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By Charles Cheney Hyde
of the Board of Editors


It is of advantage to every state in need of financial aid, as well as to the banks of every country having funds to invest abroad, that external governmental loans be generally regarded attractive. Attractiveness amounting to more than temporary and sentimental interest, depends upon the development of a conviction among the best buyers of every land that such loans constitute a safe investment in the face of every contingency reasonably to be anticipated, and that they are fairly immune from dangers which have heretofore proved to be inherent in or incidental to dealings with sovereign states of certain types—dangers of repudiation on colorable or solid grounds, dangers of invalidity, dangers arising from the operation of certain principles of international law concerning the effect of changes of sovereignty, dangers due to inadequate security or to pledges incapable of practical utilization for the benefit of the lender, dangers due to the freedom of the borrower to apply at will and without restraint the proceeds of a loan.

Experience has shown that the importance of any one of these dangers varies greatly according to the conditions of the particular case, and largely in proportion to the character and stability of the borrower. Thus in some instances the sole and reasonable concern of the lender pertains to the validity of the transaction; in others, the matter of validity affords but the first of a series of equally grave problems. The long record of losses sustained by holders of perfectly valid external bonds encourages belief that lenders have at times failed to appreciate the significance or reality of questions wholly unrelated to those of validity, and yet indissolubly connected with the matter of negotiation.

Despite the vast differences in the stability and character and credit and morale of the states comprising the international society, any one of them may seek and need foreign fiscal aid. When it does, its capacity to become a desirable borrower should be utilized. It is of highest importance that weak as well as strong states should be enabled to obtain funds for legitimate ends on just terms. If, therefore, by any process, an American bank may find itself in a position to lend with reasonable safety to a state of any

* A slight enlargement of a paper presented to the Buenos Aires Conference of the International Law Association, August, 1922.

continent and of any type or class, the means of attaining that position deserve consideration. It is not suggested that a loan to a state habitually in default and of unsavory record is to be regarded as desirable, or that the moral risk is ever to be disregarded in any transaction. It is believed, however, that as the financial history of every prospective public borrower is an open book, its idiosyncracies and propensities known, its fundamental laws within the reach of all, and the availability of its assets for hypothecation and use for the benefit of the lender under most unfavorable circumstances a matter of reasonable calculation, it lies within the power of American banks to estimate intelligently and closely the degree and kind of protection to be demanded of each particular applicant, and also to fix the terms on which it may, under most conditions, be fairly accepted as a borrower.

Another and perhaps a broader aspect of the general problem must engage attention. Arrangements acknowledged to be essential for the protection of lenders to states whose finances, through conditions of chronic disorder, have required complete rehabilitation and even political oversight, or which have not been accepted for all purposes as full-fledged members of the society of nations, should not be taken as standards of general applicability in dealings with states which have reached a higher and different plane. Certain terms imposed upon countries under the wardship of the United States, or upon others still subjected to a régime of extraterritorial jurisdiction, offer precedents of doubtful expediency in transactions with borrowers of a wholly different type. It is not suggested that necessary safeguards should ever be omitted. It is one of the chief purposes of this memorandum to emphasize the importance of safeguards which have been too often overlooked or ignored. It is merely submitted that some terms exacted of, and unwillingly yet validly accepted by, certain foreign borrowers, might prove to be the sowing of dragons' teeth and beget a popular opposition sufficing in time to jeopardize service and produce default. Involved, therefore, in every external bond transaction is the matter of fiscal statesmanship which is likely to play an increasingly important part in the largest success of foreign loans hereafter to be underwritten in the United States; for the question confronting the American lender is not entirely how rigorously or completely can the borrower be kept under the domination of the lender, but also how can the debtor be made the lasting friend of the American creditor, and inculcated with the desire both to repay obligations as they accrue, and also to seek in the United States rather than elsewhere financial aid whenever needed. It is the effect of such an idea upon the success of American diplomacy in the best sense that gives to every external loan floated in the United States a significance far beyond the horizon of the individual purchaser of a bond. Happily American bankers are not without the larger vision.


An external bond issue must be valid as a primary condition of acceptability. Validity, so far as it concerns the conduct of the borrower, ia governed by the laws and constitution (if any) of the issuing state.* Their requirements must be fully met. The lender must, therefore, satisfy itself as to compliance.3 In the course of so doing it may, in common prudence, invoke the aid of local counsel within the territory of the borrower, and deemed competent to pass judgment on the question whether every local condition essential to validity has been satisfied. Such action does not, however, remove from the lender the burden of taking cognizance of every obstacle which it has reason to believe or suspect the institutions of the borrower may oppose, and of seeking advice thereon. The lender necessarily assumes grave responsibility in accepting the assurances of foreign local advisors as to whether contemplated dangers are fanciful, or have been removed, or are non-existent. What constitutes requisite assurance and what is to be regarded as trustworthy evidence of the requirements of the local law depend largely upon the personality of the borrower and the character of its highest officials. These vary greatly. In a recent bond agreement it was announced that

The Republic hereby represents and declares that all acts, conditions and legal formalities which should have been done or which should have happened or existed prior to the issuance of the Bonds, have existed, happened or been done as required by the constitution and laws of the Republic and in strict conformity therewith. 4

It may be observed, however, that no official representation, however entitled to credibility, is necessarily decisive of the fact involved; and it may be doubted whether it precludes denial of an allegation of fact by the successor to the borrower in case the officials of the borrower have for any

•Although this condition and a variety of applications of it are familiar to American bankers and their counsel, it seems necessary, for sake of clearness, to advert to the general principle and to modes of assuring respect for it.

