these matters either. They can only accept or reject the instruments offered to them. Party autonomy is thus more one-sided in this area than reciprocal.
Bonds issued on markets outside London and New York often refer to the local law of the exchange. A bond placed in Frankfurt by a Polish company may for instance be subject to German law (→Germany). Such deference to the market law is motivated by the need to attract national investors.
Terms governing state bonds commonly refer to the law of the issuing state. From the states’ perspective, such references may prove particularly helpful because there is no international regime available for addressing state insolvencies. Should the state-issuer subsequently default, then reliance on its own laws would allow it to introduce legislation to restructure. Some investors, however, view such references to the issuer’s domestic law with suspicion. It is therefore not rare that state-issuers submit the bond to the law and the jurisdiction of the courts of the state where the instrument is distributed to investors.
2. The law applicable in the absence of a choice of law
Determining which law applies in the absence of a choice-of-law clause is largely a theoretical exercise because bonds and loans almost always include one. The issue will therefore only be treated briefly here.
Loans without a choice-of-law clause would be subject to the lex contractus. In many legal systems, the law of the lender would govern (see eg art 1211.2 Civil Code of the Russian Federation (as amended by Federal Law No 260-FZ on 30 September 2013)). In the case of a loan syndicate, the law of the state of the lead p. 217bank – the so-called arranger – typically applies because it has a closer connection to the loan.
Some authors make an exception for loans secured by mortgages. They suggest applying the law of the state where the →immovable property is located (see eg Dieter Martiny, ‘Rom I-VO’ in Franz J Säcker and Roland Rixecker (eds), Münchener Kommentar BGB, vol 10 (5th edn, CH Beck 2010) art 4 Rome I Regulation, para 172). Yet the mortgage is an accessory to the loan and not vice versa. The location of the asset does not therefore affect the loan itself. The lex loci contractus instead applies.
In the context of bonds, the law of the state of the issuer typically has less relevance. It is instead reasonable to presume that the strongest connection is to the market where the bond was issued. The private international law of the EU for example refers to this law, albeit in very cryptic terms (art 4(1)(h) Rome I Regulation (Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I),  OJ L 177/6)) (→Financial instruments).
3. The influence of internationally mandatory rules
States often try to influence the legal regime supporting loans and bonds. Past attempts include for example introducing exchange regulations that require all obligations to be repaid in local currency (→Money and currency), imposing embargoes (→Embargo) affecting foreign bond or loan creditors and declaring a moratorium on the service of foreign debt and/or a state of emergency in order to allow the restructuring of public finances. These attempts are a reflection of the importance that bonds and loans have for the supply of capital to the economy.
Courts seated in states that have enacted such laws will generally enforce them. Reactions from other legal systems have been mixed.
One reaction has been to stress the sanctity of contracts and reject outright the application of the state debtor’s attempt to influence them. This approach has been taken for instance by the French Cour de cassation in the face of the prohibition of gold clauses under Canadian law. In the famous Messagerie maritime judgment, the Court upheld the validity of such clauses irrespective of the applicable national law by virtue of the ‘ordre public international’ (Cass. civ., 21 June 1950,  Rev.crit.DIP 609). Courts in →Belgium, the →USA and →Germany have recently enforced pari passu clauses as sacrosanct in spite of the issuing state’s wish to rely on its own legislation to restructure its debt (eg Elliott Assocs, LP v Banco de la Nacion, General Docket No 200/QR/92 (Court of Appeals of Brussels, 8th Chamber, 26 September 2000); NML Capital Ltd v Republic of Argentina, 699 F.3d 246 (2d Cir 2012), petition for certiorari denied on 16 June 2014, Docket No 13–990), German Federal Court (Bundesgerichtshof, 24 February 2015, Neue Juristische Wochenschrift 2015, p. 2328)).
The alternative reaction is to accept all interferences with the contractual regime by another state. This approach has been suggested in relation to foreign capital controls. Article VIII (2)(b) of the International Monetary Fund (IMF) Agreement Articles of Agreement of 27 December 1945 (2 UNTS 39) obliges IMF members to heed such measures if they are imposed by other Member States. The application of this provision to bonds and loans is, however, subject to doubt because the wording only targets ‘exchange contracts’ (see Stefan Weber, ‘The Law Applicable to Bonds’ in Hans van Houtte (ed), The Law of Cross-Border Securities Transactions (Sweet & Maxwell 1999) para 2.14). In the USA, foreign legislation to suspend or defer payments under sovereign loans or bonds is in principle covered by the ‘Act of State Doctrine’. Yet US courts have narrowed the scope of this doctrine to the territory of the state enacting such measures (see Allied Bank International v Banco Credito Agricola de Cartago, 757 F.2d 516 (2d Cir 1985)). It would thus not benefit states who wish to restructure their foreign debt.
