CLA News / Sovereign Debt Crisis and the Rule of Law by CLA President Steven Thiru: Presentation at the 2nd New Delhi International Rule of Law Convention 2025

Governments sometimes need to restructure their debts. Otherwise, a country’s economic and political stability may be threatened. But, in the absence of an international rule of law for resolving sovereign defaults, the world pays a higher price than it should for such restructurings. The result is a poorly functioning sovereign-debt market, marked by unnecessary strife and costly delays in addressing problems when they arise.[1]

A. Introduction

Sovereign debt crises are no longer occasional shocks — they are now a recurring feature of the global economy. They affect countries across regions, but their impact is felt most acutely in the Global South. While sovereign debt restructuring is sometimes unavoidable, the absence of a coherent international legal framework can turn what might otherwise be an orderly process into one fraught with uncertainty, inequity and unnecessary hardship. This paper examines how such crises impinge not only on financial stability but also on the rule of law.

Governments turn to restructuring because the alternative is collapse, default, economic instability, and political unrest. But without a clear international rule of law for resolving sovereign defaults, the costs are multiplied. The world pays a higher price than it should: unnecessary delays, inequitable outcomes, and prolonged social hardship. Citizens often face austerity measures — cuts to subsidies, higher taxes, and reductions in social spending. The consequences ripple through societies in the form of unemployment, inflation, and unrest. These are not just economic disruptions; they strain the very fabric of governance and erode the rule of law.

In this discussion, I will therefore focus on the urgent need for an independent, permanent multilateral debt resolution mechanism under the aegis of the United Nations. Such a framework would provide a fair, transparent, and predictable process for resolving sovereign defaults — one grounded in the rule of law rather than the bargaining power of creditors or the ad hoc interventions of financial institutions. Establishing this mechanism is not an abstract ideal; it is a practical necessity if we are to prevent future crises from spiralling into prolonged social and political breakdowns.

To underscore this point, later I will briefly turn to experiences in Argentina and Zambia, which illustrate the heavy costs of the current fragmented approach. I will also use Malaysia’s 1MDB crisis as a case study of how the manipulation, corruption and weak safeguards in sovereign debt management weaken public trust in institutions, and compromise long-term economic stability.

B. Key Terms

1. Sovereign Debt Default

The consequences of sovereign default are multifaceted.^[2] Creditors inevitably suffer financial losses, while the defaulting state experiences a decline in its creditworthiness,^[3] thereby facing higher costs in future borrowing. More critically, a state’s inability to secure financing undermines its capacity to safeguard socioeconomic rights and depresses national economic output.^[4]

Owing to globalisation, such crises rarely remain confined within national borders; financial instability in one jurisdiction can trigger economic contagion to others. The early twenty-first century demonstrated this vividly, with Argentina’s unprecedented default in 2001, followed by the global financial crisis of 2007–2008 and the ensuing Greek debt crisis beginning in 2009. These events confirmed that sovereign default is not merely an affliction of developing or emerging economies, but a systemic challenge for the global financial order. The onset of the COVID-19 pandemic in 2020 further compounded vulnerabilities, casting a grim outlook for many developing and emerging economies, and heightening the likelihood of debt restructuring amidst severe macroeconomic uncertainty.^[5]

Despite the recurrence and severity of such crises, the international community has yet to establish a multilateral framework or judicial mechanism to address sovereign defaults.^[6] Accordingly, international law on sovereign default remains underdeveloped, giving rise only to what has been described as an “informal regime” of sovereign debt restructuring.^[7]

For example, through the United Nations (UN) Department of Economic and Social Affairs, efforts have been made to advance principles and frameworks for sovereign debt restructuring, including calls for transparent, timely, and equitable processes that balance the interests of both creditors and debtor states.

At the 76th Session of the UN General Assembly in 2021, these issues gained renewed urgency, as numerous Member States, particularly from the Global South, demanded reforms to the international financial architecture. Proposals included the creation of a multilateral debt workout mechanism, improved debt restructuring frameworks, immediate debt relief and cancellation, and the recognition of the growing nexus between debt sustainability and climate change. Leaders from countries such as Argentina, Pakistan, and Nigeria emphasised the need for systemic solutions, while small island developing states like the Maldives, Palau, and St. Lucia linked debt burdens directly to their vulnerability to climate threats.

The above mentioned varying interests illustrate that sovereign borrowing and default are deeply complex, spanning legal, economic, and policy dimensions.^[8] They give rise to recurring problems such as delayed government responses, negative externalities, and moral hazard such as instances where the prospect of bailouts encourages reckless borrowing or lending. While some of these issues may be best analysed through economic theory, others require an integrated, multidisciplinary approach. Among the most pressing unresolved concerns is the persistence of holdout litigation and arbitration pursued by bondholders in the aftermath of default. Such actions obstruct the orderly implementation of debt restructuring processes and exacerbate the crisis.