3 In this connection, however, another consideration should be heeded. Oftentimes agreements for external bond issues are in fact concluded and perfected in the territory of the state where the lender is located—a circumstance which serves as a warning that no provision of the contract should set at nought any prohibition of the laws of that state denouncing as invalid contracts or provisions of a particular character. It is not suggested that the validity of mortgages or encumbrances of any kind upon immovable property within the state of the borrower is likely to be affected by the statutes of a foreign sovereignty. It is merely sought to be pointed out that in other matters, the state where the agreement is made may, for reasons of public policy, impose restrictions which if disregarded might prove embarrassing to the lender should the borrower subsequently invoke them as a ground for repudiation or rescission.

4 Such is the language of a Bond Trust and Fiscal Agency Agreement between a certain Central American State and bankers of the United States, concluded in 1920.

See also Articles VI and X of Chinese Hankow Improvement Loan of September 17, reason been led to make false assertions. Oftentimes, therefore, governmental representations need to be checked up by every available means. There is never removed from the lender the serious responsibility of assuring itself beyond possibility of reasonable doubt that no undertaking on the part of the borrower is void or even voidable, constituting an abuse of power through excessive yieldings of rights or prerogatives not to be relinquished under the local law.

The question of validity concerns both the form and substance of the borrower's undertaking. Technically, it embraces generally the two-fold inquiry: first, whether the borrower has the right under its own laws to undertake to do what is sought to be done; and secondly, whether in its undertakings it has pursued the course prescribed by those laws. Practically there is another and perhaps a larger question involved in the first inquiry, and which is never to be overlooked: whether for any reason and regardless of the approval of the local law, intelligent or unintelligent opinion within the territory controlled by the borrower and affected by the loan, challenges the obligations assumed, or protests against powers conferred on the lender as subversive of rights of sovereignty and as manifesting an abuse of governmental functions by the borrower.

A few of the matters which pertain to validity may be noted and regardless of the order in which they may be expected actually to arise.

With respect to the matter of security, there is involved an inquiry touching the kind or nature of the asset sought to be pledged. Does, for example, the local law permit the mortgaging or hypothecation of the public domain or its appurtenances such as a harbor or a court house or any other thing fulfilling an essentially public function and necessarily incidental to the administration of government or the exercise of political independence?' Again, does the local law permit the use and control of the particular kind of pledged public property by or for the benefit of a foreign lender, as by a trustee in its behalf, so as to enable it directly upon default, to utilize freely the security for the loan? More broadly, does the local law permit the borrower to divest itself of possession and control of the particular thing sought to be utilized as security? Does the local law forbid mortgage agreements serving to vest title to public property in a mortgagee or trustee? Do any general prohibitions of the alienation of state property render illegal attempts to utilize it freely as security for public loans? Are pledges of public revenues to be derived from any particular sources locally deemed better or worse in point of legality than the hypothecation of existing tangible property, whether movable or immovable?

1914, MacMurray, Treaties and Agreements with and concerning China, Vol. II, p. 1172; also Article II of Chinese agreement with Lee, Higginson and Co., of April 7, 1916, ibid., p. 1279.

* A Chinese loan agreement with French bankers, January 21, 1914, for the construction of a railway, purported to pledge by way of guaranty, the Port of Yamchow, its materials and appurtenances.

Such inquiries suggest the question which may recur when pledges of public property are utilized as security, whether the lender may not in a particular case go too far, and jeopardize the safety of a loan by exacting and obtaining the control and use of something by way of security which the laws of the borrower forbid it to alienate or pledge, or which, regardless of the law, popular opinion within the territory of the borrower deems to be inalienable.

Whether general or special legislation, or executive decrees purporting to authorize the provisions of a loan agreement accord with the fundamental law or constitution of the borrower must always demand, as has been observed, rigid examination. In the course of it the lender must take heed of the known reluctance of local advisers of high repute to denounce as illegal or unconstitutional steps taken by the governmental borrower, within whose domain they reside, to procure desired credit. The lender must ever be on its guard to ascertain by some process whether executive or legislative approval, however freely given, is such as not to encourage attempts to repudiate what the borrower has undertaken to do or permit, the moment a new administration takes the reins of government and essays to frustrate the work of its predecessor.

Again, the ostensible purposes of an agreement may run counter to what the law of the borrower permits; or the validity of pledges of particular assets may impose as a condition subsequent the expenditure of the proceeds of the borrowed funds for an essentially public end local to or peculiarly connected with the community or district within which the security is found. Such requirements demand rigid scrutiny and full respect.

The foregoing inquiries indicate roughly the scope of the task confronting the lender, and to be accomplished by it before it can announce with assurance the conclusion of a valid agreement, and one which later administrations conducting the affairs of the borrower will have little or no reason to oppose as invalid. With that initial problem out of the way, others equally complex arise for solution.


In external bond issues the question must frequently arise, according to the nature of the borrower: What state or government, if any, will be responsible for service, in case the territory to which the loan directly pertains undergoes a change of sovereignty? Suppose, for example, the Government of the Republic of Mexico issues external bonds, related through the nature of the security or otherwise, to the State of Sonora. Suppose Sonora revolts and attains its independence, uniting possibly with a successful confederacy in the neighboring State of Chihuahua. What entity is in such event to be regarded as responsible to the lender? Does the Republic of Mexico retain the burden; or does the new confederacy assume it; or is there apportionment? Again, is the correct result dependent upon

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