A middle approach has been selectively to permit public interferences. EU law for example allows courts to apply the →overriding mandatory provisions of a foreign state that serve to safeguard its political, social and economic organization, even if this state is not a member of the EU (see art 9(1), (3) Rome I Regulation →Rome Convention and Rome I Regulation). Such selectivity is subject to the proviso that the mandatory rule in question renders the performance of the contract unlawful. Article 9(3) Rome I Regulation moreover only permits the application of overriding mandatory provisions of the state where the obligations arising out of the bond or loan must be performed. Since loans and bonds must usually be repaid in the investor’s state p. 218of residence, EU courts can only apply that state’s law. Other private international laws are more generous and allow to heed foreign public policy rules independently of these two restrictions, see eg art 19 Swiss Private International Law Act (Bundesgesetz über das Internationale Privatrecht of 18 December 1987, 1988 BBl I 5, as amended).
In considering foreign internationally mandatory rules, there are generally two opposing factors to weigh against each other. One is the interest in upholding the terms of the agreement in order to protect investors. This interest should not be taken lightly because deceiving investors can lead to a chill on their motivation to provide further capital to state debtors and could plunge capital markets into crisis (→Liability, capital market). The other factor is that states sometimes have a legitimate interest in not being indefinitely bound to terms that have been agreed to by previous governments. They should arguably be able to adapt terms to reflect changed economic and political circumstances, especially where a state would be unable to fulfill its essential functions if it continued to service its debt to foreign bondholders. A uniform rejection of such measures seems to go too far. The fair solution is to deliberate over the content and the specific situation on a case-by-case basis.
4. The law applicable to currency
The law applicable to the loan or bond determines the currency in which the capital must be disbursed and the debt repaid with interest (→Money and currency). It also controls whether parties are free to select a preferred currency and whether the debtor may make payments in an alternative currency.
The contract law regime does not, however, govern particular features of the currency, ie the denomination and other attributes. Insofar the so-called lex monetae applies, ie the law of the state that has issued the currency (see Stefan Weber, ‘The Law Applicable to Bonds’ in Hans van Houtte (ed), The Law of Cross-Border Securities Transactions (Sweet & Maxwell 1999) para 2.11). Currency reforms such as devaluations or currency unions are bound to the domestic legislation of the state in question. Parties may try to overcome the adverse effects of such measures by including gold or index clauses into their contractual agreement. Such clauses are, however, prohibited in some jurisdictions. On the effect of such prohibitions as mandatory rules, see supra III.3.
5. Other issues
Bonds and loans give rise to many different conflicts of laws. There are a number of issues that must be properly distinguished from the bond or loan regime.
A question that may surface is which law applies to relations between the participating banks in a bond underwriting or loan syndicate. The applicable legal regime in such cases differs from that which controls the bond or loan. The law governing relations within a syndicate will generally be determined by the parties. Otherwise one may extend the law applicable to the bond or loan to the relation among the syndicate members failing any closer connection to another law.
From the law that governs the bond, one must also distinguish the law that applies to the relationship between investors and intermediaries. Such intermediaries are for example banks (usually a member of the underwriting syndicate or their agents) who place the bond onto the market. The law applying to this relationship will be determined separately using ordinary choice-of-law rules for financial service contracts. Consumer protection (→Consumer contracts) may also play a role in this relation (see eg art 6(4)(d) Rome I Regulation; on the meaning and importance of this provision, see Francisco Garcímartin Alférez, ‘The Rome I Regulation: Exceptions to the Rule on Consumer Contracts and Financial Instruments’ (2009) 4 J Priv Int L 141; Matthias Lehmann, ‘Financial Instruments’ in Franco Ferrrari and Stefan Leible (eds), The Law Applicable to Contractual Obligations in Europe (Sellier European Law Publishers 2009) 85–98).
Another question is which law applies to a security that has been given by the debtor or issuer. The answer changes according to the type of security provided. A guarantee is subject to the →choice of law made by the parties (→Guarantees). A security relating to property such as a mortgage for example is governed by the law of the place where the property is situated (lex sitae) (→Immovable property).
