[Comments on Proposal To Restructure Foreign Military Sales Program Loans]

B-226058, Jul 21, 1987, 66 Comp.Gen. 577

MISCELLANEOUS TOPICS - National Security/International Affairs - Foreign Aid Programs - Loans - Refinancing - Authority An executive branch proposal to restructure certain loans made under the Foreign Military Sales (FMS) credit sales program, section 23 of the Arms Export Control Act, 22 U.S.C. Sec. 2763 (1982), should be legislatively authorized. One of the two restructuring options proposed would permit countries to prepay the balance of their loans without penalty, resulting in a financial loss to the United States. The other option permits reduction of the interest rates and capitalization of the difference between old and new rates, to be recovered with interest at the end of the loan period in the form of a large balloon payment. This option, too while facially proper, involves a significant financial risk of loss to the United States. The avoidance of serious damage to the foreign policy interests of the United States, which is likely to occur without rescheduling of the loans, does not constitute a sufficient "compensating benefit," within the meaning of relevant GAO decisions, to permit waiter of the government's contractual rights unless the Congress specifically authorizes the restructuring for that reason.

The Honorable David R. Obey, U.S. House of Representatives:

This is in response to your letter dated January 7, 1987, requesting that this Office review the legal propriety of the Administration's proposal to restructure certain loans made under the Foreign Military Sales ((FMS) program. For the reasons set forth below, we conclude that the Administration's restructuring proposal should not be implemented without specific statutory authority.

We requested comments from the Departments of State, Defense, and the Treasury, and the Office of Management and Budget. The Department of the Treasury coordinated its response with the Department of State in a letter dated February 6, 1987. Defense deferred to Treasury, and State and OMB declined to comment. The Treasury comments are set forth below, as appropriate.

Facts

From the mid-1970s to the mid-1980s, the United States financed a number of "credit sales" of military equipment to foreign countries under section 23 of the Arms Export Control Act, 22 U.S.C. Sec. 2763 (1982), which provides that the President "is authorized to finance the procurement of defense articles ... by friendly foreign countries." The loans here in question were financed by the Federal Financing Bank (FFB) under 12 U.S.C. Sec. 2285 (1982). The Defense Security Assistance Agency (DSAA) guaranteed the loans under section 24 of the Arms Export Control Act, 22 U.S.C. Sec. 2764 (1982), which provides that the President

may guarantee any individual, corporation, partnership or other judicial entity doing business in the United States ... against political and credit risks of nonpayment arising out of their financing of credit sales of defense articles. ...

When a debtor nation defaults on a SAA-guaranteed loan, DSAA pays FFB out of a Guaranty Reserve Fund. 22 U.S.C. Sec. 2764(c) (Supp. III 1985).

The fact that the loans were financed by FFB at "market" interest rates in the late 1970s and early 1980s has created problems, both economic and political, for several debtor nations which now face repaying long-term loans at rates much higher than current, relatively low interest rates. According to Treasury's submission:

Some of the United States' closest friends and allies have questioned how our security relationships would allow the U.S. to let them face this heavy burden without trying to assist in some way, Several key allies, including Egypt, Israel and El Salvador, have pressed us for some form of FMS loan restructuring. President Mubarak, in particular, has urged that the U.S. act to ease the heavy burden of FMS debt repayment on Egypt's struggling economy. Members of Congress ... have also expressed concern over the problem.

Accordingly, the Administration intends to offer debtor nations two options:

1. Prepayment at Par. Borrowers with the resources to do so or access to international capital markets will be permitted to repay the outstanding principal on high interest loans without penalty. The U.S. Government will not be guaranteeing any borrowed funds which may be needed to prepay these loans.

2. Partial Capitalization of Interest. The U.S. Government will reduce the original interest rates on the high interest loans to a current market rate and capitalize the difference in payments between the new and old rates. The capitalized amounts would be repaid with interest at the end of the loans' original maturity. This option will enable FMS recipients to benefit from a temporary reduction in FMS debt servicing. At the same time, the U.S. Government will still recover the full value of each loan within the life of the original loan contract.

Treasury has taken the position that the debt restructuring is proper:

The options as structured do not require new legislation nor budget authority. With regard to the first option, a provision for prepayment of FMS loans at par, in the event of default, is included in the FMS loan contracts. ... As to the second option, as the full value of the affect USG assets (i.e. the FMS loans) would be recovered within the original maturity of the underlying loan, the restructuring of repayment terms through interest capitalization is permitted. (12 U.S.C. Sec. 2281, et seq.,; 22 U.S.C. Sec. 2764).

