When a sovereign nation defaults it restructures its outstanding debt by means of an exchange offer under which creditors agree to receive a new debt instrument in exchange for the old (non-performing) one which usually implies worse financial terms. The process of drafting the proposed exchange offer comprises the views and interests of the debtor and to a certain extent those of the creditors since their participation is required. However, it is impossible to accommodate the interests of all creditors since they will have different views. Once an exchange offer has been settled the defaulting nation will commence payout of the new bonds under the restructured deal.
However, there will often be a proportion of creditors who will be holdouts on the exchange offer and who will seek a better deal than that put forward by the sovereign nation. Holdouts will usually be specialists in distressed debt – vulture funds. In the last 20 years there have been a number of high profile cases where vulture funds have been holdout to a sovereign debt restructuring. In many cases they have generated excellent returns. This article will look at an example of how a vulture fund used the holdout strategy to generate profits of 400% on distressed Peruvian debt. But the effectiveness of the holdout strategy has been thrown into question by a more recent case.