Appropriately named, vulture funds buy up the defaulted sovereign debt of poor countries and then refuse to participate alongside other official creditors in international debt relief initiatives.

The wheeze followed the heavily indebted poor countries (Hipc) initiative in 1996, when donor countries and multilateral institutions such as the International Monetary Fund (IMF) and the World Bank cancelled more than $90bn in bilateral and multilateral debt to poor countries. Hipc, however, was a voluntary initiative, not binding on private creditors. This allowed vulture funds – specialised types of private investment and hedge funds – to acquire some of this debt and insist on full repayment from countries they targeted.

In 2007, finance ministers from the G7 industrialised countries voiced their concerns about "the problem of aggressive litigation against Hipc countries", and former prime minister Gordon Brown, when he was chancellor, condemned such lawsuits as "a morally outrageous outcome" in a speech to the UN in 2002. The World Bank said vulture funds were "a threat to debt relief efforts".

The exact number of lawsuits involving vulture funds, operating in offshore tax havens such as the Cayman Islands, is unclear as they tend to emerge through reports on the ground. According to the IMF and the World Bank, many countries have been pursued by vulture funds, including Cameroon, Ethiopia, Sudan, Uganda and the Democratic Republic of the Congo, as illustrated by the case involving FG Hemisphere. The IMF has said that vulture funds are engaged in claims seeking a total of $1.47bn from Hipc countries.

The immediate impact of such lawsuits is on the targeted countries themselves, which have to fork out millions. In 2007, Zambia paid $15.4m to settle a $55m case brought by Donegal vulture fund, which had bought for $3.2m the debt Zambia originally owed to Romania. Donegal's defenders argue that Zambia broke legally binding promises on the debt.

Vulture fund litigation also complicates life for any company doing business in, or with, a country that has become a target. Vulture funds not only litigate against debtor countries, they also pursue solvent companies that have contracted to do business with the countries. To protect themselves from vulture-fund litigation, most trading partners of countries targeted have to adjust the price of their contracts to insure against expensive litigation, and the competing claims of vulture funds.

However, an IMF-World Bank report last year (pdf) says the number of lawsuits by vulture funds has dropped in recent years, from 33 to 14 during 2008, rising to 17 during 2009. This has been attributed to a number of national and multilateral responses, notably Britain's recently enacted law limiting amounts that litigating creditors can recover in UK courts against Hipc debtors.

Similar legislation is being pushed in the US, although nothing is expected before the US presidential election next year. In 2009, the African Development Bank launched its African legal support facility to provide legal help to countries facing litigation from commercial creditors.

UK legislation on vulture funds has already had an impact, when Liberia last year reached agreement to repay just over 3% of face value of $43m in debt. The case was brought by two Caribbean-based vulture funds, Hamsah Investments and Wall Capital Ltd, over a debt dating back to the 1970s. The case sparked a furore when the high court ordered Liberia to repay the full debt in 2009. The case mobilised debt campaigners, who pushed for a change in the law – resulting in the Debt Relief (Developing Countries) Act 2010 being passed.

The law, a world first, requires commercial creditors to comply with the terms of international debt cancellation schemes, which specify a single discount rate for creditors to ensure equal treatment. The law applies to the UK courts and ensures that public money given towards debt cancellation is not diverted to private investors.

However, debt campaigners point out that UK legislation applies only to the 40 Hipc countries and applies to cases before 2004.

 This article was amended on 16 November 2011. In the last paragraph of the original we stated that the law was due to expire next year. The law was in fact made permanent in April.