Analysis

Without a compensating benefit to the United States, agents and officers of the United States have no authority to dispose of the money or property of the United States, to modify existing contracts, or to surrender or waive contract rights that have vested in the government. 40 Comp.Gen. 684, 688 (1961); Union National Bank v. Weaver, 604 F.2d 543, 545 (7th Cir. 1979). This rule clearly is applicable to the loans here in question. The United States has a contractual right to receive repayment of the loans on a certain schedule and at a certain interest rate.

The rule against surrender or waiver of the government's contract rights may be inapplicable when there is specific Statutory authority for waiver of the government's interest. 62 Comp.Gen. 489, 490 (1983) (authority to "compromise" loans constitutes specific authority permitting discharge of debt at less than full value). We are aware, however, of no such specific authority applicable to the loans here in question, and Treasury has brought none to our attention. /1/

We conclude that under one of the options in the Administration's restructuring proposal, the United States would certainly incur a financial loss. Under the second option, the financial loss may be only temporary cash flow impediment but, as will be discussed, intra, there is a substantial possibility that the final payment to the United States may have to be forgiven or rescheduled. These conclusions are substantially consistent with those of the Congressional Budget Office (CBO), presented in testimony before the House Appropriations Committee, Subcommittee on Foreign Operations, on May 6, 1987. See hearings on Foreign Assistance and Related Programs Appropriations for 1988, Foreign Military Sales Debt Prepayment and Restructuring, May 6, 1987 (stenographic minutes); "Statement of James L. Blum, Assistant Director, Budget Analysis Division, Congressional Budget Office, before the Subcommittee on Foreign Operations, House Committee on Appropriations, "May 6, 1987 (hereinafter referred to as "CBO Statement").

Under the "prepayment at par" option, the United States would lose the benefit of receiving high interest payments over the remaining life of the loan. The CBO has estimated that if, in accordance with the Administration's original budget estimates, nine debtor countries prepaid, the net interest loss to the FFB would be approximately $350 million. CBO Statement at 6. Second, because the FFB would still be required to make interest payments on the public debt it incurred to finance the FMS loans, and would not have the benefit of the cash flow from the FMS loans, the FFB would need to borrow additional funds to make the payments.

Treasury has taken the position that the prepayment option is permissible be. cause the relevant loan agreements include a provision whereby, in the event of default by the debtor nation, FFB may,

declare immediately due and payable the unpaid principal and accrued interest on the Note and any other note or other indebtedness of the Borrower held by the holder of the Note and such amount shall become immediately due and payable without protest, presentment, notice or other demand of any kind, all of which hereby expressly waived by the Borrower.

Treasury, accordingly, proposes to declare a default, whereby the debtor nation would deliberately fail to make a required payment, with the concurrence of FFB, and FFB would then demand immediate prepayment in full in accordance with the loan agreement's default provision. It apparently is Treasury's position that, because the agreement permits the government to demand repayment in full upon default, the government "waives" no rights under the contract when the loan is prepaid in this manner. We do not concur in Treasury's analysis. The debt rescheduling plan does not constitute settlement of debts determined to be uncollectible, which the executive brand does have authority to compromise. See generally 31 U.S.C. Sec. 3711. There is also no persuasive evidence that default is really imminent on any of the loans in question. Treasury is reading the default provision in isolation, without looking at the entire loan agreement. The loan agreement also provides:

If the Borrower fails to make payment when and as due of any installment of principal or interest under the Note, the amount payable shall be the overdue installment of principal or interest, plus interest thereon at the rate specified in the Note, from the due date to the date of payment. the Borrower's failure to pay such installment or any part thereof continues for sixty days, the Borrower shall pay an additional charge of 4% per annum on such installment or part thereof for each day thereafter until payment is made.

Further, the promissory note annexed to the loan agreement provides that the borrower will make payments according to a schedule "without right of prepayment."

Read in the context of the entire loan agreement, it is clear that the default provision is intended to protect the lender (the FFB), not to provide a mechanism to forgive part of the borrower's obligation. Since the agreement provides another remedy for late payments-- a remedy which anticipates payments being as much as 60 days late, and which is far more advantageous to FFB-- we cannot conclude that the default provision was intended to be used when the borrower was late 10 days in making one payment, but otherwise appeared solvent. Rather, in our opinion, the default provision was intended to allow FFB to declare the entire amount due, in an attempt to salvage at least part of the debt, if it became evident that the borrower was in fact insolvent and would be unable to continue making payments. This interpretation of the intent of the default provision is certainly in accord with commercial practice.

