Valid in Venezuela?

The continuing litigation and dispute over the 2016 exchange (the “Exchange”) of 2017 unsecured notes of Petróleos de Venezuela SA (“PDVSA”) for new secured notes that matured in 2020 (the “2020 Notes”) has become a “black swan event” in the sovereign debt markets. PDVSA’s status as a state-owned entity created quasi-sovereign issues in a corporate finance context leading to litigation uncertainty. On February 20, 2024, the New York Court of Appeals, upon certification of several questions from the United States Court of Appeals for the Second Circuit, concluded that the validity of the issuance of the 2020 Notes under Section 8-110 of the New York Uniform Commercial Code¹ (the “NYUCC”) is determined by the law of Venezuela, PDVSA’s legal jurisdiction.² Effectively, the New York Court of Appeals has now required the original U.S. District Court in New York and the Second Circuit to adjudicate what the governing law was in Venezuela in the face of a declared “State of Exception and Economic Emergency” imposed by the ruling Maduro regime and a competing resolution of the Venezuelan National Assembly. Although the New York state court kicked the resolution of the validity question back to the federal courts in which the Exchange continues to be litigated with that guidance, the New York Court of Appeals reserved for itself the ultimate right to determine the consequences of any defect in validity under Section 8-202(b) of the NYUCC.³

While this decision makes its way back through the New York federal courts, a separate federal district court in Delaware⁴ moves closer to authorizing the auction of PDVSA’s interests in the intermediate holding company (“PDVH”) that owns CITGO Holding, Inc. and CITGO Petroleum Corp. (collectively, “CITGO”). More specifically, it just approved the order of priority of the judgments against the PDVH shares.⁵ Should that sale occur this summer as currently anticipated, the proceeds of that sale will almost certainly not exceed the billions of dollars of judgments that encumber PDVSA’s interests in PDVH - whether or not the liens granted in the Exchange ultimately survive. At that point, neither PDVSA nor the Republic of Venezuela would have any ownership or economic interest left in CITGO, rendering the validity question a merely theoretical or hypothetical issue as far as PDVSA and the Republic of Venezuela are concerned.

Whether or not PDVSA or Venezuela will have any continuing interest in CITGO as a result of this decision, it will likely have farther reaching implications in the sovereign debt market. While the PDVSA case focuses on a claim of invalidity premised on a lack of proper legislative approval, such claims of invalidity under local borrowing procedures can implicate a number of different aspects of what may be very complex debt authorization requirements in different jurisdictions. For example, violations of administrative processes, improper delegation of authority, violations of debt ceilings or other quantitative limits, or changes in interpretation under local law, may also be relevant to questions of validity under domestic law. While institutions, such as the International Monetary Fund and the World Bank, have developed best practices surrounding public debt management,⁶ procedures surrounding the authority to borrow and issue new debt still have the potential to differ greatly from country to country and may not be easily accessible or even clearly defined under domestic legislation. While the decision of the New York Court of Appeals addressed validity specifically in the context of Venezuela’s constitution, it is unclear whether this decision would also extend to other sources of domestic law in which authorization procedures can be enshrined.

Ultimately, the court’s decision raises questions around transparency in the domestic legal frameworks governing debt authorization, consequences for contract enforcement, and the subsequent burdens placed on both debtors and creditors in sovereign debt transactions. How far must investors’ diligence extend? The New York court’s broad definition of validity effectively imposes an extra, and in the case of PDVSA and Venezuela an extraordinary, burden on both the investors and financial intermediaries participating in sovereign, or more specifically quasi-sovereign, debt markets as well as the issuers and the law firms providing enforceability opinions, despite the inclusion of New York governing law provisions.

The acute split in governing authority in Venezuela, the metaphorical black swan on account of PDVSA’s quasi-sovereign status, crystallizes the impact of domestic legal issues in emerging markets on the treatment of PDVSA’s debt. The Maduro regime, when it controlled PDVSA, negotiated an extension, gave consideration to noteholders and performed the obligations under the 2020 Notes for a period of time until it defaulted. The Venezuelan National Assembly subsequently opposed it, but the Venezuelan courts (perceived to be under the Maduro regime’s control) did not adjudicate the actions of the Maduro regime in the context of the National Assembly’s resolutions. In the end, to the extent that the federal district court in New York re-examines the validity issue, the New York Court of Appeals claims the right to determine the consequences of any such invalidity under Section 8-202 of the NYUCC. Any finding of invalidity does not mean that the 2020 Notes cannot be enforced in their current form. When it comes back around after the trial and subsequently on appeal again, the New York Court of Appeals could still enforce the 2020 Notes, notwithstanding any invalidity issues. By the time that occurs, odds are that neither PDVSA nor the Republic of Venezuela will have any legal or beneficial interest in CITGO or its proceeds.

Footnotes

<sub>1. NY UCC § 8-110 (McKinney 2024).
2. Petroleos de Venezuela S.A. v. MUFG Union Bank, N.A., ___ N.E. 3d ___, 2024 WL 674251 (Feb. 20, 2024).
3. Id. at 22-23.
4. See Crystallex Int’l Corp. v. Bolivarian Rep. of Venezuela, Case No. 17-mc-151 (LPS) (the “Delaware Action”).
5. See Id., Priority Order, dated March 1, 2024.
6. See generally, D. Rivetti, DEBT TRANSPARENCY IN DEVELOPING ECONOMIES. Washington, DC: World Bank. (2021).</sub>