2. Who is the Sovereign?

When medieval monarchs such as Edward III of England sought financing for their wars, they turned to wealthy banking families, famously those of Florence. These families extended loans that were extremely costly, and when Edward’s campaign to claim the French crown failed, he could not repay them in full. From these origins, what began as the personal debts of rulers gradually evolved into the vast, complex system of “sovereign debt” — a global web of obligations measured in trillions, denominated in multiple currencies, and owed by states rather than kings. Yet, this evolution raises a fundamental question: who exactly is the “sovereign”, when we speak of sovereign debt?

As observed by Odette Lienau, one view is that sovereignty rests with the state as a juridical entity, a government exercising effective control over a defined territory and population, regardless of its origins or legitimacy. This statist conception, rooted in legal positivism and realist international relations theory, treats sovereignty as continuity. In other words, regimes may change, but the state remains bound by its financial obligations. Without such continuity, creditors fear, lending to governments would collapse.

A competing perspective holds that sovereignty belongs to the people. From this standpoint, debt incurred by a dictatorial or corrupt regime, without popular consent and yielding no benefit to citizens, cannot truly bind the population once that regime falls. This is the rationale underpinning the doctrine of odious debt, which argues that successor governments should not inherit loans contracted by despotic rulers for illegitimate purposes. The debate over Iraqi debt after Saddam Hussein’s fall in 2003 exemplifies this tension. Some United States (US) officials insisted that the Iraqi people should not bear debts incurred under tyranny, while many European creditors rejected such reasoning as destabilising for credit markets.

Lienau further highlights that the binary between “statist” and “popular” conceptions is overly rigid. A third, intermediate approach emerged in the early twentieth century through US Chief Justice William Howard Taft’s arbitral decision in the Tinoco Arbitration (1923).^[9] Taft acknowledged that sovereignty requires effective control, but he also insisted that contracts entered into by a government must comply with that state’s internal legal framework. In other words, even a de facto regime cannot freely bind its country internationally if it violates its own constitutional or statutory requirements in doing so. This “rule-of-law” conception emphasises procedural legitimacy, insisting that rulers, however constituted, remain bound by the legal rules they themselves promulgate.

The approach adopted in the Tinoco Arbitration offers a balanced path forward, as it recognises the necessity of continuity and stability in sovereign lending while also ensuring that obligations must be grounded in a government’s own internal legal order. By requiring rulers, regardless of their political legitimacy, to respect their own constitutional and statutory framework, Taft’s decision provides a principled middle ground that protects creditors without forcing unjust burdens onto populations for debts incurred outside the bounds of lawful governance.

C. Illustrative Case Studies: Argentina, Zambia and Malaysia

1. Argentina

When Argentina defaulted in late 2001, the Government imposed limits on bank withdrawals (the infamous corralito), triggering widespread protests. In Buenos Aires, demonstrations — initially peaceful — escalated into violent confrontations, culminating in riots in Plaza de Mayo. Several protesters were killed, and banks and businesses were destroyed, leading to the president’s resignation and a state of emergency. These events exposed the fragility of the rule of law when economic measures disproportionally harm ordinary citizens and provoke societal breakdown.

2. Zambia

Zambia became the first African country to default in 2020 during the COVID-19 pandemic, sparking prolonged delays in debt restructuring under the G20 Common Framework. These delays severely hampered fiscal planning, constraining social spending on health, education, and electricity subsidies — services essential to maintaining public order and wellbeing. The depreciation of the Kwacha led to uncontrolled inflation, escalating living costs, and foreign exchange shortages, making imports — including fuel and medicine — unaffordable and inaccessible. The combination of austerity, rising prices, and curtailed public services sparked concern among UN human rights experts, who warned the delay risks retrogression in development and human rights obligations.

3. Malaysia

Malaysia’s notorious 1Malaysia Development Berhad (1MDB) saga, which began in 2015, shows how governance failures can fuel unsustainable sovereign debt. Created in 2009 as a state investment fund, 1MDB instead became the subject of extensive domestic and international investigations over billions of dollars siphoned through opaque structures, leaving the Malaysian Government to bear the fund’s mounting obligations.

The Government responded not with transparency but with measures that directly contravened the core principles of the rule of law. Key audit reports were classified under the Official Secrets Act 1972, curtailing transparency and accountability; media and online commentary were curbed through the Communications and Multimedia Act 1998; and detention without trial laws were used to intimidate those investigating the case. Together, these actions undermined accountability and deepened the perception that legal instruments were being weaponised to protect those in power. The 2018 Government brought numerous charges against those allegedly involved. Najib was subsequently prosecuted for several offences, and convicted in a 1MDB-linked case.[10] The Malaysian Government has also made efforts to retrieve the lost funds through several means.

