422.11G93/1688
The Minister in Ecuador ( Gonzalez ) to the Secretary of State
[Received June 30.]
Sir: In confirmation of my telegram No. 25 of June 20, 12 noon, 1936,62 reporting developments in the matter of The Guayaquil and Quito Railway Company subsequent to my despatch No. 392 of June 9 [2], 1936,62 I have the honor to furnish details and later developments. On Thursday morning, June 18th, Mr. Alfonso Terán, Secretary-clerk of the British Minister in Quito, was requested by the Minister of Finance to call at his office. Mr. Terán has a general authorization from the British Minister to discuss with the authorities matters relating to The Guayaquil and Quito Railway. A copy of a memorandum prepared by him giving the substance of the ensuing conversation is enclosed, together with a copy with English translation of the memorandum63 furnished him by the Minister of Finance which outlines the bases for a debt settlement of the First Mortgage Bonds of The Guayaquil and Quito Railway Company.
It will be observed that the Finance Minister stated that the Government had almost terminated the civil action against the Railway; that it will be declared in bankruptcy and sold at public auction; and that as the Government owns the majority of interest it will be adjudicated to the State. Thereupon, a new company will be formed and the bondholders will be given 20% of their bonds and coupons in new bonds which will be guaranteed by the Government and with the Railway as a mortgage. The Finance Minister emphasized that the bondholders would have to accept the exchange of bonds in accordance with paragraph 2 of the memorandum on the grounds that [Page 537] the Railway will have become the exclusive property of the Ecuadorean Government and that, according to a legal opinion from the United States, a government can offer as settlement whatever amount it considers compatible with its economic resources; “that the creditors can accept or reject such an offer, but that should they reject, they will hold the obligations of a non-existing company”.
Apparently Mr. Ayala, Minister of Public Works, was not in agreement with the Finance Minister and he inquired what the Government would do in the event that the bondholders rejected the offer and kept the old bonds. To this the Finance Minister replied that the bondholders would be the losers. The point was then made that the offer was not at all attractive in the absence of a cash payment. The Finance Minister then inferred that a cash payment might be feasible since he has about terminated an arrangement with an American Bank which will advance US$10,000,000 to the Central Bank. Two representatives of the Chase National Bank are arriving in Ecuador today and it is understood that the Government will discuss with them a possible loan.
It will be noticed from the memorandum (enclosures Nos. 2 and 3) that a discrepancy exists as to whether the new bonds would cover 20% of the total amount owed, or only 20% of the face value of the principal of the bonds. In view thereof the British Minister interviewed the Minister of Finance on the afternoon of June 18, 1936, and specifically inquired as to what was the correct statement as to this point. The British Minister states that the Finance Minister unhesitantly expressed that he meant 20% of the amount owed. The British Minister reiterated the question in the sense whether the payment would thus involve more than US$4,000,000 in bonds of the new company, and to this the Finance Minister again said, “Yes!” However, the Minister had hardly returned to his Legation when the Finance Minister called by telephone and stated that he had made a mistake and that he was sending a corrected memorandum, a copy of which with English translation is also enclosed.64
This memorandum contains the plan of debt settlement which the Government of Ecuador apparently is prepared to offer to the bondholders. It will be noted that the bondholders will be given bonds of the new company in the amount of 20% of the principal of the ones they now hold, or US$2,236,380. As concerns the interests in arrears on the First Mortgage Bonds they will be given scrip in the amount of US$235,942, one-half of which will be paid in cash upon the exchange of the coupons, and the balance six months after the issuance date of the new bonds. The interest on the Salt Certificates, amounting to US$128,772 will be paid in cash. The new bonds will [Page 538] earn 4% interest, payable semi-annually, and will be amortized in twenty years by means of semi-annual drawings in the event that they are quoted above par, or by purchase in the open market if they are below par. These bonds will be guaranteed by a first mortgage on the Railway and the Government will constitute itself as guarantor to cover any deficit in the service. The funds necessary for the payment of the service will be obtained from a special 3% ad valorem consular invoice stamp tax, which the Government proposes to have sold and affixed to all invoices. The net profits from the operation of the Railway will be employed for extraordinary amortization of the bonds. The statement in paragraph 8 concerning the establishment of a stabilization fund is not clearly understood since the separate memorandum referred to has not been made available.
In view of the foregoing which indicated an apparent desire to prepare the stage for a unilateral debt settlement, I availed myself of the opportunity afforded by contradictory press reports to approach the Minister of Public Works who is the cabinet officer in charge of the Railway. I had a long interview with him on the afternoon of June 19th and he stated that he was not at all in accord with the plans of the Minister of Finance. He said that the latter intended to foreclose the Railway under Ecuadorean law which, it is alleged, is now permitted under the new American Federal Bankruptcy Act.65 He added that the Finance Minister insisted that under such a foreclosure action instituted in Ecuador, the Government had the right to have the Railway delivered to it immediately, and that it would then distribute to the bondholders, whether they liked it or not, new bonds of a value of approximately US$2,000,000. The Minister of Public Works objected to this proposal on the grounds that he considered the proposed action fraudulent and confiscatory. He remarked that the Minister of Finance is continually placing the Ecuadorean Government in a delicate position, and that this latest measure would create a very delicate situation for his Government with the United States and Great Britain. He further stated that the Minister of Finance intended to proceed without giving notice of any kind to the bondholders and, therefore, he had refused to become a party to it and would take the matter up with the President.
