411.12/914a

The Secretary of State to the Ambassador in Mexico (Morrow)37

No. 578

Sir: Referring to the informal and general discussions between us regarding the possibility of reaching an agreement with the Government [Page 462] of Mexico as to a lump sum settlement of the various claims of American citizens against Mexico, I submit below comments and instructions for your guidance in connection with any negotiations which you may undertake with a view to reaching such an agreement.

As your reports38 clearly indicate, there are very large obligations against Mexico running not only in favor of our government but in favor of other governments and also in favor of the nationals of our government and of other governments. There are also large obligations running in favor of Mexican nationals. Some of these obligations are liquidated and some are unliquidated.

These obligations are both express and implied. The express obligations are in part diplomatic arrangements and in part undertakings with private parties with reference both to financial operations, such as bonds and other treasury obligations, and to industrial or commercial obligations, such as concessions and contracts. The implied obligations arise out of contractual relations between Mexico and the nationals of this and other countries, and out of the tortious taking of property real or personal, or the infliction of injuries or wrongful death. These obligations, both the express and the implied, are frequently unliquidated as to their exact amounts.

Without entering into any extended discussion of Mexico’s exact financial condition, it is sufficient to say that the preliminary examinations which have been made of Mexico’s finances, the result of which examination is contained in the Sterrett-Davis report39 and in your reports to the Department, disclose that the Mexican Government is not able to pay all of her debts now due and payable, and therefore is in a position analogous to that of an insolvent debtor under private law.

In regard to the Mexican obligations to the nationals of other countries, the primary interest of the United States is that there shall be no preferences made in favor of the nationals of other governments as against the nationals of the United States, either as to the kind of obligations recognized or paid, or as to the time or the manner of payment. Comity requires that Mexico shall treat all nations alike.

There was not long since a renewal of press reports, more or less current in November of last year, to the effect that the holders of Mexican bonds—approximately 20 per cent only of whom appear to be Americans—are again seeking with Mexico some kind of adjustment of their holdings. The Department is not advised as to the exact amount of Mexico’s bonded obligations, but is under the impression [Page 463] that, including bonds the payment of which Mexico guarantees, the amount runs well toward five hundred millions of dollars.

It is obvious that an adjustment of these obligations might be made that would quite forestall any possibility of Mexico’s meeting her other obligations, in any adequate way and in normal course.

With reference to these obligations and the adjustment thereof, I desire to discuss somewhat the matters and principles involved, and to call attention to certain precedents.

It seems that not only under the Anglo-American system of law, based on the old common law and equity of Great Britain, but also under the civil law system, secured creditors against an embarrassed or insolvent debtor are not always entitled to preferences over general creditors; indeed there are certain types of general creditors who enjoy preferences over the secured creditors. In the United States the law has perhaps been most fully developed in connection with receiverships of railways, and it appears to be the law that “mere contract debts of a railroad company, as for labor, materials and supplies, incurred prior to the appointment of a receiver, and unsecured by any lien upon the property, may, through the aid of a court of equity, be given priority over antecedent mortgages.” (High, Receivers, Fourth Edition, Section 394a, p. 503)

It seems also to be a general rule with reference to railways that the receiver’s expenses constitute a prior charge over mortgage indebtedness, as also charges for extending the railway line, damages incident to the operation of the railway, rentals, supplies, taxes, et cetera.

Among receivers’ liabilities which must be met prior to the payment of the secured obligations are “damages for personal injuries sustained by passengers and employees, by reason of defects in the road or equipment, or the negligence or misconduct of the receiver’s servants. Receivers as such have also been held liable for damage or loss of goods entrusted to them for carriage, for injuries inflicted upon travelers, for injuries to stock arising from a failure to fence the road, and, in general, for all damages for torts for which the corporation itself would be liable under similar circumstances.” (1 Elliott on Railroads, Section 577, p. 842)

As already stated, the same general principles exist in the civil law. Domat in his work on Civil Law, (Volume 1 (Cushing Edition, 1850) p. 681) discusses the privileges of creditors and states that “the privilege of a creditor is the distinguishing right which the nature of his credit gives him, and which makes him to be preferred before other creditors, even those who are prior in time and who have mortgages.” In the succeeding pages Domat discusses the giving of privileges to various individuals, and lists among them those who lend money for the purchase price of a property, or to preserve the rest, or to make improvements, and many others.