International enforcement has played a decisive role in advancing accountability in the 1MDB scandal. Convictions of bankers and executives in the United States, alongside a settlement by JPMorgan Chase & Co. and a separate penalty imposed on its Swiss subsidiary, signalled that even powerful actors can be held liable when they exploit the financial system. Notably, the US Department of Justice’s Kleptocracy Asset Recovery Initiative (KARI) demonstrated the rule of law in action: corruption proceeds were pursued through US courts, and approximately USD1.4 billion has been repatriated to Malaysia as of June 2024. This approach demonstrates how a nation can use its legal system to apply principles of justice and accountability  in cases of international financial crime. A legal and transparent framework was used to address the case, rather than relying on political power and or military forces.

The 1MDB case underscored how sovereign debt, when mismanaged and manipulated for corrupt purposes, can erode good governance, financial credibility and the rule of law. While subsequent reforms and ongoing asset recovery efforts illustrate the resilience of the rule of law, the saga remains a cautionary tale of the dangers posed by unchecked executive discretion and the lack of robust oversight mechanisms. For Malaysia, the path forward lies in strengthening fiscal responsibility laws, bolstering anti-corruption safeguards, protecting whistleblowers, and ensuring that political authority cannot override institutional integrity.

D. The Structural Weaknesses of Current Mechanisms

Governments often face situations where they must restructure their debts to preserve both economic and political stability. Yet, in the absence of a clear international legal framework for sovereign debt restructuring, these processes are often messy, delayed, and more costly than necessary. Instead of smooth resolutions, markets are marked by disputes, uncertainty, and unnecessary hardship for debtor nations and their citizens.

The current approach relies too heavily on market forces and negotiation among parties with highly unequal bargaining power. In such settings, powerful creditors frequently impose their will on weaker states, leading to solutions that are neither equitable nor sustainable. Often, one debt crisis is merely followed by another. Without a framework that prioritises sustainability, both debtors and creditors end up worse off.

In domestic settings, no state allows market forces alone to dictate debt resolution. Bankruptcy laws exist precisely to provide fairness, order, and efficiency in negotiations between debtors and creditors. Sovereign debt, however, is substantially more complex, crossing multiple jurisdictions, involving numerous types of creditors, and concerning assets that are difficult to define. For this reason, it is striking that many powerful actors continue to resist calls for an international rule of law, insisting that the current system is sufficient, when it plainly is not.

While a full international bankruptcy code may be difficult to achieve, consensus could still be built around key principles. These could include halting disruptive litigation during restructuring; prioritising creditors who lend fresh funds to struggling nations; and reaffirming that sovereign rights, such as immunity, cannot be permanently signed away. Limits should also be placed on the extent to which one government can bind future governments, especially when loans are made recklessly or corruptly. Such rules would encourage more responsible lending and borrowing, to prevent future generations from paying the price of short-sighted or corrupt decisions.

E. Renewed Momentum for a UN-Based Mechanism

In recent years, momentum has been building for a truly multilateral solution under the auspices of the United Nations.

1. UN General Assembly Endorsement (2015)

Inspired by these systemic flaws, the UN General Assembly adopted a resolution in 2015 highlighting key principles for sovereign debt restructuring — sovereign equality, impartiality, sustainability and transparency. The Debt Justice Campaign (formerly Jubilee Debt Campaign) noted at the time that for any debt arbitration mechanism to succeed, it must be independent — housed not in an institution that is itself a creditor, like the IMF, but in the UN.

2. UNCTAD’s Analysis

The United Nations Conference on Trade and Development (UNCTAD) has been one of the strongest advocates for a fair, transparent, and rules-based international debt workout mechanism. In its Sovereign Debt Workouts: Going Forward report, UNCTAD warned that the current system lacks legitimacy, impartiality and effectiveness. It has argued that only a multilateral statutory process, administered under international law, can deliver equitable burden-sharing between creditors and debtors.

3. UNU–CPR’s Insight (2024)

The United Nations University Centre for Policy Research urged consideration of a UN-led multilateral sovereign debt mechanism. Its 2024 report argued that such a framework can bring “greater predictability, transparency and equity” to sovereign debt workouts, and linked the discussion directly to the broader Financing for Development agenda. This agenda, launched in Monterrey in 2002 and reaffirmed in Addis Ababa in 2015, provides the UN’s framework for mobilising resources for sustainable development, with sovereign debt sustainability identified as one of its central pillars.

F. Why the UN Mechanism Matters for the Rule of Law

This is not just about efficiency. It is about embedding the principles of the rule of law in global economic governance. An independent, permanent, UN-led debt resolution mechanism would ensure that restructuring processes are transparent, rules-based, and equitable. It would provide debtor nations a genuine voice, while also offering creditors predictability and fair treatment.

