The Doctrine of Odious Debts (Chapter 17)
From Odious Debts: Loose Lending, Corruption And The Third World's
Environmental Legacy

by Patricia Adams (1991, 256 pages, Earthscan)

IN THE LATE 1800s, with the Spanish empire on the wane and American influence in its ascendancy, the Cuban people - then under Spanish rule - yearned for self-government. But democratic reforms, though promised, never came. Then Cuba's sugar exporting economy foundered: competition from sugar beet producers in Europe and elsewhere, combined with U.S. protectionism, devastated sugar markets, driving down the world price of sugar from eight to two cents a pound. As deprivation and hardship grew, Cubans took to guerrilla warfare, burning loyalists' plantations by night and hiding in the hills by day. The exasperated Spanish, to restore order, incarcerated suspects in concentration camps.

Sympathizing with the Cubans, Americans armed the guerrillas and talked of intervention. Then on February 15, 1898, an explosion - believed to have been caused by the Spanish - sank the American battleship Maine in Havana harbor, taking with it 260 lives. War followed, and the Spanish were soon routed.

In the subsequent peace negotiations, the Spanish argued that the U.S. - which now held Cuba's sovereignty - should assume Cuba's debts. The Spanish asserted a principle of international law: that state obligations belong to a land and its people, not to a regime:

It would be contrary to the most elementary notions of justice and inconsistent with the dictates of the universal conscience of mankind for a sovereign to lose all his rights over a territory and the inhabitants thereof, and despite this to continue bound by the obligations he had contracted exclusively for their regime and government.

These maxims seem to be observed by all cultured nations that are unwilling to trample upon the eternal principles of justice, including those in which such cessions were made by force of arms and as a reward for victories through treaties relating to territorial cessions. Rare is the treaty in which, together with the territory ceded to the new sovereign, there is not conveyed a proportional part of the general obligations of the ceding state, which in the majority of cases have been in the form of a public debt.
To bolster their argument, the Spanish cited historical precedents.

The Americans replied that the cases cited by Spain were inapplicable, legally and morally, to the so-called "Cuban debt," the burden of which, "imposed upon the people of Cuba without their consent and by force of arms, was one of the principal wrongs for the termination of which the struggles for Cuban independence were undertaken." Furthermore, the Americans added, much of the borrowing was designed to crush attempts by the Cuban population to revolt against Spanish domination, and so was expended in a manner contrary to Cuba's interest. "They are debts created by the Government of Spain, for its own purposes and through its own agents, in whose creation Cuba had no voice." As such, the Americans argued, these debts could not be considered local (Cuban) debts, nor could they be binding on a successor state.

As for the lenders, the Americans replied that "the creditors, from the beginning, took the chances of the investment. The very pledge of the national credit, while it demonstrates on the one hand the national character of the debt, on the other hand proclaims the notorious risk that attended the debt in its origin, and has attended it ever since."

In the end, the United States never acknowledged any liability for the Cuban debt, nor were any Spanish debts assumed by Cuba or by the United States, nor did the holders of the so-called Cuban debt collect fully on their claims.

The dispute over the "Cuban debts" became one of the most contentious cases of debt repudiation - repudiation caused not because the debts imposed an excessive burden on the successor, but because they were contracted for illegitimate purposes by illegitimate parties. Such debts became known in law as "odious debts."

The legal doctrine of odious debts was given shape by Alexander Nahum Sack a quarter of a century after the settlement of the Spanish-American War. Sack, a former minister of Tsarist Russia and, after the Russian Revolution, a professor of law in Paris, authored two major works on the obligations of successor systems: The Effects of State Transformations on Their Public Debts and Other Financial Obligations and The Succession of the Public Debts of the State. With colonial territories becoming independent nation states and colonies changing hands, with monarchies being replaced by republics and military rule by civilian, with constantly changing borders throughout Europe, and with the ascendant new ideologies of socialism, communism and fascism overthrowing old orders, Sack's debt theories dealt with the practical problems created by such transformations of state. Like many others, Sack believed that liability for public debts should remain intact, for these debts represent obligations of the state - the state being the territory, rather than a specific governmental structure. This he based not on some strict dictate of natural justice, but on the exigencies of international commerce. Without strong rules, he believed, chaos would reign in relations between nations, and international trade and finance would break down.

