Blogs review: A new Argentina

What’s at stake: The U.S. Supreme Court (SCOTUS) inflicted a major blow last week to Argentina in its decade-long legal struggle with some of its creditors since it defaulted in 2001. Several authors fret that the ruling has far-reaching implications for other countries, which seek to reduce or stretch out payments on foreign debt.

Background on the ruling

Brett House writes that four years after its default, Argentina offered a take-it-or-leave-it deal in 2005 to its defaulted bondholders: a one-time offer to exchange their impaired bonds for new paper worth between 25 and 35 percent of the nonperforming debt. To encourage participation in the debt exchange, the Argentine Congress passed a law in February 2005 that forbade the government to make payments on any bonds not tendered, to later reopen the exchange or to settle with nonparticipating creditors one-by-one on the side. Despite its promises never to do so, Argentina re-opened its 2005 debt exchange to holdout creditors in 2010 and pushed participation up to 93 percent of eligible debt.

Free Exchange writes that for nearly a decade Argentina has refused to obey American court orders requiring it to settle up with these “hold-outs”. Frustrated with Argentina’s intransigence, in 2012 a judge in New York devised a formidable tool to bring the country into line. He issued an order that would prevent its government from servicing the debt of the investors who had participated in its restructuring unless it also made a lump-sum payment to the hold-outs for the entire value of their claim: the full face value of their bonds plus all past due interest. To beef up the threat, he also forbade financial intermediaries from helping Argentina circumvent his directive. For two years, Argentina managed to fend off the order by filing a series of appeals. But now that the Supreme Court has declined to hear the case, the country has no further legal recourse. 

The Economist reports that the hedge fund’s legal case hinges on the argument that a “pari passu” clause in the original bond documentation, which guarantees equal treatment for investors, bars Argentina from paying holders of the exchanged debt if it does not also pay the holdouts. A New York district court and appeals court backed this view, leading Argentina to petition the Supreme Court to hear the case.

Mark Weidemaier reports in the blog Credit Slips that SCOTUS has also ruled against Argentina on the merits in its discovery dispute with NML. The case involves whether NML can take broad discovery of Argentina’s assets in an effort to locate assets that might not be protected by sovereign immunity. If it can find non-immune assets, NML can try to seize them to satisfy money judgments it holds against Argentina.

Implications for sovereign-debt restructuring

Floyd Norris writes that up to now troubled countries negotiated with their lenders to restructure their debts. Bondholders could, and did, hold out. But they faced the risk that the restructuring would go through and those who agreed would get (partial) payouts, while the holdouts got none. Sometimes, if there were a small number of holdouts, the government might choose to pay them off to avoid future problems. If not, the holdouts could go to court. Which court depended on clauses in the bonds. If it was a court in the country borrowing the money, the creditors were at a severe disadvantage. But if it was in New York, the holdouts could normally get a court order directing the country to pay. The catch was that the order was usually unenforceable. Countries had sovereign immunity for many of their assets located abroad.

Free Exchange writes that the decision’s impact on future bond swaps is worrisome. If this ruling becomes a precedent, a single recalcitrant owner of bonds issued under American law will be able to stop all other lenders from getting paid until his demands are met. This means that holding out has now become the optimal strategy. But if every creditor holds out for a better deal, insolvent governments will be unable to reach an agreement with them, and restructurings will fail. That hurts no one more than bondholders, who do not get paid a cent until a debt swap is successful.

Brett House writes that beyond Argentina’s specific situation, the refusal to hear the appeal has potentially far-reaching implications for sovereign-debt restructuring practices around the world. The case hinged on the pari passu provision included in most sovereign bond contracts. This clause provides for equal-treatment of creditors across bond series, but its exact meaning has never been pinned down. New York Federal trial judge Thomas Griesa and the Second U.S. Court of Appeals both ruled that Argentina’s unwillingness to pay defaulted holdout creditors while servicing newer debt issued in the 2005 and 2010 exchanges violated the spirit of pari passu. More broadly, the U.S. Supreme Court’s decision throws restructuring of NY-law sovereign debt into question. If holdout creditors have a right to be paid when restructured debt is serviced, then any holdouts from past debt restructurings now have a channel to seek payment. Looking forward, the incentive for any bondholder to participate in future restructurings of NY-law debt is compromised.

Anna Gelpern writes in Credit Slips that:

1. Governments trying to restructure NY-law debt contracts have less scope to threaten default.
2. Financial market service providers are now sovereign debt enforcement agents. Any service provider or intermediary dealing with a government in default should expect orders and subpoenas targeting the sovereign's assets and activities anywhere and everywhere.
3. The IMF, the G-7 governments, and others in the official sector will have to rethink their reliance on sovereign immunity for getting restructurings done. My hunch is that the bulk of the activity will be on the contract reform front – pari passu and Collective Action Clauses – not sovereign bankruptcy. 

Argentina’s remaining options before June 30

Floyd Norris writes that on June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do. The Economist writes that if Argentina settles only with NML, the other vultures will demand the same terms. Better to deal with them all at once. But that raises the biggest question of all: Argentina’s constrained finances. With its foreign-exchange reserves having dipped below $29 billion, Argentina does not have a lot of room to offer the holdouts an attractive deal. Free Exchange writes that paying all the hold-outs in full would cost $15 billion. The Economist Intelligence Unit also notes that any negotiation with holdouts is complicated by clauses in the restructured bonds that would allow the latter to be renegotiated in the event that other creditors are offered better terms. These clauses expire at end-2014.

FT Alphaville writes that Argentina's current plan is to offer to let everyone swap into local-law bonds to be paid in Argentina. Mark Weidemaier argues that this, however, sounds like a violation (the injunction quite plainly applies to any payments made on bonds issued in a swap - see par. 2a.) And even if Argentina is willing to thumb its nose at the US courts, most plans to defy the courts would require the participation of financial institutions that have better things to do than expose themselves to the risk of contempt sanctions. And anyway, it isn't clear that such a plan can be put in place by June 30.

Adam Levitin think that there might be a non-default route open to Argentina.

• Scenario 1: No Payment, and No Default. In the base scenario, Argentina avoids default by offering to pay BNYM, and BNYM declines the payment without any liability. Argentina, then hasn't paid anyone and still hasn't defaulted. The result is that the obligation remains in a sort of suspended animation. In theory this could continue indefinitely.
• Scenario 2: Trustee Files an Article 77 Petition in NY State Court and Gets a State Court Ruling on Pari Passu. What is particularly appealing about Article 77 here is that it is a very open-ended, ill-defined inquiry. That means that it might be possible to get the NY State court court to rule on the interpretation of the pari passu clause. If that happens and the Republic got a favorable interpretation, then the Republic could then turn around and seek to get the federal court to rescind its injunction on something like a Rooker-Feldman doctrine basis.