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While it is well understood that principles of private law, as such, are not necessarily applicable or controlling in relations between states, particularly where the states concerned have different systems of law, yet it may be observed that where the fundamental principles of the private law of two states are in substantial harmony, it is considered not unreasonable in the intercourse between such states to apply such common principles to the relations between them in the absence of some applicable and controlling principle of international law.

In this view it would not be possible to regard as contrary to legal principles or to legal morals, a contention that even the secured bonds of a nation (to say nothing of those which, being unsecured, have behind them only the general credit of the country), should not be placed higher than national obligations of other sorts; indeed neither law nor legal morality would be violated if secured obligations were subordinated to certain of the general obligations of a state. For just as under private law claims for the protection, the betterment, the upkeep, and the general maintenance of an industrial or other enterprise—those things which enable the enterprise to continue as a “going concern”—must be met in preference to the secured creditors of the enterprise, for the reason, among others, that unless the enterprise is kept as a “going concern”, the securities held by the creditors would become valueless, so those claims against a government which result in its enrichment or in its general betterment as a government, its general maintenance and upkeep charges, its torts, whether against person or property, inflicted in the course of its carrying on as a “going concern,” should be given equal treatment with, if not indeed preference over, the holders of secured obligations, and for the same general reason that operates in the private law towards the industrial enterprise, namely, that unless the government be a prosperous “going concern”, its secured creditors may not confidently expect to realize upon their securities.

The Department does not, however, at this time wish to insist upon the application of this strict doctrine.

In this relation the rule must be brought into view that contract claims generally, including bond claims, hold in international law a position inferior to claims arising out of torts. The rule as to contract claims, as stated by Mr. Moore and supported by almost innumerable authorities, is:

“It is not usual for the government of the United States to interfere, except by its good offices, for the prosecution of claims founded on contracts with foreign governments.” (VI Moore’s Digest, p. 705)

A distinction is sometimes taken between those contractual obligations of a state which result in the creation of a bonded debt and other [Page 465] contractual obligations of a state by which other liabilities are incurred. Westlake, in his work on International Law, (Volume I, Peace, Second Edition, pp. 332–334) comments as follows upon the principles involved:

“It appears to us that contracts with foreign governments ought not to be treated as forming a single class. We will repeat on that point language of which ten years’ experience and reflection have confirmed to us the justice. ‘A distinction seems to exist between the case of bonds forming part of a public loan on the one hand, and contracts such as those for concessions or the execution of works on the other hand. Interests of the latter kind usually enjoy regular protection by law, notwithstanding that a government is the defendant against whom relief is to be sought. There is a petition of right, a court of claims, or an appropriate administrative tribunal before which to go. The case is not essentially different from any other arising between man and man. The foreigner who has contracted with the government has not elected to place himself at its mercy, and the rule of equal treatment with nationals requires that he shall have the full benefit of the established procedure, while if in a rare instance there is no such established procedure, or it proves to be a mockery, the other rule of protecting subjects against a flagrant denial of justice also comes in. But public loans are contracted by acts of a legislative nature, and when their terms are afterwards modified to the disadvantage of the bondholders this is done by other acts of a legislative nature, which are not questionable by any proceeding in the country. If therefore the rule of equal treatment with nationals be looked to, the foreign bondholder has no case unless he is discriminated against. And if the rule of protecting subjects against a flagrant denial of justice be looked to, the reduction of interest or capital is always put on the ground of the inability of the country to pay more—a foreign government is scarcely able to determine whether or how far the plea is true—supposing it to be true, the provisions which all legislations contain for the relief of insolvent debtors prove that honest inability to pay is regarded as a title to consideration—and the holder of a bond enforceable only through the intervention of his government is trying, when he seeks that intervention, to exercise a different right from that of a person whose complaint is the gross defect of a remedial process which by general understanding ought to exist and be effective.’ Hence we think that the assistance of their state ought not to be granted to the bondholders of public loans, unless the defaulting government presumes to treat its internal and external debts on terms of inequality unfavourable to the latter. But we see no reason for not granting, on other contracts with foreign governments, the same assistance which, on the general principles relating to the protection of subjects, is due to them when suffering the denial or failure of justice on their contracts with private persons.

