Overview
First Tuesday Update is our monthly take on current issues in commercial disputes, international arbitration, and judgment enforcement.
When we last discussed the potential sale of the stock of Citgo in Crystallex International Corporation v. Bolivarian Republic of Venezuela, No. 17-mc-151, D. Del. (Crystallex), we noted that briefing was ongoing in a New York Court of Appeals case to determine the validity of the 2020 PDVSA bonds and the lien on a majority of shares in Citgo. [See here]. On February 20, 2024, the New York Court of Appeals issued its opinion, holding that Venezuelan law governs validity but New York law governs the consequence of any invalidity. Bondholders are now asking if the 2020 bonds are valid under Venezuelan law (possibly) and if they are invalid, what are the consequences under New York law? The uncertainty surrounding the 2020 bondholders’ lien will likely impact the bids in the Citgo sale—as the bidders will be uncertain if they need to pay off or otherwise restructure the 2020 PDVSA bonds or if the bondholders will have no claims against Citgo, only PDVSA. Additionally, if the bonds are invalid, most of the litigation will focus on what the UCC means when it says a “purchaser for value and without notice of the defect” in determining, notwithstanding that potential finding, whether certain bondholders’ claims will remain valid. Other bondholders may also have non-UCC claims to repayment. In addition, the rulings on this issue are likely to have an impact on how certain terms are applied throughout the UCC and on how secured debt, including any secured sovereign debt like the 2020 bonds, are treated. One thing we can say for certain—there will be much more litigation before these issues are resolved.
Background: PDVSA 2020 Bonds
In 2016, PDVSA issued a tender offer to exchange 2017 PDVSA bonds with new 2020 secured bonds with a pledge of a controlling interest in Citgo Holding, Inc. The Exchange Offer occurred during an intense political conflict in Venezuela.
In December 2015, political parties opposed to President Maduro won an overwhelming majority of the seats in the Venezuelan National Assembly. In May 2016, the National Assembly passed a resolution reciting that contracts of national public interest between the Venezuelan executive branch and foreign companies needed to be approved by the National Assembly. Several months later, in September 2016, the Exchange Offer was announced. It was approved by the PDVSA board, the company’s sole shareholder (the Republic of Venezuela), and the boards of those PDVSA subsidiaries with oversight and control of PDVSA. PDVSA’s legal counsel gave unqualified opinion letters, under New York and Venezuelan law, opining that the Exchange Offer did not need to be approved by “any governmental agency or governmental authority in Venezuela.”
In late September 2016, the National Assembly passed a second resolution, reciting that the Exchange Offer required PDVSA to offer 50.1% of Citgo stock as collateral, and the Venezuelan Constitution empowered the National Assembly to exercise control over transactions that committed PDVSA’s assets as collateral. In October 2016, the Exchange Offer closed.
In October 2019, the National Assembly passed a third resolution which specifically addressed the Exchange Offer. It recited that “the 2020 Bond indenture is a national public contract that should have been authorized by the National Assembly, in accordance with Article 150 of the Constitution,” and “ratified ‘that the 2020 Bond indenture violated Article 150 of the Constitution of the Bolivarian Republic of Venezuela, since it concerned a national interest public contract, executed with foreign companies, which was not authorized by the National Assembly.’” Petroleos de Venezuela S.A. v. MUFG Union Bank, N.A., 495 F. Supp. 3d 257, 267 (S.D.N.Y. 2020) (PDVSA I).
When the October 2019 principal and interest payments came due a few weeks after the resolution was passed, PDVSA failed to pay, and two days later PDVSA filed a lawsuit in the United States District Court for the Southern District of New York (SDNY). PDVSA’s suit sought a declaration that the 2020 bonds were invalid pursuant to the UCC, which it said required the Court to apply Venezuelan law.
The district court determined that New York law—not Venezuelan law—applied to questions of validity. The Second Circuit certified the question to the New York Court of Appeals, noting “if the court concludes Venezuelan law applies to the particular issue of PDVSA’s legal authority to execute the Exchange Offer, then we would likely remand for an assessment of Venezuelan law on that question and, if necessary, for consideration of the Creditors’ equitable and warranty claims.” Petroleos de Venezuela S.A. v. MUFG Union Bank, N.A., 51 F.4th 456, 475 (2d Cir.) (PDVSA II).