But Sack believed that debts not created in the interests of the state should not be bound to this general rule. Some debts, he said, were "dettes odieuses."

If a despotic power incurs a debt not for the needs or in the interest of the State, but to strengthen its despotic regime, to repress the population that fights against it, etc., this debt is odious for the population of all the State.

This debt is not an obligation for the nation; it is a regime's debt, personal debt of the power that has incurred it, consequently it falls with the fall of this power.

The reason these "odious" debts cannot be considered to encumber the territory of the State, is that such debts do not fulfill one of the conditions that determine the
legality of the debts of the State, that is: the debts of the State must be incurred and the funds from it employed for the needs and in the interests of the State.

"Odious" debts, incurred and used for ends which, to the knowledge of the creditors, are contrary to the interests of the nation, do not compromise the latter - in the case that the nation succeeds in getting rid of the government which incurs them - except to the extent that real advantages were obtained from these debts. The creditors have committed a hostile act with regard to the people; they can't therefore expect that a nation freed from a despotic power assume the "odious" debts, which are personal debts of that power.

Even when a despotic power is replaced by another, no less despotic or any more responsive to the will of the people, the "odious" debts of the eliminated power are not any less their personal debts and are not obligations for the new power...

One could also include in this category of debts the loans incurred by members of the government or by persons or groups associated with the government to serve interests manifestly personal - interests that are unrelated to the interests of the State.

For creditors to expect any protection in their loans to foreign states, their loans must be utilized for the needs and interests of the state, otherwise the loans belonged to the power which contracted them, and were therefore, "dettes de régime."

Sack was no stranger to odious debts. He had watched as the Tsarist debts were first honored by the Provisional Government and then promptly repudiated once the Bolsheviks were in power. In 1918, the new Soviet government decreed: "All foreign loans are hereby annulled without reserve or exception of any kind whatsoever." When creditor countries protested, the Soviets maintained that "governments and systems that spring from revolution are not bound to respect the obligations of fallen governments." According to the Institute of Soviet Law, the debts were personal debts of the Tsarist government and therefore could not be transferred to the new Soviet government.

The Bolshevik debt repudiation challenged international law, which rarely countenanced the repudiation of state debts, and then only when sovereignty changed hands. But here, in Russia, was a change in government so dramatic that the distinction between a change in government and a change in sovereignty was meaningless.

Although the doctrine of odious debts had become recognized in international law, it was open to abuse by self-serving interpretation. To avoid arbitrarily repudiated debts, Sack proposed that a new government be required to prove that the debt ill-served the public interest and that the creditors were aware of this. Following these proofs, the onus would be upon the creditors to show that the funds were utilized for the benefit of the territory. If the creditors could not do so, before an international tribunal, the debt would be unenforceable.

For a while, during the 19th century especially, international tribunals held that states were not bound by ultra vires contracts (contracts made by someone without proper authority) with foreigners. So, when the Venezuelan President Páez had his New York consul improperly enter into contracts that fell within the legislature's authority, the contracts were later declared ultra vires and claims under the contracts were rejected.

Perhaps the best known case absolving states of responsibility for debts involved the governments of Costa Rica and Great Britain. In that case, President Tinoco, a Costa Rican dictator, had made a sweetheart deal with a British oil company, granting it a concession through a contract authorized by him and approved by the Chamber of Deputies, a Costa Rican House of Congress. But under the Costa Rican constitution, a contract involving a tax provision, as that one did, required the approval of both Houses of Congress. After the Tinoco government fell, the new government repudiated the contract on the grounds that those who had entered into it acted ultra vires.