I gathered from this interview that the Minister of Finance intended to proceed in a precipitate manner without affording the bondholders an opportunity to protect their interests and, under the circumstances, I approached the Minister for Foreign Affairs and expressed informally my concern with regard to this procedure. The Foreign Minister assured me that the Government of Ecuador did not contemplate any procedure which would injure the rights of the foreign bondholders. [Page 539] He added, however, that he would discuss the matter with the President and inform me later.
In the afternoon the Minister of Public Works telephoned me that he had talked over the situation with “the President but that he was afraid that it was too late since the matter had advanced to a stage where the Government would be obliged to go through with the scheme. However, the Foreign Minister called me later and stated that he had been instructed by the President to assure me “that the interests of the bondholders would be protected and guaranteed”. He added that the President would be pleased to confirm personally these assurances in view of which I expressed a desire to interview him on the following morning which was duly arranged.
During this interview the President made it clear that it was not the intention of the Government of Ecuador to violate its guarantee to the bondholders. Moreover, the bondholders would be legally served with notice of the proposal to the end that they could make arrangements to protect their interests. He added, however, that while the Ecuadorean Government was financially unable to meet its commitments under the bonds, it desired to reach a settlement within its financial capacity which was approximately that set forth in the proposed settlement, which had been formulated by the law firm of Carter, Ledyard and Milbourne of No. 2 Wall St., New York. In conclusion he stated that he would furnish me a memorandum, copy and translation enclosed,66 from which I would see that the notification of the bondholders has been and is contemplated.
The memorandum in question was received on Saturday afternoon and does set forth that notice will be served on the bondholders before the auction sale is effected. However, it is apparent that the purpose of the notice is simply to conform with Article 2410 of the Civil Code of Ecuador67 since in the absence of such notice the mortgage against the property would subsist, the State would acquire a Railway with liens, and the State, now the guarantor, would convert itself into the principal debtor.
The memorandum also reveals that those attending the meeting called on June 20 by the President were of the opinion “that the wisest thing would be to obtain the public auction of the Railway by continuing the suit instituted by the Central Bank”. It is added that an executory judgment has already been rendered in this suit ordering the Railway Company to pay the amounts demanded and providing that the arrears of interest shall be determined in a summary oral hearing. According to a statement made by the Minister of Finance today this latter step has been completed and the public auction can now be petitioned.
[Page 540]The penultimate paragraph of the memorandum states that “surely the State will be the only bidder since nobody would be interested in purchasing a railway whose value is less than the credit of the Republic of Ecuador (£2,364,266–10–05, US$1,433,400) and that of the Central Bank (US$661,200)”. The obvious inference is that in distributing the proceeds of the public auction sale, these credits of approximately US$14,000,000 would be given precedence over any other credits.
After studying very carefully the memorandum and in the light of previous information, I reached the conclusion that the plan was manifestly unethical since priority was apparently to be granted the claim of the Ecuadorean Government and the bonds purchased in the open market at default prices by the Central Bank, over those held by the foreign bondholders. However, I felt that the underlying purpose of the plan was not to obtain for the State the extinguishment of the mortgage and guarantor obligations, but rather to place the Government in a position to dictate the terms of a debt settlement which the bondholders could accept or leave, in other words, a unilateral debt settlement.
In view of these conclusions I decided that it was necessary to approach the President again in order to obtain his confirmation or correction of this understanding. Accordingly, and at the invitation of the British Minister to accompany him, I interviewed the President this afternoon. The attached memorandum68 sets forth briefly my oral statement of my understanding of the plan of the Government and my inquiry as to the grounds on which the State and the Central Bank would be accorded priority in their claims over those of the bondholders. The President replied that obviously a misunderstanding existed since it is not the intention of the Ecuadorean Government to violate its guarantee of the mortgage bonds. He explained that the Republic of Ecuador is not in a position to fulfill its commitments under the First Mortgage Bonds and that steps now must be taken to liquidate those bonds in accordance with the financial capacity of the country. He stated that the Government proposed to conclude the prosecution of the Central Bank suit and then to petition the public auction of the Railway and its properties. However, the Government at no time will repudiate or extinguish its guarantor obligations, but after the auction it will offer the bondholders the settlement already referred to. In answer to an inquiry as to whether the claims of the Government, totaling approximately US$14,000,000, would be the bases for the minimum bid at the public auction, the President replied that the procedure under Ecuadorean law is to appoint two experts to evaluate the Railway and that the minimum acceptable bid must be [Page 541] a cash offer of two-thirds of that evaluation. He added that the Government has two prior claims against the Railway, namely, the Prior Lien Mortgage Gold Bonds issued by the Railway in February, 1909 (US$2,486,000), and the Ecuadorean Government Salt Bonds issued at the same time (US$1,075,000), both of which issues were subsequently redeemed by the Government itself. The precedence of the remaining claim of the Government and of the Central Bank will be determined in accordance with Ecuadorean Law, but it will not have priority over the bondholders. He also stated that the Government now owns 48% of the outstanding bonds. The President agreed to furnish me tomorrow a complete memorandum setting forth the plan and explaining the points which are now obscure.
I gather that it is the intention of the President to attempt to reach an amicable settlement with the bondholders, based on the financial capacity of Ecuador. However, it also appears that if the bondholders are intransigent, the legal set-up will be such that they will have no alternative. However, I shall refrain from making any recommendation in the premises until I have received the memorandum which the President has promised to furnish me.
Respectfully yours,