How Argentina lost game of chicken with renegade bondholders

November 26, 2012

The integrity of the federal judicial system rests on the bedrock principle that judges will put aside personal feelings and issue rulings based on the facts and the law. No matter how odious litigants (or their lawyers) may be, our system says they’re entitled to fair treatment. But judges are also human. If you push them hard enough, over a long enough period of time, they’re going to push back. And that is why Argentina now faces a dire choice: Either it puts $1.3 billion into an escrow fund to pay off renegade bondholders who refused to participate in the country’s two rounds of sovereign debt restructuring or it risks entering a technical default on $24 billion of restructured bonds. Argentina’s crisis is the product of almost 10 years of litigation, in which U.S. courts have labored to honor the rights of a foreign sovereign — and Argentina has offered no such reciprocal respect for the power of our courts.

Argentina is imminently expected to ask the 2nd Circuit Court of Appeals to reinstate a stay on a series of injunctions issued earlier this year by U.S. District Judge Thomas Griesa of Manhattan. You probably remember the background. The bond exchange holdouts filed suits in federal court in Manhattan, claiming that Argentina was violating the pari passu, or equal footing, clause of their contracts when it paid exchange bondholders without paying them. Griesa, who has been supervising litigation between Argentina and the holdouts for almost a decade, agreed. He enjoined Argentina from making payments to exchange bondholders before paying the holdouts what they’re owed. In October, the 2nd Circuit affirmed Griesa, sending the case back to him for clarification of the terms of the payments Argentina must make to holdouts. After the appeals court’s ruling, Argentina’s political leaders nevertheless vowed not to pay the renegade bondholders, which they (and others) call vultures.

At a hearing earlier this month, Griesa warned Argentina’s longtime lawyers at Cleary Gottlieb Steen & Hamilton that if their client continued to defy U.S. court rulings, “steps can be taken to sanction any misconduct.” Last Wednesday night, Griesa laid down the law. Despite pleas by Argentina and the exchange bondholders, the judge lifted the stay on his injunctions. He ruled that Argentina may not pay the exchange bondholders the $3.41 billion they’re due in December unless it also puts up $1.3 billion for the holdouts. With Argentina steadfastly insisting it will not pay holdouts, Griesa’s ruling puts the country on the brink of an economic catastrophe.

There’s a good argument to be made that the catastrophe is of Argentina’s own making. To understand why, you have to look back to the 1990s, when Argentina issued the debt at the heart of the dispute with holdouts. In those bond contracts, to reassure investors, Argentina explicitly agreed to submit to the jurisdiction of U.S. courts — specifically, New York courts — despite its immunity as a foreign sovereign.

Argentina went into default in 2002. More than 90 percent of its bondholders eventually agreed to exchanges in 2005 and 2010 that gave them about 30 cents on the dollar. Some so-called distressed debt investors, however, decided to take their chances and litigate in federal court in Manhattan to enforce their rights under the original bond contracts. Through those suits, which began to be filed in 2003 and have since ended up before Griesa, the holdouts have obtained billions of dollars of judgments against Argentina.

But as hedge fund holdouts like NML Capital (part of Elliott Capital) and Aurelius Capital tried to enforce those judgments against a sovereign that vowed it would never pay, U.S. judges sided with Argentina time and time again. Frequently it was Griesa who blocked the hedge funds’ attempts to get their hands on Argentine assets; on the relatively rare occasions when he gave the holdouts a green light, the 2nd Circuit usually reversed him, citing Argentina’s rights as a foreign sovereign. In 2007, for instance, the appeals court ruledthat Argentine funds held at the Federal Reserve were immune from attachment, even though they were being used to repay the International Monetary Fund. In 2009, the 2nd Circuit thwarted the hedge funds’ bid for private funds held in the United States that were about to be transferred to the Argentine government’s social security system. Last July, the appeals court rejected another go at Argentine central bank money held at the Federal Reserve. The 2nd Circuit has upheld a couple of small attachmen t s, but U.S. courts have been incredibly mindful of Argentina’s rights.

That’s not to say, however, that Griesa or the judges of the 2nd Circuit haven’t been keenly aware of Argentina’s flagrant disregard of judgments against it. In the 2009 decision on Argentine social security funds, for instance, 2nd Circuit Judge John Walker and U.S. Senior District Judge Clifford Wallace (sitting by designation) wrote, “We understand the frustration of the plaintiffs who are attempting to recover on judgments they have secured. Nevertheless, we must respect the … strict limitations on attaching and executing upon assets of a foreign state.” Two years later, in the 2011 ruling that refused to attach central bank money, 2nd Circuit Judges Roger Miner, Jose Cabranes and Chester Straub explicitly noted Argentina’s “appalling” record of repaying creditors. “We share the district court’s understandable irritation at the Republic’s ‘willful defiance of (its) obligations to honor the judgments of a federal court,'” the appellate opinion said, and then repeated its reluctant conclusion from 2009.

With attachment efforts seemingly doomed by foreign sovereign immunity, NML Capital embarked on a new course against Argentina in 2009. It began filing suits claiming that Argentina was violating the equal footing clauses of its original bond contracts. There’s precedent for the argument; as I’ve reported, a Belgian court (in a case involving Peruvian bonds) and a California federal court (in a case against the Republic of Congo) have previously ruled that equal footing clauses apply to holdouts in foreign debt restructurings. Other hedge fund holdouts picked up the strategy and filed their own pari passu claims. But the holdouts knew that for a ruling from Griesa to have any tangible effect on Argentina, they needed more than just a district court judgment that the clause applies. Argentina, after all, has ignored judgment after judgment entered by Griesa. The hedge funds needed an injunction barring Argentina from paying exchange bondholders unless it also paid them.

That’s where Argentina’s flouting of previous rulings came back to haunt it. Exercising his discretion, Griesa granted injunctions to NML and eventually other holdout bondholders because he said Argentina would otherwise ignore him. “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).” Judges Barrington Parker, Rosemary Pooler and Reena Raggi of the 2nd Circuit endorsed Griesa’s “considerable latitude” to fashion relief for the holdout bondholders, given “Argentina’s continual disregard for the rights of its … creditors and the judgments of our courts to whose jurisdiction it has submitted.” And with Argentina more defiant than ever after the 2nd Circuit ruling, no one should have been surprised that Griesa took the opportunity to show the foreign sovereign who is the boss of his courtroom.

Argentina has already requested a rehearing of the 2nd Circuit ruling from October, but I doubt that the appeals court will take up Argentina’s case en banc. The court rarely hears en banc appeals, for one thing. For another, a broad swath of 2nd Circuit court judges have heard one Argentine appeal or another, so the court is quite aware of Argentina’s history of recalcitrance. That history could also impact the country’s chances of persuading the U.S. Supreme Court to take its case; you can bet that the hedge funds will argue that Argentina is unparalleled in its defiance of U.S. court judgments, so the facts of its case are too idiosyncratic to merit Supreme Court appeal.

Meanwhile, a little-noticed 2nd Circuit decision from last August could augur more bad news for Argentina. Judges Cabranes, Walker and Joseph McLaughlin affirmed Griesa’s ruling that Argentina’s hedge fund creditors have the right to subpoena information from the country’s bankers about Argentine assets held outside of the United States. The Argentine naval ship that was seized by Elliott in October to satisfy a judgment wasn’t disclosed pursuant to one of these subpoenas, but the hedge funds could end up with a handy list of future targets.

I left messages requesting comment with Carmine Boccuzzi and Jonathan Blackman of Cleary, but neither called back.

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