“Hall however sees no difference in principle between what may be called the private contracts and the public loans of a government, though he admits a difference in practice relating to them. And both Lord Palmerston and Lord Salisbury maintained the view that the [Page 466] right of intervention on behalf of bondholders is unquestionable, although its exercise ought to depend on the balance of considerations, the amount of loss in the particular instance being weighed against the general expediency of discountenancing hazardous loans. Continental writers uphold such intervention as an important exercise of the right of self-preservation applied to the national fortune.”

The statement by Hall, to which Westlake made reference, reads in its full form as follows:

“There is one general point upon which a few words may be added. It has become a common habit of governments, especially in England, to make a distinction between complaints of persons who have lost money through default of a foreign state in paying the interest or capital of loans made to it and the complaints of persons who have suffered in other ways. In the latter case, if the complaint is thought to be well founded, it is regarded as a pure question of expediency on the facts of the particular case or of the importance of the occurrence whether the state shall interfere, and if it does interfere, whether it shall confine itself to diplomatic representations, or whether, upon refusal to give redress, it shall adopt measures of constraint falling short of war, or even resort to war itself. In the former case, on the other hand, governments are in the habit of refusing to take any steps in favour of the sufferers, partly because of the onerousness of the responsibility which a state would assume if it engaged as a general rule to recover money so lost, partly because loans to states are frequently, if not generally, made with very sufficient knowledge of the risks attendant on them, and partly because of the difficulty which a state may really have, whether from its own misconduct or otherwise, in meeting its obligations at the time when it makes default. Fundamentally however there is no difference in principle between wrongs inflicted by breach of a monetary agreement and other wrongs for which the state, as itself the wrong-doer, is immediately responsible. The difference which is made in practice is in no sense obligatory; and it is open to governments to consider each case by itself and to act as seems well to them on its merits.” (International Law, Sixth Edition, pp. 275–276)

While it is not believed that the distinction made by Westlake is sound in logic or in morals, or indeed in recognized international law, yet it must be said that the customary conduct of nations has generally been more or less closely in accord with the principles announced by him.

A statement of this customary view, so far as Great Britain is concerned, was made by Lord Palmerston in his famous circular dated January 18, 1848. This reads:

“Her Majesty’s Government had frequently had occasion to instruct her Majesty’s representatives in various foreign States to make earnest and friendly, but not authoritative representations, in support of the unsatisfied claims of British subjects who are holders of public bonds and money securities of those States.

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“As some misconception appears to exist in some of those States with regard to the just right of her Majesty’s Government to interfere authoritatively, if it should think fit to do so, in support of those claims, I have to inform you, as the representative of her Majesty in one of the States against which British subjects have such claims, that it is for the British Government entirely a question of discretion, and by no means a question of International Right, whether they should or should not make this matter the subject of diplomatic negotiation. If the question is to be considered simply in its bearing upon International Right, there can be no doubt whatever of the perfect right which the Government of every country possesses to take up, as a matter of diplomatic negotiation, any well-founded complaint which any of its subjects may prefer against the Government of another country, or any wrong which from such foreign Government those subjects may have sustained; and if the Government of one country is entitled to demand redress for any one individual among its subjects who may have a just but unsatisfied pecuniary claim upon the Government of another country, the right so to require redress cannot be diminished merely because the extent of the wrong is increased, and because instead of there being one individual claiming a comparatively small sum, there are a great number of individuals to whom a very large amount is due.

