Creditors are coming for Venezuela's assets

For almost a decade now, Canadian gold miner Crystallex has sought to establish a single fact: Venezuela's state-owned oil company PDVSA is the "alter ego" of the state.

In other words, Venezuela is so enmeshed in PDVSA's daily operations and personnel that they are essentially one and the same. The designation would allow Crystallex, which is backed by hedge fund Tenor Capital, to go after PDVSA assets in the US once sanctions are lifted. The company is still owed hundreds of millions from Venezuela as part of a $1.4bn arbitration award it won three years ago after the government nationalised its gold mining project in 2011.

Earlier this week, Crystallex came one step closer to cementing the linkage between PDVSA and the state. A victory for the gold miner would create a window of opportunity for the swathes of investors and companies who hold defaulted Venezuelan debt or arbitration awards to seize assets associated with the country in the US, at a time when Venezuela's economic and humanitarian catastrophe rages on.

On Monday, lawyers representing Venezuela, PDVSA and a motley of creditors convened in Philadelphia, Pennsylvania at the US Court of Appeals for the Third Circuit to deliver oral arguments in the case between Crystallex and the country. Over four hours, each representative tried to persuade a panel of three judges that their reasoning was correct. Lawyers defending the government and those defending PDVSA argued that a previous ruling that the state-owned oil company was Venezuela's "alter ego" didn't hold water.

In August, US federal judge Leonard Stark of the Delaware District Court had invoked the alter-ego argument and given Crystallex permission to seize the shares of the Venezuelan holding company — PDV Holding — that owns the US oil refining giant, Citgo. The holding company is in turn owned by PDVSA. Judge Stark based his decision on a Supreme Court case involving a Cuban bank. The Bancec case, as law professor Mark Weidemaier of UNC Chapel Hill points out, established two instances when courts can disregard the legal status of a state-owned corporation — meaning they can deem a company an "alter ego" of the state:

First, when the government so extensively controls day-to-day operations that a 'relationship of principal and agent is created.' Second, when respecting the corporate form would result in a fraud or injustice.

Crystallex is only claiming the first point, not the second. And given that no one has tried to make the case that the gold miner is a victim of fraud or unfairness, "on merits, Crystallex has the better of arguments," Weidemaier tells Alphaville. "The state's level of control and domination here is quite extraordinary." For that reason, Weidemaier says he would be surprised if the Court of Appeals overturns the alter-ego finding.

Russ Dallen at Caracas Capital Markets, who attended the oral arguments, agrees. Not least because he thinks Crystallex's counsel Miguel Estrada of Gibson Dunn "was the best litigator in the room". Dallen also tells Alphaville that he got the sense that the judges seemed to accept the alter-ego argument point blank.

The implications of a Crystallex victory are enormous. According to Dallen, "if the Court of Appeals upholds this [alter-ego] finding, it's open season on PDVSA assets." While creditors wouldn't be able to seize any PDSVA asset that piques their interest without first going through the courts, it would certainly make the process easier.

And if sovereign creditors can more easily lay claim to parts of PDVSA, existing PDVSA creditors could now have a lot more competition when it comes to repayment — a point the legal counsel representing BlackRock and hedge fund Contrarian Capital tried, and, according to Dallen, failed to make on Monday. Other creditors holding a PDVSA bond due in 2020 would surely be impacted by the ruling, given the bond is collateralised by 50.1 per cent of Citgo’s shares. Russia's Rosneft holds the remaining 49.9 per cent, which were exchanged for a $1.5bn loan.

A potential silver lining does exist for those owed money from PDVSA. As Weidemaier points out to Alphaville: "This is a road map for PDVSA bondholders, trade creditors and others to go after the government's assets." Not all are convinced though. A sovereign debt lawyer involved in the ongoing situation in Venezuela disagrees that the alter-ego argument would work in reverse. And even if it does, the government owns so few assets that are not protected by some form of diplomatic immunity that there is little for PDVSA creditors to collect.

Ultimately, a favourable ruling for Crystallex could change the arithmetic for creditors when it comes to obtaining a judgment. Since December, there have been multiple new lawsuits filed against Venezuela and PDVSA. Expect more to come.

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