With regard to the "capitalization of interest" option, Treasury has taken the position that, because the principal and amortized interest will be scheduled to be repaid in full during the term of the loan, there is no surrender of any right or property by the government. We conclude that, at least in theory, Treasury is correct. The "capitalization of interest" option does provide for recovery by the government of all principal and interest, including interest on the Capitalized interest. Nevertheless, Treasury is proposing rescheduling of the debt because the current payments are too high. However, the capitalization of interest option would require a participating debtor nation to pay a very large balloon payment at the end of the term of the loan. A debtor nation realistically might have difficulty in meeting this large balloon payment, and there is a Substantial possibility that the loan would have to be forgiven or again rescheduled. See GAO, "Unrealistic Use of Loans to Support Foreign Military Sales," ID-83-5, January 19, 1983; GAO, "Military Loans: Repayment Problems Mount as Debt Increases," NSIAD-86-10, October 30, 1985. If the loans here in question are forgiven or rescheduled again, the government would suffer a loss.

The CBO, using the Administration's budget estimates, calculates these added costs to the government in the case at hand would be approximately $210 million. CBO Statement at 7. Accordingly, although the "recapitalization of interest" option does contemplate, on its face, that the United States will be made whole, there is a substantial risk under that option that the government would in fact suffer a significant loss.

"Adequate Compensation"

We have concluded that under the options available to debtor nations under the Administration's debt restructuring proposal, the United States will incur either a financial loss or a substantial risk of significant financial loss.

As discussed in our earlier analysis, no agent or officer of the United States may surrender or waive vested contract rights to the financial detriment of the United States without an adequate compensating benefit, in the absence of specific statutory authority to surrender or waive such rights. The only compensating benefit suggested by the Treasury is that its proposal will alleviate the financial plight of several friendly nations and thus advance the foreign policy interests of the United States.

We have no doubt that Treasury's foreign policy concerns are serious and that it might be in the best interests of the United States to relieve the heavy debt burden of our friends and allies. Moreover, our decisions on adequate compensation have never insisted that the benefit be entirely financial. See, for example, 58 Comp.Gen. 7, 9 (1978), in which we decided that the government could waive the right to a special discount for federal employees on accommodations in national parks provided in standard National Park Service concession contracts. We overruled an earlier case (40 Comp.Gen. 234 (1960)), in which the concessioners were seeking to be relieved of the obligation, and we advised the Secretary of the Interior that he could not waive a contract right solely because the concessioners found it to be onerous and Interior wished to accommodate them. In the 1978 case, a study conducted by the House Government Operations Committee, with which the Secretary of the Interior concurred, found that the acceptance of free or reduced rate accommodations by government employees on official business might violate-- or appear to violate-- federal conflict of interest laws. We sanctioned the waiver because (1) failure to do so might actually call in question the integrity of a government agency; and (2) the agency's oversight committees had made it clear that they considered the continued use of the contract benefit to isolate other federal laws. See also B-223329, October 17, 1986 (66 Comp.Gen. 51 (1986)). The Soil Conservation Service, Department of Agriculture, asked for an advance decision from our Office approving the modification of certain fixed-price construction contracts to delete a requirement that the contractors pay premium rates for overtime worked in excess of 8 hours a day. (The requirement had been deleted in a statute enacted after the contracts in question were signed, but the coverage of the statute was prospective only.) The only reason offered for waiving the requirement was the avoidance of contract complaints and objections from the contractors whose costs were higher than they would otherwise be. However, the contract was "fixed-price"; in the absence of some compensating benefit to the United States, there was not reason to change the contract. We rejected the argument that "public policy" alone was sufficient to justify the modification of the contract. See also, 35 Comp.Gen. 56, 59 (1955). Modification of Foreign Investment Guarantee contracts to lower insurance rates, based on a desire to facilitate administration of the program and create a feeling of confidence in the business community was too intangible and speculative to constitute adequate compensation for sustaining a financial loss.

In each of these cases, it was clear that the lack of adequate compensation for a financial concession would not prevent such action if there was specific legislative authority for the agency to waive a contractual right. We have been unable to find any such statutory authority. On the contrary, we note significant interest and concern with the debt problems of friendly nations and a distinct aversion to the only solution proposed by the Administration to date.

In 1985, the Congress amended the Arms Export Control Act to authorize the President to finance sales at concessional (or less than market) rates of interest. International Security and Development Cooperation Act of 1985, Sec. 102, Pub.L. No. 99-83, 99 Stat. 190, 195 (Aug. 8, 1985). The statute also extended the period of repayment of loans for certain countries. Id., Sec. 101(b). In explaining the concessionary financing provision, the House Foreign Affairs Committee stated:

This new section 23 facilitates the new approach to FMS financing which enables foreign recipients to repay FMS loans on a concessionary interest rate basis. It is the committee's expectation that such concessionary financing will be available for countries facing serious debt-servicing problems as defined by internationally recognized economic criteria. Countries facing such problems are countries that have accumulated significant arrears in their long-term external debt, have rescheduled debt, have sizeable external debt and debt-service ratios, are drawing on credit facilities of the International Monetary Fund, or have low per capita incomes. The committee expects to be fully consulted regarding terms and countries made eligible for concessionary FMS financing.