“It is therefore simply a question of discretion with the British Government whether this matter should or should not be taken up by diplomatic negotiation, and the decision of that question of discretion turns entirely upon British and domestic considerations.

“It has hitherto been thought by the successive Governments of Great Britain undesirable that British subjects should invest their capital in loans to foreign Governments instead of employing it in profitable undertakings at home; and with a view to discourage hazardous loans to foreign Governments, who may be either unable or unwilling to pay the stipulated interest thereupon, the British Government has hitherto thought it the best policy to abstain from taking up as International Questions the complaints made by British subjects against foreign Governments which have failed to make good their engagements in regard to such pecuniary transactions.

“For the British Government has considered that the losses of imprudent men, who have placed mistaken confidence in the good faith of foreign Governments, would prove a salutary warning to others, and would prevent any other foreign loans from being raised in Great Britain, except by Governments of known good faith and of ascertained solvency. But nevertheless, it might happen that the loss occasioned to British subjects by the nonpayment of interest upon loans made by them to foreign Governments might become so great that it would be too high a price for the nation to pay for such a warning as to the future, and in such a state of things it might become the duty of the British Government to make these matters the subject of diplomatic negotiation.

“In any conversation which you may hereafter hold with the … Ministers upon this subject, you will not fail to communicate to them the views which her Majesty’s Government entertain thereupon, as set forth in this despatch.” (Phillimore’s International Law, Vol. II, pp. 9, 10, 11)

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To this time there have been such few occasions upon which the question was presented to the Department of State that a clear American rule upon the matter cannot be stated. In 1874 the Acting Secretary of State, Mr. Cadwalder, in instructing our Minister to Mexico regarding forced loans, said:

“It is not denied that, if the loan had been a voluntary one, the lenders should not have expected diplomatic interposition in their behalf, at least until they had exhausted all means of obtaining redress through the courts.” (VI Moore’s Digest, p. 678)

In 1884 Secretary Frelinghuysen stated:

“There are also cases, but not common enough to form a rule of action, where the bonds of one government being wholly or largely held by the citizens of another, upon default thereof, the government of which the creditors are citizens may endeavor, by diplomatic remonstrance or negotiation, to effect an international agreement between the two countries, prescribing the time and manner of adjustment.” (VI Moore’s Digest, p. 713)

In 1904 the United States presented a diplomatic claim with respect to certain bonds issued by the Government of Haiti to an American firm in payment for coal furnished by such firm, and the claim so presented was adjusted by the Government of Haiti. (Foreign Relations, 1904, p. 392)

A distinction has been drawn as to the position of bondholders who have nothing but the general credit of the country behind their bonds and those bondholders who have pledges on special securities, such as customs, et cetera, from which their obligations are to be served. This distinction sanctions interposition upon behalf of the holders of secured bonds when the debtor government converts the funds pledged to other uses, on the theory, it would seem, that by such conversion the debtor government commits a “tort” which justifies the government of the creditor to interpose in his behalf.

Under the Convention between the United States and Mexico of 186840 the Commissioners held that the diversion by public authority to other purposes of customs receipts pledged for the payment of a certain obligation (it does not appear that this was a bond obligation) “was a tortious act, which formed a basis for an award, without reference to the question whether the commissioners could allow claims founded in contract.” (4 Moore’s Arbitrations, p. 3465)

The Domestic Commission organized under the Act of March 3, 1849, to adjudicate claims of Americans against Mexico, in an opinion concurred in by all the Commission, made the following observation:

“Nor does the fact alleged in the memorial that the debts were ‘to be paid out of the receipts of the custom-house’ impose any obligation [Page 469] upon Mexico, unless those receipts had been pledged by the government for the payment of these debts, which is not asserted in the memorial.” (4 Moore’s Arbitrations, p. 3458)

Just what constitutes such a pledge of revenues is a question of considerable difficulty. (Case of Peruvian Corporation Limited, Tribunal Arbitral Franco-Chilean; Twycross v. Dreyfus (1877) L.R. 5 Chancery 617)

The adjustments, in which the United States has taken part in the past, of the indebtedness of various countries to their creditors have been carried out upon the theory that no distinction, as to priorities in time or method of payment, existed between the bonded debt, debts which resulted from arbitral awards, and obligations which followed the settlement of individual claims against a government either through formal diplomatic means or under and through diplomatic good offices, or (seemingly) by private adjustment.

