Odious debt is sovereign debt incurred by a government lacking popular consent, utilized for no legitimate public purpose. This specific subset of sovereign debt is separate from such issues as unsustainable debts incurred by democratic or quasi-democratic developing countries, or debts incurred by nondemocratic regimes for legitimate public ends. This paper is concerned with the narrow problem of money borrowed by dictators from foreign creditors that is then either spent on illegitimate ends, such as repressing the country's population, or simply looted and deposited into the private offshore bank accounts of the ruling class. Many legal scholars advocate that international law grants successor regimes permission to repudiate inherited debts meeting the odious debt standard. Whether international law theoretically does or does not provide for such a remedy, however, the fact remains that for practical purposes successor governments to illegitimate regimes do not invoke the odious debt doctrine, out of fear that doing so would deprive them of necessary access to global credit markets.
Odious debt is a moral issue, as it is manifestly unfair to demand that a population repay what are basically the personal debts of its former captors--loans that were in many cases used to actually fund the machinery of public repression. But beyond purely ethical considerations, there are significant prudential reasons for the international community to reform the treatment of odious debts. Successor governments to fallen dictatorial regimes are often placed in the position of rebuilding a shattered nation with scarce resources. This scarcity is severely compounded when the meager resources of a successor government are diverted toward servicing the odious debts of the prior regime rather than invested in constructing a secure and sustainable platform for national development. This is a problem of economic development, but it is also a problem of national security. Failed states are increasingly recognized as posing significant threats to the security of the global community through such vectors as destabilizing broad neighboring regions, hosting potentially hostile nonstate actors, and providing breeding grounds for infectious diseases outside the reach of coordinated medical intervention. It is in the security interest of the global community to forestall state failure where possible and to facilitate the rebuilding of failed states in an expedient manner. A properly designed policy on odious debts can help to prevent state failure by limiting the spoils available to a potential autocrat from looting the state--thus hopefully discouraging some would-be state destabilizers at the margin--and it can also free resources for the use of postauthoritarian governments. These additional resources might in some cases make the difference between sustainable democratic redevelopment or a relapse into chaotic autocratic state failure.
Most supporters of reforms in the area of odious debt believe that such debt should be challenged in courts and other judicial-style fora. While this would likely be preferable to the status quo, there are several reasons why another type of reform model would yield superior results. The determination of whether a certain regime does or does not enjoy popular consent for its actions is at least as much a political issue as a legal one, and thus the judiciary may be an inappropriate venue for implementing an odious debt policy. Second, it is critical to secure as much ex ante certainty for potential creditors to sovereign governments as possible; that is, creditors should be highly confident in the legal enforceability of their rights before loans are made. The importance of global capital flows to developing countries in today's globalized financial environment is significant, and any policy that curtailed legitimate lending to sovereigns due to unnecessary ex ante uncertainty might cause more harm than good.
As an alternative to the traditional reform program, which will be referred to as the Classical Model, this paper proposes a Due Diligence Model for the resolution of odious debts. (1) The Due Diligence Model requires that a country be officially declared "odious debt-prone" in order for debts to potentially fall within the scope of invalidity, and, crucially, only debts incurred after the declaration would be eligible. (2) This safeguard, and the anticipated rarity with which countries would be placed on such a list, ensures that the vast bulk of sovereign lending to developing countries would be securely outside the scope of any potential interference. Under the Due Diligence Model, lenders to countries declared odious debt-prone would be required to cite the specific legitimate ends that the funds are intended for and the due diligence monitoring plan that the lender intends to implement to ensure that the funds go toward these stated uses. A loan would only be invalidated if the funds were diverted toward illegitimate ends and the lender failed to make a good faith effort to comply with its own preapproved due diligence plan. This policy structure is a promising way not only to achieve most of the objectives of odious debt reform in a manner which should be largely acceptable to creditor countries, global financial intermediaries, and sovereign debt investors.
REASONS TO RETHINK THE STATUS QUO
Can it truly be fair to demand responsibility of a population for debts that were incurred not only against its will but were in many cases used to fund the mechanisms of its prior torment? Debt incurred by a governing regime for personal benefit or nefarious purpose should be considered the private debt of the illegitimate regime and the country's citizens should not be held responsible for its repayment. (3) Individuals do not have to repay money that others fraudulently borrow in their names, in the same way that a corporation is not liable for contracts that the chief executive officer enters into without the authority to bind the firm. Basic logic and justice demand that a corresponding rule exist for sovereign borrowing. While this moral argument is a strong and sufficient case for reform on its own, there are additional rationales for a new policy approach toward odious debts that are directly rooted in the national interests of the developed world powers.
The Economic Rationale for Reform
A precondition to the proper functioning of financial markets is a stable body of legal rules governing the full investment cycle from initial due diligence through liquidation. Without a known and transparent playing field of legal governance, the risk premium for making any investment is too high to qualify as anything but speculative gambling.
In the aftermath of the 2003 invasion of Iraq, there were widespread calls across the political spectrum to eliminate what commentators openly declared Iraq's "odious debts." (4) For example, House Resolution 2482, introduced but not passed by the 108th Congress, with twenty-eight cosponsors from both the Republican and Democratic parties, called for the cancellation of loans made to Iraq by the multinational financial organizations. The bill argued for the necessity of canceling debts incurred by dictators not only on grounds that such debts impede a successful rebuilding of post-authoritarian states, but also because those debts were never legitimate inheritances of the new government due to the doctrine of odious debts.
House Resolution 2482 should serve as a warning call to the international financial community that the status quo of traditional sovereign lending law could be radically reformed by legislative action with possible retroactive impact. While the resolution failed to pass, its existence with nontrivial bipartisan support should alert lenders that the prospect of future legislative reforms in this area are far from negligible. It is therefore in the interest of the international financial community to embrace the issue head-on and work to develop a fair body of prospective rules governing sovereign lending that address the issues raised by odious debt and cause minimal disruption of beneficial lending to developing nations. Purely prospective rules will not solve the problem of existing debts, but they will establish a stable framework to assure present investors in new loans that there is not a contingent danger to their capital in the form of future retroactive legislative actions.
Financial intermediaries and investors should consider that eventual odious debt reform is sufficiently likely and that any small loss of profits from a slightly curtailed scope of lending activities would be more than offset by the decreased risk that future reforms with possible retroactive effect could place a broader swath of investments made today in jeopardy. By way of analogy, in the past several years, increasing numbers of companies in the energy industry have recognized the economic merits of coming to a regulatory solution to the problem of carbon emissions sooner rather than later. The energy sector is highly capital-intensive and projects can have multi-decade timelines. These firms realize that eventual carbon emission regulation is a sufficiently likely scenario and that it is better for them if these rules are established now, when they can be incorporated into prospective planning. The benefits from delaying any regulation are outweighed by the potentially catastrophic financial impact if tomorrow's regulations eviscerate the value of large investments made today. Forward-looking capital market participants should take a similar attitude toward odious debt reforms.
The National Security Rationale for Reform
National security is rarely cited as a motivating factor behind campaigns to reform existing policies on odious debts. Yet changes in Western strategic doctrine in the post--Cold War era offer an opportunity for traditional civil society...