The new Costa Rican government also challenged odious debts entered into between the Tinoco government and the Royal Bank of Canada. The law Costa Rica passed to renounce both of these dealings, the Costa Rican Law of Nullities, was challenged in Great Britain vs Costa Rica, heard before Chief Justice Taft of the U.S. Supreme Court, sitting as an arbitrator. But the challenge failed, and the law was upheld in Justice Taft's 1923 ruling that decided:

The transactions in question, which in themselves did not constitute transactions of an ordinary nature and which were "full of irregularities," were made at a time when the popularity of the Tinoco Government had disappeared, and when the political and military movement aiming at the overthrow of that Government was gaining strength. The payments made by the bank were either in favor of Frederico Tinoco himself "for expenses of representation of the Chief of the State in his approaching trip abroad," or to his brother as salary and expenses in respect of a diplomatic post to which the latter was appointed by Tinoco. "The case of the Royal Bank depends not on the mere form of the transaction but upon the good faith of the bank in the payment of money for the real use of the Costa Rican Government under the Tinoco régime. It must make out its case of actual furnishing of money to the government for its legitimate use. It has not done so. The bank knew that this money was to be used by the retiring president, F. Tinoco, for his personal support after he had taken refuge in a foreign country. It could not hold his own government for the money paid to him for this purpose." The position was essentially the same in respect to the payments made to Tinoco's brother. The Royal Bank of Canada cannot be deemed to have proved that the payments were made for legitimate governmental use. Its claim must fail. [The matter quoted within the above passage refers to evidence presented by the parties.]

Because of the international significance of Great Britain vs Costa Rica, Chief Justice Taft accepted no payment for adjudicating the case:

So far as the payment of the expenses of the arbitration is concerned, I know of none for me to fix. Personally, it gives me pleasure to contribute my service in the consideration, discussion and decision of the questions presented. I am glad to have the opportunity of manifesting my intense interest in the promotion of the judicial settlement of international disputes, and accept as full reward for any service I may have rendered, the honor of being chosen to decide these important issues between the high contracting parties.

In the twentieth century, legal thinking swung away from these principles and toward pragmatism. Coincident with the rise of Keynesian economics, concern grew for the hardship of lenders, and for the difficulty of fostering international trade and investment without lenders feeling secure. States were increasingly made responsible for those who acted with apparent, not real, authority. This bias toward international financial intercourse persists to this day. To this same end, international legal thinking also favors recognizing de facto governments, and supports their power to bind their people even in the absence of a social contract with them.

But this new legal thinking could be short-lived: more traditional principles, still firmly rooted in law and precedent, needing only to be tested anew to determine their worth and relevance, could reemerge.

For this reason, lawyers at The First National Bank of Chicago wrote in a professional journal article in 1982: "The consequences of a change of sovereignty for loan agreements may depend in part on the use of the loan proceeds by the predecessor state. If the debt of the predecessor is deemed to be "odious," i.e. the debt proceeds are used against the interests of the local populace, then the debt may not be chargeable to the successor." Although the intended use of proceeds is usually spelled out in bank loan agreements, the lawyers went on to say, the use described is often too general to ensure that the loan benefited the people and so to guarantee loan enforcement. Moreover, the loan documents rarely restrict the money's use.

"Commercial banks should be alert to the dangers of such doctrines," the bank lawyers warned. "Because successor governments have invoked doctrines based on an 'odious' or 'hostile' use of proceeds, lenders should describe with specificity the uses of the loan proceeds and, if possible, bind the borrower by representation, warranty, and covenant to those uses." For years bankers have not exercised the vigilance that would make state debts lawful. The consequences could be breathtaking: the Chase Manhattans, Lloyds and Ex-Im banks might find that their Third World loans were uncollectable, except from the personal estates of the Marcoses and the Mobutus who contracted them.

Lenders who finance the arming or enrichment of despotic rulers and the suppression of popular insurrections - as the Spaniards discovered with their Cuban debts - have no guarantees of protection from international law. Financing the colonization of the Amazon and its peoples by Brazil, or of Indonesia's outer islands, would also be odious, according to Sack: "When a government incurs debts to subjugate the population of a part of its territory or to colonize it with members of the dominant nationality, etc., these debts are odious to the indigenous population of that part of the territory of the debtor State."

Even those loans extended for purposes that are broadly governmental - to an electric utility or for balance of payments' support - are subject to challenge. When government officials treat state investments as vehicles for political favors, graft, and capital flight, and are prepared to turn a blind eye to the technical and economic viability of such projects, foreign bank loans become grease in wheels that turn against state interests. Foreign bankers who fail to recognize or to act upon pricing irregularities, slipshod plans, and suspect contracts soon become parties to hostile acts against a populace.

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