If Argentina restructures bonds to evade hedge funds, sanctions loom

June 16, 2014

Argentina is just about out of legal options in its blood feud with NML Capital, Aurelius Capital and other holdout bondholders.

On Monday, the U.S. Supreme Court refused outright to hear Argentina’s appeal of a ruling from the 2nd U.S. Circuit Court of Appeals that prohibits the foreign country from making payments to bondholders who exchanged defaulted debt without also paying holdout hedge funds that have won about $1.5 billion in judgments against Argentina. Argentina had been hoping the justices would at least ask for briefing from the U.S. Solicitor General, which would have bought it some time. But time is up for Argentina: The country’s next payment to exchange debtholders is due on June 30, and if it fails to pay the hedge funds at the same time or tries to restructure its bonds to evade U.S. courts, Argentina risks monetary sanctions and being held in contempt of court.

Such a ruling would further blacken Argentina’s reputation in global debt markets — but it wouldn’t have much actual effect on whether the hedge funds are able to collect what they’re owed. According to Michael Mukasey of Debevoise & Plimpton, a former U.S. attorney general and former chief U.S. district judge in Manhattan, Argentine assets in the United States would probably still be protected by the Foreign Sovereign Immunities Act even if Argentina were found in contempt and hit with sanctions. “What can (U.S. courts) do about it?” Mukasey said. “Not a whole lot.”

Mukasey was one of six former federal judges who submitted a friend-of-the-court brief urging the Supreme Court to reject Argentina’s appeal, arguing that Argentina didn’t deserve the justices’ consideration because its lawyers had already told judges at the 2nd Circuit that Argentina would not “voluntarily obey” U.S. court directives. In a subsequent brief at the Supreme Court, Argentina pledged to comply with U.S. court orders, but warned that if the justices didn’t agree to hear its appeal, it might be forced to default on its debt.

NML, meanwhile, said in a separate proceeding in the lower courts that Argentina had a secret plan in case it was rebuffed at the Supreme Court. According to the hedge fund, a leaked memo from Argentina’s lawyers at Cleary Gottlieb Steen & Hamilton showed that Argentina intended not simply to default on its exchanged debt but immediately to restructure the bonds to put them out of the reach of U.S. courts.

While Argentina’s petition was before the Supreme Court, NML told U.S. District Judge Thomas Griesa of Manhattan, who is presiding over Argentina’s litigation with the hedge fund holdouts, that Argentina was flauting Griesa’s October 2013 injunction barring it from changing bond mechanisms in order to evade payments to the hedge funds. NML asked Griesa to issue a supplemental injunction to clarify that Argentina is permanently prohibited from making such changes. At a June 3 hearing, Cleary partner Carmine Boccuzzi said the firm was just outlining options for its client and that Argentina had no plan to restructure its debt. “We have never advised a client just to turn their nose up to the court’s orders and to evade them,” Boccuzzi told Griesa.

Griesa found earlier this month that the Cleary memo is privileged but hasn’t done anything else with NML’s motion. If, however, Argentina follows through with what Cleary called its “best option” and restructures its debt to avoid paying the hedge funds, NML and the other holdouts will undoubtedly ask Griesa to hold Argentina in contempt and hit it with sanctions.

The U.S. government has twice argued in federal circuits that foreign sovereigns cannot be held in contempt of U.S. courts. In 2006, the 5th Circuit agreed, but in a 2011 ruling called FG Hemisphere v. Democratic Republic of Congo, the D.C. Circuit said that the Foreign Sovereign Immunities Act does not bar a federal court from holding that another country is defying its orders. “There is not a smidgen of indication in the text of the FSIA that Congress intended to limit a federal court’s inherent contempt power,” the D.C. Circuit opinion said.

The Supreme Court signaled a similar view of the law on Monday — in another dispute between Argentina and NML. In a unanimous decision, the court authorized NML to conduct court-approved discovery on Argentine assets even though the Justice Department sided with Argentina in opposing the discovery. The opinion, written by Justice Antonin Scalia, said that FSIA protection is limited to the two immunities Congress specified in the law, and that if the Justice Department is worried about the policy implications of otherwise subjecting foreign nations to U.S. court orders, it should ask Congress to amend the law. “Today’s decision,” said FSIA lawyer Richard Klingler of Sidley Austin (who was not involved in the NML case), “says that if you’re a foreign sovereign, you don’t get special rules unless Congress said so.”

Nevertheless, as the D.C. Circuit pointed out in the 2011 Congo case, FSIA protects even the assets of foreign sovereigns found in contempt. Argentina’s hedge fund opponents have been attempting for a decade to execute some $15 billion in judgments against the country. They haven’t been very successful, despite some of the most creative theories ever to surface in post-judgment enforcement litigation. Monetary sanctions against Argentina would add to the total due to the hedge funds — but wouldn’t help them collect it.

Will Cleary Gottlieb face any consequences if Argentina restructures its bonds and is found in contempt? Klingler said that if Argentina does attempt to evade U.S. court orders, Judge Griesa in Manhattan will probably press Cleary for more details on what the firm knew about its client’s plans. He and Mukasey both said, however, that as long as Cleary lawyers could show that they had a reasonable and good-faith basis for their representations to Judge Griesa, the firm should be fine.

I emailed Boccuzzi, Cleary partner Jonathan Blackman, a Cleary spokeswoman and Argentina Supreme Court counsel Paul Clement of Bancroft. None got back to me. A Cleary spokeswoman said in an email, “As stated on the record in the district court and to the Supreme Court, Argentina will not evade any rulings and will comply, although that means Argentina faces, objectively, a serious and imminent risk of default.”

Argentina’s president, Cristina Fernandez de Kirchner, is scheduled to deliver a speech Monday night on the standoff with the hedge funds. We’ll know then whether Argentina will live up to its pledge to comply with U.S. court orders.

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