Bond issuance and distribution requires a prospectus disclosing information about the issuer and the instrument. The applicable law is determined by the public law of the market where the bond is traded (supra III.2.) (→Financial instruments).
p. 219An issuer’s legal personality and capacity must also be distinguished from the bond or loan regime. These questions are usually subject to the law of the country where the issuer is incorporated. Treatment of claims against insolvent debtors and issuers will be determined by the governing insolvency law (→Insolvency, applicable law). This applies particularly to the rank and the subordination of the bond to other claims.
The law that applies to the conditions and effects of a transfer are important when assigning loans. Special conflicts rules on assignment apply. The same is true for charges on a loan claim, eg a pledge. The law that applies to a bond transfer is determined differently. A bond’s dual nature as a contract and a financial instrument raises proprietary issues such as who the rightful owner of the bond is or whether it is subject to a charge. These questions are dealt with by specific rules (→Financial instruments).
Francisco Garcímartin Alférez, ‘New Issues in the Rome I Regulation: The Special Provisions on Financial Market Contracts’ (2008) 10 YbPIL 245;
Francisco Garcímartin Alférez, ‘Assignment of Claims in the Rome I Regulation: Article 14’ in Franco Ferrrari and Stefan Leible (eds), The Law Applicable to Contractual Obligations in Europe (Sellier European Law Publishers 2009);
Francisco Garcímartin Alférez, ‘The Rome I Regulation: Exceptions to the Rule on Consumer Contracts and Financial Instruments’ (2009) 4 J Priv Int L 141;
Yener Altunbas, Blaise Gadanecz and Alper Kara, Syndicated Loans: A Hybrid of Relationship Lending and Publicly Traded Debt (Palgrave Macmillan 2006);
Joseph Becker, ‘Choice-of-Law and Choice-of-Forum Clauses in New York’ (1989) 38 ICLQ 167;
Marida Bertocchi and others, Euro Bonds: Markets, Infrastructure and Trends (World Scientific Publishing 2013);
Olivier Cachard, Droit Du Commerce International (2nd edn, LGDJ 2011);
Mark Campbell and Christoph Weaver, Syndicated Lending: Practice and Documentation (6th edn, Euromoney Books 2013);
Ross Cranston, Principles of Banking Law (2nd edn, OUP 2002);
Dorothee Einsele, Bank- und Kapitalmarktrecht (2nd edn, Mohr Siebeck 2010);
Herbert Kronke and Jens Haubold, ‘Börsen- und Kapitalmarktrecht’ in Herbert Kronke, Werner Melis and Anton Schnyder (eds), Handbuch Internationales Wirtschaftsrecht (5th edn, Otto Schmidt 2005);
Matthias Lehmann, ‘Financial Instruments’ in Franco Ferrrari and Stefan Leible (eds), The Law Applicable to Contractual Obligations in Europe (Sellier European Law Publishers 2009);
Dieter Martiny, ‘Rom I-VO’ in Franz J Säcker and Roland Rixecker (eds), Münchener Kommentar BGB, vol 10 (5th edn, CH Beck 2010);
Andrew McKnight, The Law of International Finance (OUP 2008);
Agasha Mugasha, The Law of Multi-Bank Financing: Syndicated Loans and the Secondary Loan Market (OUP 2007);
Agasha Mugasha, ‘International Financial Law: Is the Law Really “International” and Is It “Law” Anyway?’ (2011) 26 BFLR 382;
Rodrigo Olivares-Caminal, ‘The pari passu Clause in Sovereign Debt Instruments: Developments in Recent Litigation’ (2013) 72 BIS Papers 121;
Charles Proctor, The Law and Practice of International Banking (OUP 2010);
Sara Sánchez Fernández, Ley aplicable a la responsabilidad derivada del folleto (Doctoral Thesis, Universidad Autónoma de Madrid 2014);
Allison Taylor and Alicia Sansone, The Handbook of Loan Syndications & Trading (McGraw-Hill 2006);
Stefan Weber, ‘The Law Applicable to Bonds’ in Hans van Houtte (ed), The Law of Cross-Border Securities Transactions (Sweet & Maxwell 1999);
Philip Wood, Conflict of Laws and International Finance (Sweet & Maxwell 2007);
Philip Wood, International Loans, Bonds, Guarantees, Legal Opinions (2nd edn, Sweet & Maxwell 2007).