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Second Circuit Clarifies New York Law On Enforcement Of Debt Instruments

Since the early 1980s, lender banks have been selling to other investors the non-performing debt of countries that have ceased to service their external debt. These sales enable the banks to reduce their exposure and to make additional loans to developing countries. Participants in the sizable secondary market in the debt of emerging countries watched with interest - and filed five amicus curiae briefs - in a case decided by the United States Court of Appeals for the Second Circuit.

The Background

In Elliott Associates, L.P. v. Banco de la Nacion and The Republic of Peru, Elliott Associates, L.P. executed a series of letter agreements to purchase from international banks approximately $20.7 million in principal amount of the working capital debt of Peruvian banks, Banco de la Nacion and Banco Popular del Peru. All of the debt purchased by Elliott was guaranteed by the Republic of Peru pursuant to a written guaranty. By their terms, both the letter agreements and guaranty were governed by New York law.

Elliott subsequently delivered notices of the assignments to the reconciliation agents of Peru and Banco de la Nacion (collectively, the "Debtors") to register the debt it had purchased in order to obtain its pro rata share of interest payments the Debtors had promised to make to all creditors. Elliott also notified the Debtors that it was now one of their creditors and wished to initiate discussions regarding repayment.

The Debtors took the position that Elliott was not a proper assignee of the debt because it was not a "financial institution" within the scope of the assignment provision of the letter agreements and, therefore, Elliott should either transfer the debt to an eligible "financial institution" or participate in Peru's Brady Plan with the Debtors' other creditors. Pursuant to a Brady Plan, a committee of a less-developed nation's largest institutional creditors negotiates with the debtor country and commits to restructuring the debt of the country on agreed terms, which also are offered to the country's other creditors. While the members of the negotiating committee usually agree to be bound by the negotiated terms, the terms are not binding on other creditors.

After a continued impasse in negotiations with the Debtors, Elliott sent the Debtors a notice of default formally requesting repayment of its debt. Ten days before the Exchange Agreement contemplated by Peru's Brady Plan was scheduled to be executed, Elliott filed suit against the Debtors in New York state court seeking attachment of assets located in New York. The suit subsequently was removed to federal district court. In connection with pre-judgment attachment proceedings, the district court dismissed Peru's argument that Elliott was not a "financial institution." Thereafter, and following extensive discovery and a trial, the district court issued an 86-page decision dismissing Elliott's suit on the ground that Elliott's purchase of the Peruvian debt violated Section 489 of the New York Judiciary Law. The district court found that because Elliott purchased the debt with the intent and purpose to bring suit, Elliott's contracts violated Section 489 of the New York Judiciary Law and, therefore, were unenforceable.

The Case

The Second Circuit reviewed the plain language of the statute and determined that it offered little guidance as to the intended scope of the provision. After reviewing the relevant case law interpreting the provision, however, the court concluded that acquisition of a debt with an intent to bring suit against the debtor is not a violation of the statute where, as was the case here, the primary purpose of the suit was the collection of the debt acquired. The Second Circuit noted that, while courts have recognized that Section 489 is a statutory codification of the ancient doctrine of champerty - that is, maintaining a suit in return for a financial interest in the outcome - the Second Circuit stated that New York courts have interpreted the statute as proscribing something narrower than the definition would suggest.

The Second Circuit examined prior case law and found that it confirmed that the mischief Section 489 was intended to remedy did not include the acquisition of debt with the motive of collecting it, even if litigation might be a necessary step in the collection process. Rather, Section 489 was intended for the narrow purpose of preventing attorneys from buying debts as an expedient means to obtain costs for bringing suit.

The Second Circuit stated that a violation of Section 489 should turn on whether the primary purpose for purchase of the debt was to bring suit or whether the intent to bring suit was merely incidental and contingent. The court explained that where a debt instrument is acquired for the primary purpose of enforcing it, with an intent to resort to litigation only if necessary to enforce the debt, the intent to litigate is merely incidental and contingent and, therefore, does not violate Section 489 of the New York Judiciary Law.

The Second Circuit stated that the district court had expressly found that "Elliott's primary goal in investing in the Peruvian debt was to be paid in full." The Second Circuit noted that "the district court found that if the Debtors did not pay in full, it was Elliott's intent to sue for such payment." In concluding that Elliott had violated Section 489, the district court had reasoned that Elliott had an intent to sue because Elliott knew that Peru would not pay in full. The Second Circuit disagreed with this reasoning and noted that the Debtors could have paid Elliot but chose not to do so.

In the Second Circuit's view, Elliott's principal aim was to be paid in full. To achieve that primary goal, it was incidental that Elliott intended to sue for payment if the debtor failed to perform. The suit also was contingent because the district court had found that there would have been no lawsuit if the Debtors had agreed to pay Elliott the money owed to it.

The Second Circuit characterized Elliott's intent to be paid in full or sue for payment as a legitimate business purpose for the purchase of the debt - to turn a profit. The court explained that because Elliott had a legitimate business purpose for purchasing the debt, its purchase was not proscribed by the statute. Section 489 of the New York Judiciary Law is only violated if the primary purpose of taking an assignment is to commence a suit and not some other purpose. Therefore, the court concluded that Elliott's primary purpose of making a profit was a legitimate purpose rather than a collateral purpose prohibited by Section 489.


Based on the district court's erroneous interpretation of Section 489 and the compelling policy considerations, the Second Circuit reversed the district court's judgment and remanded the case to the district court for calculation of the breach-of-contract damages owed to Elliott by the Debtors. Traders in emerging market debt breathed a collective sigh of relief. In light of the Second Circuit's decision in Elliott, debtors are unlikely to attempt to use Section 489 of the New York Judiciary Law as a defense against legitimate investors who have purchased debt with the intention of enforcing their rights as creditors.

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