Vulture Funds: Feasting on Poverty

At a time when the rich world is slowly moving towards eradicating extreme poverty in the developing world, a small band of private companies is looking to make a killing.

Vulture Funds, a name popularly ascribed to a particular type of commercial creditor, buy portions of developing countries’ debt at a cheap rate and then sue the countries and make a considerable profit.

Such commercial activity has wide-reaching implications. It takes away much needed revenue from developing countries and undermines benefits such as spending on education and healthcare that should accrue from debt cancellation. The very existence of Vulture Funds points to an urgent need for stronger company regulation, both at the national and international levels, and for a fair and comprehensive international system to deal with the pressing issue of debt in developing countries.

Earlier this year a High Court case in London involving Zambia vs Donegal International demonstrated how Vulture Funds seek to profit from poor countries with a record of debt management problems.

In 1979, the Zambian government borrowed $15 million (£7.5m) from Romania to purchase Romanian tractors and other agricultural equipment. However, a combination of factors, not least the fall in copper prices, on which Zambia is highly dependent, meant Zambia was unable to pay back the debt. Some 20 years later the Zambian government continued to have debt repayment problems and negotiated a deal with Romania under which it would pay back only $3.5 million of the amount borrowed. Zambia was given a deadline of 31st January 1999 to confirm this offer, but on 19th January, 12 days before the deadline, Donegal International, a subsidiary of US company Debt Advisory International, bought the debt from Romania for $3.3 million.

Having procured the debt, Donegal International then attempted to sue the Zambian government for $55 million; the full cost of the original loan plus 5.5% yearly compound interest and court fees. They undertook this action at a time when Zambia had been recognised by the World Bank and IMF as a highly indebted poor country and had had its debts from these and other institutions cancelled.

Donegal International applied the legal principle of Pari Passu, which requires that all creditors “should be treated on equal terms without discrimination”. In other words, the fact that some creditors, such as the IMF and the World Bank, had forgiven their portion of the debt, does not mean that other creditors have to make similar concessions or, indeed, any concessions at all. It is worth noting that this principle does not apply to domestic debt as under UK law all creditors must abide by any debt relief planagreed by creditors who own 75% of an individual’s debt.

When the case was heard at the High Court in London earlier this year, the Judge concluded that Donegal International’s claim was legal but the company had improperly sought and obtained confidential state information, an action which he described as "unlawful or immoral". At the time the Zambian Justice Minister, George Kunda, described the company’s behaviour as showing a “consistent pattern of irregularity, corruption, and fraud.” The Judge ruled that the Zambian government would have to pay $15.5 million.

Whilst this figure was substantially less than Donegal had originally claimed for, it was far more than Zambia can afford. To put this in perspective, $15 million is roughly three quarters of the amount the Zambian government has allocated to spend on recruiting teachers in 2007. It is money that is badly needed elsewhere in a country where one in three children do not attend primary school, up to a fifth of the population are living with HIV/AIDS, and the average life expectancy is 37 years. Indeed, a recent United Nations Development Programme report found that, in order for Zambia to fund the programmes necessary to halve poverty and meet the Millennium Development Goals by 2015, it should substantially increase spending to 5.5% on health, 1.9% on water and sanitation and 2.7% on social safety nets. These crucial life and death targets will be even more out of reach if Zambia is forced to make this payment at the expense of its citizens.

Unfortunately, the case of Zambia is not an isolated incident. A particularly notorious case was Elliot Associates vs Peru. Elliot Associates, a US firm, successfully sued the Peruvian government for $58 million on a debt they had procured for $11 million and then took out a legal injunction preventing Peru from paying its other creditors until they had been paid in full. The World Bank has calculated that 43 companies are currently pursuing court cases in 10 more countries, from the war-torn Democratic Republic of Congo to Nicaragua and Honduras.

It is clear that this form of corporate activity undermines efforts by developed countries to free up much needed resources to help poorer countries out of poverty. In some instances developing countries are being assisted to buy back their debts from commercial creditors and given help with their legal expenses. When Chancellor, Gordon Brown, in a speech to the UN, said that Vulture Funds are “morally outrageous” and that the “international community should consider giving technical assistance to any Highly Indebted Poor Countries being sued by a Vulture Fund, and provide them with expert financial advice on debt restructuring to prevent future legal claims.”

However, this is essentially treating the symptom and not the cause of the problem. Inspired by Catholic Social Teaching, with its emphasis on addressing the root causes of problems, the Scottish Catholic International Aid Fund (SCIAF) has launched a campaign to pressure the UK government to change the law to prevent future Vulture Fund cases. With nearly a third of these companies operating out of UK territory, such as the British Virgin Islands and Caymen Islands, SCIAF believes legal action to tackle these corporate ventures must start at home with domestic solutions and be accompanied by international agreements on sustainable debt resolution.

At the moment many Vulture Funds, by virtue of being private companies, are not covered by key rules designed to govern the behaviour of the UK’s public companies. As such, the 2006 Companies Act which states that companies must not just consider their profit margin, but must also have regard to the social and environmental impact of their actions, is not applicable to them.

For these reasons, SCIAF’s campaign is asking the UK government to amend the Companies Act, to close the loopholes that exclude Vulture Funds, and to introduce new laws to combat the problem. In taking action, the UK government would be following in the footsteps of the United States which has prohibited the purchase of debts solely for the purpose of litigation, and of Belgium which, following the case of Elliot Associates vs Peru, changed its laws to prevent such cases recurring. SCIAF is also calling for the UK government to work internationally to establish a fair and transparent international system to deal comprehensively with developing countries’ debt, to cut opportunities for corporate vultures to feed off poverty stricken countries.

Article originally published in Tablet magazine.

October 2007