A huge legal battle between Lebanon and its creditors looms

If international creditors sue Lebanon, its financial standing will be further battered

Nash Weerasekera

The state's refusal to engage with bondholders risks keeping Lebanon out of the funding markets, draining its remaining reserves as creditors seek redress.

A huge legal battle between Lebanon and its creditors looms

Salwa Baalbaki

last update on 21 Apr 2024

Just when you thought Lebanon’s financial crisis could not possibly get any worse, the possibility looks increasingly likely.

The country doesn't seem to be cooperating with international creditors ahead of a legal deadline for them to do so, meaning that they will sue over missed bond payments.

Ignoring creditors will have serious consequences: investors will press for a wider restructuring of its debt burden, as denominated in foreign currency.

Lebanon defaulted on payments in 2020, and legal action in the New York courts is limited to five years. Bondholders had hoped for better, but Lebanon’s government has been inert ever since.

As the US litigation deadline looms, the need to engage becomes urgent. If the country is sued, its financial standing will be further battered.

In 2019, it became clear that Lebanese citizens' bank deposits had been used to try to plug a $72bn gap caused by the state overborrowing from local lenders.

The government then stopped servicing its debts on Eurobonds (loans taken out in a currency other than Lebanon's, typically US dollars).

It cited low foreign exchange reserves but has continued to spend up to $20bn on subsidies, hastening a financial, fiscal, and monetary collapse. The state is now effectively bankrupt and shut out of international markets.

Axel Rangel Garcia

The human cost

Lebanon’s financial crisis has left scars on the majority of the population.

Take Adib, for example. In his 70s, he retired to a rural home he had saved up for after decades of working in Africa. After a life of hard work, he sought comfort and security for himself and his family. After 40 years, he had saved around $100,000 for his retirement.

He distrusted commercial banks after the 1966 collapse of Intra Bank, so instead, he turned to the state to keep his nest egg, using it to buy Eurobonds.

Lebanon had a prosperous past and a reputation for reliability. It was an international lender in its own right, with a stable and trusted currency. He never imagined that the state would fail to honour its debts.

From statesmen to salesmen

Yet Lebanon had changed by the time Adib was approaching retirement. Respected statesmen no longer ran it. Instead, self-interested and partisan politicians had taken over, fighting over the country's resources.

As the state's finances faltered and inflation soared, liquidity in banks dried up, and the Lebanese pound plummeted. Then, after a steep drop in the price on the secondary market, the Eurobond default occurred.

Adib's life savings became worthless overnight, and his retirement plans were shredded. His money became paper holdings for unpaid debt. He owned nothing more than a share of the state's failed finances. Like so many other Lebanese, he faced hunger, distress, and financial ruin.

Those in power safeguarded their wealth in foreign banks and tax havens, just as savers in Lebanese banks saw their savings wiped out by the state's raid on deposits.

Adib still struggles to come to terms with what has happened. The stark reality of what happened shattered his belief that the state could never go bankrupt.

As the US litigation deadline looms, the need to engage with international creditors becomes urgent. If Lebanon is sued, its financial standing will be further battered.

International legal action

The government's refusal to confront its international creditors before legal action is taken will make any recovery for the Lebanese people in the future more difficult. Experts agree that ignoring the problem makes the fallout from default even worse.

The Eurobond default clearly creates a need to agree on debt restructuring, which should have been addressed four years ago.

Banking specialist Adel Afiouni told Al Majalla that "sovereign debt defaults aren't uncommon globally", but burying the state's head in the sand was not an option.

"The failure to propose a fiscal and financial reform plan, engage in debt restructuring, or negotiate with creditors for such an extended period sets a perilous precedent with significant fiscal, financial, and legal ramifications."

Being serious

Lebanese authorities must demonstrate credibility with a transparent and realistic financial recovery plan to secure an agreement with creditors. Doing so will not be easy.