The New York Court of Appeals Decision
On February 20, 2024, the New York Court of Appeals held that “Venezuelan law governs the validity of the notes under Uniform Commercial Code § 8-110 (a) (1),” but “New York law governs the transaction in all other respects, including the consequences if a security was ‘issued with a defect going to its validity’ (UCC 8-202 [b] [1]-[2]).” Petróleos de Venezuela S.A. v. MUFG Union Bank, N.A., No. 6, 2024 WL 674251, at *1 (N.Y. Feb. 20, 2024) (PDVSA III). The court noted that “in light of New York’s ‘status as a commercial center’ … the application of Venezuelan law to the Governing Documents must be narrowly confined. The exception provided by UCC 8-110 … does [not] affect the adjudication of any question under the contract other than whether a security issued by a foreign entity is valid when issued.” Id. at *9.
Upon remand, the SDNY will apply Venezuelan law to the question of whether the “failure to receive authorization from the National Assembly prior to issuing the 2020 Notes means that the notes were invalid under the law of Venezuela at the time of their issuance.” Id. If the SDNY determines the bonds are valid under Venezuelan law, the bondholders are likely to prevail. However, if the bonds are invalid under Venezuelan law, PDVSA will not necessarily prevail. Instead, the SDNY will apply New York law—specifically, UCC 8-202—to the question of the consequences of an invalid issuance of a security.
UCC 8-202 provides that “(b) [I]f an issuer asserts that a security is not valid: (1) A security other than one issued by a government or governmental subdivision, agency, or instrumentality, even though issued with a defect going to its validity, is valid in the hands of a purchaser for value and without notice of the particular defect unless the defect involves a violation of a constitutional provision. In that case, the security is valid in the hands of a purchaser for value and without notice of the defect, other than one who takes by original issue.”
If the SDNY determines that the bonds were invalidly issued in violation of a constitutional provision, the most critical open question the Southern District must decide is how to apply UCC 8-202. The Court will focus on the clear text of the provision and probably consider whether holders of the bonds were original purchasers or obtained the bonds on the secondary market. The Court will also consider what UCC 8-202 means when it states a purchaser “without notice of the defect.”
Regardless of how the SDNY rules, the losing party is likely to appeal to the Second Circuit, and possibly then the Supreme Court. The one thing that is clear is that this case is unlikely to reach final resolution for some months, and probably longer. Should the auction in Crystallex occur as scheduled in July 2024 (as discussed in greater detail below), bidders will not have any certainty on the outcome of the 2020 bondholder litigation.
Impact on the Crystallex case
The first round of bids in the Crystallex case—referred to as indications of interest—closed on January 22, 2024. The Special Master informed Judge Stark (who is overseeing the sale of PDV Holdings’ stock in Citgo) in a February 27 hearing that 12 parties (including “private financial buyers, strategic buyers, and existing PDVSA creditors”) submitted indications of interest, and nine of those 12 will come through Citgo for management presentations over the next few months. Per the bidding procedures, each bidder was required to include, among other issues, the bidder’s “proposed treatment of the outstanding indebtedness of PDVH and its subsidiaries and the purported pledge of shares of CITGO Holding (CITGO Holding Pledge) for the benefit of holders of that certain series of bonds issued by PDVSA due in 2020 (PDVSA 2020 Bondholders).” Crystallex, Misc. No. 17-151 (Dkt. 480-1).
Despite the uncertainty regarding the 2020 bonds, the sale process appears to be on track for a July 2024 sale hearing. On March 1, Judge Stark entered a priority order in Crystallex, setting 18 priority slots for 26 creditors based on the date they moved for a writ of attachment which was ultimately granted (some creditors moved on the same day and will take pro rata). Crystallex, Misc. No. 17-151 (Dkt. 996). Each creditor (except Crystallex, which is first in line) has a writ conditioned on an OFAC license.
This won’t be the last time we write on this topic in these First Tuesday Updates before July. If we can help you with questions about the 2020 Bonds, or the Crystallex sale, do not hesitate to reach out to us, and subject to conflicts, we would be happy to help.