In the adjustment which took place in 1906–1907 between Santo Domingo and her creditors, no distinction was made between the various classes of obligations as above named. The Convention between the United States and the Dominican Republic signed February 8, 1907,41 recites that the Dominican Republic’s debts amounted to over thirty millions of dollars. To discharge these thirty millions of dollars the Dominican Government arranged to issue bonds in the amount of twenty millions of dollars, which latter sum covered not only the said obligations, which amounted roughly to seventeen million dollars, but also a sum to be used for internal purposes in Santo Domingo. These various sorts of obligations, including the bonds, were by this adjustment reduced from their face value in amounts varying from 90 per cent to 10 per cent of such value. The bonds covered by the plan were cut down 50 per cent. An arbitral award was cut down 10 per cent. Some certificates and certain floating indebtedness were cut down 90 per cent. (See Confidential Executive Document No. 1, 59th Congress, First session;42 Agreements covering loan made between Santo Domingo and Kuhn, Loeb and Company of September, 1906;43 Letter of September 12, 1906, of Señor Velazquez enclosing plan of adjustment; I Malloy’s Treaties, p. 418)

During the months of 1909 the differences existing between the Government of Honduras and its bondholders had reached the point where that Government was under the necessity of making some arrangement regarding its debt. When this question first arose, information was conveyed to the Department of State that an American citizen had presented to the Government of Honduras a plan to place [Page 470] Honduras under the same character of regime for the settlement of external and internal debts that had been applied to Santo Domingo, including the taking over by the Government of the United States of the customs of Honduras. As pointed out above, this plan embraced the non-preferential treatment of the creditors of Honduras.

The American Minister at San Salvador, Mr. Dodge, having communicated the foregoing information to the Department, Secretary Root, under date of January 26, 1909, advised the Minister as follows:44

“The United States cannot, of course, take the position or subject itself to the imputation of directly or indirectly suggesting such a plan as you describe in your telegram received January 23d, but you would be safe in expressing to the Minister for Foreign Affairs your confidential opinion that any overture in that direction from the Government of Honduras would be considered by the Government of the United States with the strongest possible desire to be of service to Honduras and to contribute towards bringing about such a satisfactory result as has recently been attained in Santo Domingo.”

On March 21, 1909, the American Minister at Honduras advised the Department of certain negotiations which had taken place between the foreign bondholders as unofficially represented by the British Minister to Central America and the Government of Honduras, and stated as follows:

“Before knowing exact terms of proposition, I notified Government of Honduras in writing, that while it was desirable Honduras should meet such obligation, my Government desired a settlement favorable to all interests which would also safeguard revenues and resources of Honduras; that an agreement which ignored or endangered the interests of all other creditors would be viewed by the Government of the United States as an unfriendly act.”

The Minister transmitted with a despatch dated March 19, 1909, a copy of a communication which he made to the Minister of Foreign Affairs of Honduras, in which communication the Minister stated:

“I feel it my duty, however, to formally notify Your Excellency’s Government that any arrangement which may ignore or endanger the interests of all other creditors would be viewed by my Government with profound regret and be considered as an act inconsistent with the friendly relations so happily existing between the two countries.”

Under date of December 21, 1909, Mr. Jennings of Stetson, Jennings and Russell, attorneys for the American bankers, announced that an agreement had been reached between the bankers and the Government of Honduras which provided for the issue of bonds [Page 471] which was to cover outstanding foreign bonds and debts, and the settlement of claims which had been made by individuals against the Government of Honduras.

Loan agreements were actually signed with the bankers in February of 1911.45 These agreements, however, were not finally carried out.