H.R. Rep. 39, 99th Cong., 1st Sess. 12 (1985).

The same year, in section 551 of the Foreign Assistance and Related Programs Appropriation Act, 1986, the Congress again addressed the FMS debt problem, as follows:

The United States foreign military assistance loan programs, which have had very high interest rates in past years, have contributed to the security of our friends and allies, but also have played a contributing role in adding to the debt burdens of many of our friends and allies;

The past few years have seen several positive legislative steps taken to alleviate the FMS loan-related debt burdens of our friends and allies by reducing interest rates, stretching out the repayment period of these loans, and by increasing the level of MAP grants and forgiven FMS credits;

These steps have helped to ease these problems in the short term, but the long-term debt servicing problems of our friends and allies remain; ...

The statute then concluded,

(5) the President is urged to propose, in the next formal Congressional Presentation for Security Assistance Programs, reforms and refinements in the foreign military assistance programs along these lines for consideration by the appropriate committees of the Congress.

Pub.L. No. 99-190, Sec. 101(i), 99 Stat. 1185, 1314 (Dec. 19, 1985).

The President responded on December 18, 1986 with the two alternate proposals for debt restructuring we have been discussing, supra. The proposals were not warmly received, at least by the House Committee on Appropriations. H.R. 1827, making supplemental appropriations for fiscal year 1987, initially contained a provision forbidding the President to implement either proposal until the later of October 1, 1987 or passage of a regular appropriation to the programs for fiscal year 1988. This restriction was dropped by agreement of the full House from the version of H.R. 1827 which became Pub.L. No. 100-71, enacted July 11, 1987, 101 Stat. 391. Nevertheless, the House committee report reads as follows:

The Committee has substantial concerns about the advisability of the Administration's proposal. It appears to have substantial budgetary ramifications by decreasing future year revenues while at the same time failing to truly assist countries deeply burdened by their military debts. The Committee is deeply concerned that the proposal, if fully implemented, will create a future debt payment crisis far greater than the one which is currently being faced by these countries.

The moratorium will allow the Committee and the Congress the time to fully study the potential ramification of this proposal.

H.R. Rep. 100-28, 100th Cong., 1st Sess., March 25, 1987.

These legislative provisions indicate that the Congress has been aware of and it planning to act on the debt problems of friendly nations. It is apparent that the committees are not satisfied with the Administration's December 18, 1986 proposals.

For all of the above reasons, we believe that the Administration should not attempt to implement the proposals or any other debt restructuring proposal without clear evidence of congressional approval.

Depletion of the Guaranty Reserve Fund

Subsequent to the receipt of your January letter, a member of your staff orally requested that we review the recent depletion of the Guaranty Reserve Fund to determine if the depletion of that fund violated the Anti- deficiency Act. 31 U.S.C. Sec. 1341. The Guaranty Reserve Fund constitutes "a single reserve for the payment of claims under guaranties" issued under the "credit sales" program. 22 U.S.C. Sec. 2764(c), (Supp. III 1985).

We received two oral requests from other congressional sources for opinions on the same subject. The last requestor called our attention to the new amendment to section 24(c) of the Arms Export Control Act, enacted on July 11, 1987 as part of Pub.L. No. 100-71, 101 Stat. 391, 409, the Supplemental Appropriations Act for fiscal year 1987. Section 24(c) of the AECA, as amended, provides alternative sources of funding to pay claims of the FFB when the Guaranty Reserve Fund is inadequate for that purpose.

The new amendment may possibly change our answer to your question. However, its enactment is so recent that we have not yet had time to study its implications thoroughly. With your permission, we would prefer to respond to this question at a later time.

This letter will be available for release to the public 30 days from today, unless released earlier by you or your staff.

/1/ Section 633(a) of the Foreign Assistance Act, 22 U.S.C. Sec. 2393(a) (1982), provides that, with regard to functions authorized under that Act, the President may waive provisions of law "regulating the making, performance, amendment, or modification of contracts." The FMS loans here in question, however, were made under the Arms Export Control Act, which includes no such authority See 22 U.S.C. Sec. 2751 (note) (1982). The Treasury Department does have certain authority to modify contracts "without regard to other provisions of law," when the modification would "facilitate the national defense." 50 U.S.C. Sec. 1431 (1982), Pub.L. No. 85804, 72 Stat. 972 (Aug. 28, 1958). See Executive order No. 10789, November 14, 1958. It is not clear whether the statute could be applicable in the instant case. See 22 U.S.C. Sec. 2751 (note) (1982). The legislative history of section 1431 indicates that it was intended to apply in "emergency" situations. B-212529, May 31, 1984. In any event, Treasury does not rely on this statute in its submission or otherwise indicate that it intends to invoke it and comply with its various restrictions and reporting requirements. Accordingly, we will not discuss further its applicability here.