The other loser in Argentina debt saga: U.S. courts

July 31, 2014

There’s been a lot of talk in the Argentine debt crisis about whether U.S. courts have overstepped their bounds. At the end of 2011, you’ll recall, U.S. District Judge Thomas Griesa of Manhattan ruled that the pari passu, or equal treatment, clause of Argentina’s bond contracts entitles hedge fund holdouts that refused to participate in debt restructurings to payments alongside the more obliging exchange debtholders. Since then, Argentina and its allies, including the U.S. Justice Department, have argued that Griesa’s interpretation of the pari passu clause — which was subsequently affirmed by the 2nd U.S. Court of Appeals and left intact by the U.S. Supreme Court last month — gives too much power to creditors and undermines sovereigns.

On Wednesday, Argentine officials chose to default on exchange bonds rather than pay about $1.6 billion to, or otherwise reach a settlement with, the hedge fund holdouts. That decision exposed a stark truth: All the might of the U.S. judicial system cannot force a foreign nation to pay its debtors. U.S. judges can’t order the seizure of a foreign sovereign’s assets and they can’t throw foreign officials in jail for contempt. As Georgetown law professor Adam Levitin wrote in a very smart column in the Wall Street Journal, “There’s no way to bind a sovereign to its promise of complying with court orders any more than there is to its promise of payment.”

Griesa and the 2nd Circuit thought the pari passu injunctions were the club that would finally bludgeon Argentina into submission, after years of Argentine defiance of court-ordered judgments for NML Capital, Aurelius Capital and other holdout debt investors. The holdouts — many of which acquired defaulted Argentine debt on the cheap, gambling that they’d be able to recover from Argentina via litigation — tried all kinds of maneuvers to attach Argentine assets, only to run time and again into the country’s immunity as a foreign sovereign.

The pari passu injunctions, though, implicated not just Argentina but also the global banks that transfer money from Argentina to its exchange bondholders. Technically, the injunctions barred Argentina from making interest payments on its restructured debt without also paying the holdouts. Practically, the injunctions meant that financial institutions such as the bond trustee Bank of New York Mellon could not transfer interest payments from Argentina to exchange bondholders without violating U.S. court orders. Unlike Argentina, global banks that do business in the United States can’t simply ignore U.S. rulings they don’t like.

Those banks, as well as the exchange bondholders, protested to Griesa and to the 2nd Circuit that the pari passu injunctions turned them into hostages in the gunfight between Argentina and the holdouts. That’s a fair point, and they have eloquent sympathizers like Felix Salmon in Foreign Affairs. But it’s also true that Argentina’s exchange bondholders and payment agents subjected themselves to U.S. jurisdiction though their contracts with Argentina. (A caveat: As Floyd Norris pointed out in a New York Times column last week, Judge Griesa and the 2nd Circuit haven’t done a good enough job of distinguishing between Argentine bonds issued under New York law and those issued under the law of other jurisdictions, which has created considerable confusion about precisely which interest payments are covered by the pari passu injunctions.) If you agree to submit to a court’s jurisdiction, you’re stuck with the obligation of following its rulings.

Unless, of course, you’re a foreign sovereign. Argentina decided Wednesday that it would rather face the consequences of defaulting on its exchange bonds than make a deal with the hedge fund holdouts it routinely calls vultures and extortionists. We don’t know yet what that decision will mean for the Argentine economy. The court-appointed mediator who oversaw fruitless settlement talks, Daniel Pollack of McCarter & English, said Wednesday that default was “a real and painful event” that will victimize ordinary Argentines. Bloomberg columnist Matt Levine, however, wrote that if Argentina can resolve the default quickly, “that’s almost as good as not defaulting at all.” And remember: Argentina has been thinking about the contingency plan of defaulting on its exchange bonds for at least three months, dating back to when its lawyers at Cleary Gottlieb Steen & Hamilton advised government officials that defaulting and immediately restructuring sovereign debt to avoid U.S. court jurisdiction was Argentina’s “best option.”

The hedge funds meanwhile, have to be chastened by Argentina’s intransigence in the face of default. Peter Eavis and Alexandra Stevenson at the New York Times pointed out Thursday that Paul Singer, who oversees NML Capital through his Elliott Management fund, makes money by enforcing the rights of creditors. The story quoted fellow hedge funder Daniel Loeb, who said Singer “believes deeply in the rule of law.” I’ve heard the same thing said about Aurelius principal Mark Brodsky, a Harvard Law School graduate. The whole strategy of distressed debt investors, after all, is to bet that through shrewd litigation tactics, they can turn a profit on undervalued bonds. Their business model depends on the enforceability of court orders. Unfortunately for them, Argentina has beaten that strategy, albeit at a potentially devastating cost to the country.

Levitin, the Georgetown law professor, argued that U.S. courts should have abstained from hearing the hedge funds’ case against Argentina because they couldn’t “administer an appropriate remedy.” That seems like bad policy to me. Argentina issued its original bonds under New York law, and investors bought them with the expectation that U.S. courts would exercise jurisdiction over disputes between them and Argentina. Levitin assumes that U.S. judges ought to have known Argentina would defy their orders, but how could they have known for sure unless they issued those rulings? And if they abstained from hearing claims by legitimate creditors against a sovereign debtor, why would bond buyers ever again trust that U.S. courts would enforce their rights? Or any court, for that matter?

Levitin is right that the hedge fund litigation with Argentina has laid bare the limits on the power of U.S. courts, the borderline between litigation and foreign policy. Thanks to Argentina, bond investors are now on notice that they might not be able to enforce U.S. judgments against foreign sovereigns. They’ll have to factor that risk into investment decisions.

But at least investors know. U.S. courts fulfilled their duty. They heard all sides, rendered decisions and reconsidered those decisions on appeal. They laid down the law. They just can’t get Argentina to follow it.

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