In 1912 the Government of Nicaragua after a considerable preliminary negotiation made an arrangement with American bankers for the adjustment of the obligations of that country.46 This arrangement, like the arrangement with Santo Domingo, provided for the service and payment of bonds, for the payment of awards made by the Nicaraguan (domestic) Commission, and for the adjustment of other claims (particularly German and English) which were the subject of adjustment between the representatives of Great Britain and Germany and the Nicaraguan authorities. From the records of the Department it would appear that no one class of these claims enjoyed a preference over any other class.

The settlement by Haiti of her obligations through the issuance of the forty million dollar gold loan, which was authorized by the Haitian Decree of June 26, 1922,47 covered not only the bonded indebtedness but also arbitral awards and compromises of claims, all on a non-preferred basis.

As will be seen, in each of the foregoing adjustments the cardinal principle has been a non-preference of any class of creditors over any other class of creditors. An equally basic principle has been that the creditors of no one nation should receive a preference over the creditors of other nations. The influence of this government has always been directed and exercised to this end.

In view of the foregoing principles, the precedents set out, and the practice of this Government whenever it has had opportunity to exercise a suggestive or directing course, you will, whenever the question shall arise in connection with the creditors of Mexico, frame your representations in accordance with those same principles, precedents, and practices.

The Department takes this opportunity to reiterate the views expressed in its telegram to you of November second last,48 and to direct that if and when the occasion shall arise you will in your discretion make known the views set out in this instruction and in that telegram to the proper officials of the Mexican Government, and will say to that Government that the United States must ask and will expect that all [Page 472] American creditors as among themselves will be treated on an equivalent basis so far as preferences and priorities are concerned, and that American creditors generally will be placed in a position as to preference and priority which shall not be inferior to the position given to the creditors of any other nation.

Should any question arise as to the preferences or priorities, if any, which are to be given to Mexican bonds for the service of which specific Mexican revenues have been designated or pledged, you will consult the Department for its further direction. You will, however, observe from what has already been said that under the custom of nations and the theory that a bondholder deprived of revenues allocated to the service of his bond has suffered a tort, such bondholders can as to their claims hardly be placed higher than other claimants who have been tortiously deprived of their property or property rights; a fortiori, bondholders having no such allocations cannot be placed so high.

But, as already stated, the Department does not now deem it necessary to insist, as against Mexican bondholders (the bulk of whom are not American citizens) upon the strict preferences and priorities sanctioned by the custom of nations in favor of claims arising out of other than bond transactions, though in your representations to the Mexican Government you should not commit your Government to an abandonment of such preferences and priorities should the course followed by the bondholders make it necessary to invoke such in order adequately to protect American claimants.

I am [etc.]

Frank B. Kellogg
  1. The Ambassador transmitted a copy of this instruction to Vernon Monroe, Secretary of the International Committee of Bankers on Mexico, in New York, in a covering letter dated July 10, 1929, not printed (411.12/930).
  2. Not printed.
  3. The Fiscal and Economic Condition of Mexico, Report submitted to the International Committee of Bankers on Mexico by Joseph Edmund Sterrett [and] Joseph Stancliffe Davis, May 25, 1928.
  4. Claims convention, concluded July 4, 1868; Malloy, Treaties, 1776–1909, vol. i, p. 1128.
  5. Foreign Relations, 1907, pt. 1, p. 307.
  6. Report on the Debt of Santo Domingo, Submitted to the President of the United States by Jacob H. Hollander, Special Commissioner.
  7. See Foreign Relations, 1907, pt. 1, p. 355.
  8. None of the following quoted correspondence relating to Honduras is printed in Foreign Relations; but see undated memorandum entitled “Proposed adjustment of the debt of Honduras by the United States,” Foreign Relations, 1912, p. 549.
  9. See ibid., pp. 562 ff.
  10. See ibid., pp. 1071 ff.; also Department of State, Latin American Series No. 6: The United States and Nicaragua, a Survey of the Relations from 1909 to 1932 (Washington, Government Printing Office, 1932), pp. 17 ff.
  11. Foreign Relations, 1922, vol. ii, p. 500.
  12. Ibid., 1928, vol. iii, p. 321.