In Argentine bond ruling, 2nd Circuit upholds power of U.S. courts

By Alison Frankel
October 29, 2012

Here’s a prediction: When historians look back at the legacy of U.S. Supreme Court Justice Antonin Scalia and his conservative colleagues, they will pay close attention to the justices’ reluctance to extend the dominion of U.S. courts beyond our country’s borders. Scalia made that sentiment clear in his 2010 opinion in Morrison v. National Australia Bank, and the court is right now considering the reach of a U.S. law that provides a cause of action for human rights victims in Kiobel v. Royal Dutch Petroleum (Shell). Scalia, who has spoken about the danger of applying rulings from international courts to cases in the United States, believes that the same holds true in reverse: The laws of the United States govern only the United States.

But in a ruling Friday in Argentina’s long-running dispute with vulture funds that hold defaulted Argentine bonds, the 2nd Circuit Court of Appeals drew a line in the sand. The appeals court held that Argentina cannot submit to the jurisdiction of U.S. courts when it issues sovereign debt, then defy the power of our courts to interpret the governing contracts with bondholders. The 2nd Circuit reached that conclusion despite Argentina’s invocation of the Foreign Sovereign Immunities Act — and despite our own government’s dire warning of a public policy disaster if the court sided against Argentina. The opinion, by Judge Barrington Parker for a panel that also included Judges Rosemary Pooler and Reena Raggi, is notably devoid of fiery pronouncements from a court that has repeatedly (if reluctantly) agreed with Argentina that the FSIA precludes bondholders from snatching the sovereign’s assets in the United States. But make no mistake. The 2nd Circuit is defending the power of U.S. courts in the face of a defendant that has so far refused to submit to their authority.

As Jon Stempel explained in a wonderfully lucid Reuters piece Friday, the 2nd Circuit’s opinion came in a fight over $100 billion in sovereign debt that Argentina issued in the 1990s and restructured in 2005 and 2010. The issue is whether Argentina can continue to make payments to bondholders who participated in the restructurings even as it refuses to pay vulture funds that refused to participate in the restructurings. More than 90 percent of Argentina’s bondholders took the exchange offer (which gave them between 25 and 29 cents on the dollar) after Argentina explicitly warned that those who did not participate would not receive payment on their defaulted notes. Distressed debt funds including NML Capital and Aurelius Capital nevertheless opted to hold onto their bonds. They’ve since obtained billions of dollars in judgments against Argentina.

Argentina and its lawyers at Cleary Gottlieb Steen & Hamilton have been extremely successful in thwarting execution of those judgments, as the 2nd Circuit mentioned in a footnote to Friday’s ruling. So the hedge funds took a different tack in the case that led to that decision. Argentina’s 1994 Fiscal Agency Agreement bonds included a so-called pari passu, or equal footing, clause, which said that the sovereign’s obligation to bondholders “shall at all times rank at least equally with all its other present and future unsecured and unsubordinated external indebtedness.” In 2011 NML, Aurelius and other vulture funds that claim they’re owed $1.4 billion in unpaid principal and interest on those 1994 bonds argued that Argentina was violating the pari passu clause by paying bondholders who participated in the restructuring before it paid them. The Argentine bonds were issued under New York law, so U.S. District Judge Thomas Griesa of Manhattan has presided over the litigation between Argentina and its bondholders. In a series of rulings in early 2012, he agreed to enjoin Argentina from paying the exchange bondholders before paying the hedge funds.

Griesa, who has seen Argentina refuse to pay up despite his previous rulings in the hedge fund bond litigation, expressed his frustration in the injunction rulings, in words the 2nd Circuit quoted in Friday’s decision. “The Republic has made clear — indeed, it has codified (in a 2005 law) — its intention to defy any money judgment issued by this court,” Griesa wrote. “If there was any belief that the Republic would honestly pay its obligations, there wouldn’t be any need for these (injunctions).”

In its appeal of Griesa’s orders, Argentina raised all sorts of arguments, including the judge’s supposedly incorrect interpretation of the equal footing clause and his alleged impinging on Argentina’s rights as a sovereign. The U.S. government chimed in on Argentina’s side, asserting that Griesa’s reading of the equal footing clause could undermine other foreign governments’ attempts to restructure their debt. “The district court’s interpretation of the pari passu provision could enable a single creditor to thwart the implementation of an internationally supported restructuring plan, and thereby undermine the decades of effort the United States has expended to encourage a system of cooperative resolution of sovereign debt crises,” the U.S. amicus brief said.

The bondholders’ lawyers — led by Gibson Dunn & Crutcher, Dechert, Friedman Kaplan Seiler & Adelman and MoloLamken — pointed out that Argentina’s bonds were issued under New York law. They argued (among many other things) that Griesa, as a federal judge in New York, is empowered to interpret the laws of New York.

That point was echoed, loudly, in the 2nd Circuit’s ruling Friday. “The (bond issue) is governed by New York law and further provides for jurisdiction in ‘any state or federal court in The City of New York,’” the panel said, rejecting Argentina’s argument that the pari passu clause is boilerplate with settled meaning in the sovereign debt community. In New York, the panel said, a bond is a contract, so Griesa’s task (and that of the appeals court) was to interpret the contract. Argentina agreed to that when it issued its bonds under New York law, the appeals court said.

The judges also said that once Griesa determined that Argentina had breached the equal footing provision when it put exchange bondholders ahead of the vulture funds, “the court had considerable latitude in fashioning the relief.” Given “Argentina’s continual disregard for the rights of its … creditors and the judgments of our courts to whose jurisdiction it has submitted,” the 2nd Circuit said, Griesa’s injunctions were an appropriate remedy.

And because those injunctions didn’t actually attach Argentine property, the 2nd Circuit said, they’re permissible regardless of Argentina’s immunity as a foreign sovereign. “Argentina voluntarily waived its immunity from the jurisdiction of the district court” because of the New York law provisions of the 1994 bond offering, the 2nd Circuit said. “The FSIA imposes no limits on the equitable powers of a district court that has obtained jurisdiction over a foreign sovereign.” Griesa’s injunctions, the opinion said, simply direct Argentina to comply with its contractual obligations and “can be complied with without the court’s ever exercising dominion over sovereign property.” Reuters financial blogger Felix Salmon called this the “weakest bit” of the 2nd Circuit’s ruling. I happen to think it’s a welcome affirmation of the jurisdiction of U.S. courts.

The 2nd Circuit also said that the U.S. government’s concerns about widespread chaos in the bond markets were misplaced, since collective action clauses in the overwhelming majority of recent sovereign debt offerings have mitigated the power of any single bondholder to hold up a restructuring. And besides, the appeals court said, Spain, Portugal and Greece — whose bonds Argentina cited in doomsday predictions — weren’t issued under New York law.

The appeals court remanded the injunctions to Griesa to clarify how the injunctions should impact the U.S. banks that actually administer Argentine payments to exchange bondholders. Argentina told Reuters Friday that it intends to “take all the legal steps necessary to contest the decision.”

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