Institutional features should include:

1. Independent arbitration panels: to ensure that disputes are resolved by a neutral and impartial body;
2. Clear, transparent and objective criteria for assessing debt sustainability: to create predictability and fairness, helping prevent arbitrary decisions and restoring trust among both debtors and creditors;
3. Automatic standstills on litigation during negotiations: to stop creditors from rushing to courts to seize assets, giving countries the breathing space they need to negotiate in good faith; and
4. Binding rulings that prevent endless creditor delays: to guarantee that once a fair agreement is reached, it applies to all parties, avoiding the holdout problems that have plagued, for example, Argentina.

Such a framework would help prevent situations where citizens bear disproportionate costs of crises they did not create. When debt workouts are delayed or distorted by creditor power, the result is austerity that strips away basic social protections. This erodes trust in governance and undermines the rule of law both domestically and internationally. A fairer, rules-based system would distribute burdens more equitably, protecting vulnerable populations and reinforcing the legitimacy of the global financial order. Social inequality, lawlessness, and governance breakdown become preventable, rather than inevitable, outcomes.

As Anna Gelpern has eloquently argued, “the lack of a transparent, enforceable priority structure of sovereign debt makes debt restructuring and crisis management more painful and costly than it could be, complicates risk assessment, and encourages overborrowing and secured lending in the absence of higher political accountability”. As such, “improving its transparency and predictability would be good for the system”.

G. The Lawyer’s Role in Debt Justice

Now, this is where we, as lawyers, come in. Associations like the Commonwealth Lawyers Association can play a pivotal role. We can mobilise expertise to shape fair and transparent frameworks, highlight the human rights and governance costs of debt crises, and insist that restructuring processes are guided by the rule of law — not just by market leverage. And because we bring governments, international organisations, and civil society into the same room, we are in a unique position to keep the conversation anchored in legal principles.

At the national level, local bar associations and even individual lawyers can make a real difference. We can press for stronger domestic debt management laws, demand transparency in borrowing, and litigate cases that expose corruption or mismanagement. We can also demystify these financial issues for the public, translating complex arrangements into clear language that empowers communities to hold their leaders accountable. In short, the legal profession has a dual role here: protecting justice in the courtroom, and embedding the rule of law in the governance of the global economy.

H. Conclusion

The sovereign debt crisis is, at its core, a rule-of-law challenge. In the absence of clear legal rules, outcomes reflect power dynamics rather than justice. An independent, permanent mechanism under the UN can deliver predictability, fairness, and stability. Crucially, it can restore trust in governance and align global financial architecture with the values of international law.

This is not a radical idea — it is the logical next step in aligning global finance with the rule of law. Without it, we risk repeating cycles of crisis, delay, and hardship. With it, we have the opportunity to embed fairness, justice, accountability, and stability into the lifeblood of global economic governance.

Steven Thiru

President

Commonwealth Lawyers Association

Steven Thiru records his appreciation to Jaishanker Sadananda, Phoebe Yeoh Pae Lii and Chin Oy Sim for their assistance in preparing this article

NOTES:

[1] Stiglitz, J. E., & Guzmán, M. (2015, June 15). Why we need an international rule of law for sovereign debt. World Economic Forum. Retrieved from https://www.weforum.org/stories/2015/06/why-we-need-an-international-rule-of-law-for-sovereign-debt/

[2] International Monetary Fund. (2021). Issues in restructuring of sovereign domestic debt (IMF Policy Paper No. 2021/071). International Monetary Fund.

[3] International Law Association, Sovereign Insolvency Study Group. (2010). State insolvency: Options for the way forward (Report for the Hague Conference, 2010).

[4] Goldmann, M. (2012). Sovereign debt crises as threats to the peace: Restructuring under Chapter VII of the UN Charter. Goettingen Journal of International Law, 4(1), 153–175.

[5] Cohen, C., et al. (2020). The role of state-contingent debt instruments in sovereign debt restructurings (IMF Staff Discussion Note SDN/20/06). International Monetary Fund.

[6] Greenwood, C., & Mercer, H. (1995). Considerations of international law. In B. J. Eichengreen & R. Portes (Eds.), Crisis? What crisis? Orderly workouts for sovereign debtors (pp. 113–136). Centre for Economic Policy Research.

[7] Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/05, Decision on Jurisdiction and Admissibility, 4 August 2011, para. 40.

[8] Nakajima, K. (2017). Traditional and modern designs for international law of sovereign debt restructuring: A way forward. In C. Renshaw, H. Cullen, & J. Harrington (Eds.), Experts and networks in international law (pp. 230–256). Cambridge University Press.

[9] Tinoco Case (Gr. Brit. v. Costa Rica), 1 R. Int’l Arb. Awards 369 (1923)

[10] Dato’ Sri Mohd Najib bin Hj Abd Razak v Public Prosecutor and other appeals (No 1) [2022] 5 MLJ 85