It means bold reforms and a comprehensive financial support programme from the International Monetary Fund (IMF) and donor countries, conditions essential for any external debt restructuring agreement.

AlMajalla

Unfortunately, Lebanese authorities show no seriousness in this regard. Ducking negotiations with Eurobond creditors only highlights this.

This lack of engagement jeopardises Lebanon's ability to address its debt crisis and regain financial stability. Ignoring creditors has significant repercussions.

Seasoned international investors have handled distressed countries before. They have the expertise, experience, and leverage necessary. In short, they can help.

Bondholders will sue if there are no serious restructuring talks before the deadline. The Lebanese government's failure to engage shows weakness and bad faith, and the courts will take a dim view.

Price collapse

The price of Lebanon's Eurobonds on the secondary market fell before the default as confidence drained.

In the summer of 2019, they went for 75 cents on the dollar. In the winter, just 50 cents. In 2020, they fell to less than one cent. A Lebanese Eurobond could be had for 0.70 cents, less than 1% of its value just months earlier.

Afiouni says this shows a complete lack of faith in any prospect of restructuring. "This market judgment underscores the severity of Lebanon's financial crisis", he added.

Lebanon's central bank has face-value holdings of around $5bn in Eurobonds, and Lebanese banks have another $15bn.

They sold most of it to people like Adib or international investors, who now own less than half the total. Local banks hold less than $3bn, and Lebanese individuals own the remaining portion through banks.

Lebanese authorities must demonstrate credibility with a transparent and realistic financial recovery plan. Doing so will not be easy.

Collateral damage

Regarding redress for their debts, bondholders are creditors of the Lebanese government, distinct from the central bank.

"Legally, bondholders have no right to seize the bank's assets or claim them as collateral," said Alfiouni.

"Lebanese state property abroad is generally limited and enjoys sovereign immunity from seizure by creditors.

"State revenues from external sources could potentially be subject to seizure by bondholders, but these revenues are currently limited due to Lebanon's fiscal and financial situation."

According to Afiouni, calls for state assets to be used to settle the central bank's debts to private banks could damage the chances of individual Eurobond holders being repaid, with the central bank given priority.

He says such proposals "carry serious repercussions" as they could fuel Eurobond holders' belief that they are entitled to these assets in the jostling repayment hierarchy.

Possible redress

If state assets are used to settle central bank debts, there may be a route to redress, yet this would blur the distinction between them or conflate them in the eyes of the law.

Taken to the extreme, that could mean gold reserves or other publicly-owned assets, such as airlines, could be chased as collateral.

"This scenario could pose a risk to assets like gold reserves and Middle East Airlines (MEA)," said Alfiouni.

AFP — Lebanon fears new destruction for its planes and airport, and some planes were transferred to other airports last week after the outbreak of the Gaza war.

"Therefore, it is imperative to clearly differentiate between the state and the central bank regarding credit. Confusing the two could lead to unfavourable legal consequences."

Furthermore, the issuance of new debts by the state to the central bank without disclosing this in the original legal documents of the Eurobonds is considered misleading to investors and a violation of capital market laws and principles.

"This failure to provide essential information could give bondholders grounds to sue the Lebanese authority for investor abuse and misinformation, which carries serious legal implications," said Alfiouni.

Unheeded warnings

Whatever happens with any legal claims from bondholders, Lebanon faces a challenging future.

Its only path forward involves reaching an agreement with creditors, which in turn requires securing funding through the IMF. That can only be done via an honest and comprehensive financial plan alongside serious economic reforms.

"Failure to achieve these steps will leave Lebanon without external funding," said Alfiouni.

"This would lead to the continued depletion of reserves and risk the entirety of deposited funds… High stakes highlight the urgency of decisive action and reform."

What he says rings true, but this cautionary message has been issued by experts for years and has so far gone unheeded. Sadly, there is no reason to think that Lebanon will change its wayward ways now.

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