Why Argentina’s likely to beat Elliott Associates

By Felix Salmon
July 25, 2012
journalists -- filed into the Ceremonial Coutroom of the Second Circuit Court of Appeals for an hour-long hearing about two sentences in old Argentine bond documentation.

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There were lines out the door of 500 Pearl Street on Monday afternoon, as a surprisingly large crowd of jurists and hedgies and bankers and wonks — and even a few journalists — filed into the Ceremonial Coutroom of the Second Circuit Court of Appeals for an hour-long hearing about two sentences in old Argentine bond documentation. The case is huge in the world of sovereign debt, arguably the biggest that world has ever seen. And it was no surprise to see Treasury’s lawyer get up in front of the judges to make his case that they should overturn Thomas Griesa’s lower-court decision, which seeks to force Argentina to pay off its holdout bond creditors.

If you want some extremely smart analysis of what happened at the hearing, I’d point you to two pieces: Anna Gelpern’s, at Credit Slips, and Vladimir Werning’s, for JP Morgan. The two of them take different routes to arrive at much the same conclusion: although Argentina’s lawyer, Jonathan Blackman, got beaten up much more than Ted Olson, who was representing Elliott Associates, ultimately the chances are that Argentina will prevail.

If nothing else, the hearings made it clear that a decision to uphold Griesa, and to find in favor of Elliott, would have such enormous consequences, not only for Argentina but for the entire world of sovereign debt, that I can’t imagine it wouldn’t be appealed all the way to the Supreme Court. (Where, interestingly, Antonin Scalia wrote one of the more important precedents for this case, in Argentine litigation dating back to 1992.)

One key precedent that the Second Circuit would set, were it to find in favor of Elliott, would be a significant weakening of the Foreign Sovereign Immunities Act (FSIA). Sovereigns have sovereign immunity, and can basically do what they like, and all sovereign bondholders know this — but in order to uphold Griesa’s order, the New York court would essentially be constraining what Argentina can do with its own foreign exchange. Everybody in the court agreed that Argentina’s foreign reserves are immune from attachment, but if the order were upheld, then Argentina would find itself in one of two states. If it continued to pay existing bondholders who tendered into its bond exchange, it would have to pay holdout bondholders as well. Alternatively, if it continued to refuse to pay holdout bondholders, it would be barred from paying holders of the new bonds at the same time.

Under the FSIA — and the US government made this argument reasonably forcefully on Monday — it’s really hard to make the case that the US can or should force Argentina’s hand in either case: it can’t compel Argentina to pay holdout bondholders, and it can’t restrain Argentina from paying other bondholders. Which means that no matter what the pari passu clause means, the FSIA presents a formidable roadblock to Elliott Associates, and one which the Second Circuit is likely to be reluctant to dismantle. The way that one judge, Reena Raggi, put it, if Argentina was determined not to pay its holdouts, it could do anything it wanted with its money — even spend it on hookers and blow, if it wanted — except pay its other bondholders. And as Gelpern notes, the FSIA “does not provide for sliding scale immunities”.

What’s more, upholding Griesa’s decision would have significant waterfall effects: it would hit not only Argentina, but a lot of private-sector institutions in New York as well, not least Bank of New York, which is the trustee for Argentina’s new bondholders. Olson made it very clear that if the order was upheld, and Argentina kept on trying to pay its new bondholders while stiff-arming its holdouts, then Elliott would go after Bank of New York for “aiding and abetting” Argentina in flouting the order.

That would put Bank of New York in a very invidious position. On the one hand, it acts as a trustee for the new bondholders, and if it is given a coupon payment by Argentina, then that coupon payment belongs to the bondholders. BoNY has to pass the coupon payment on to them. On the other hand, if it does so, it might well be found in contempt of court. The Second Circuit is going to have to think long and hard about what exactly it would expect BoNY to do in such a situation — not least because that subsidiary case is very likely to come up in front of them if they find in favor of Elliott here.

Finding in favor of Argentina, then, is the easy way out, and as a result the appeals court is likely to hold its nose and find in favor of a defendant whom they really don’t like. That might explain why the justices were so hard on Argentina during oral argument: if they’re going to find in the country’s favor in their decision, they really ought to at least make the country’s lawyer squirm a bit in person. It’s — almost literally — the least they can do.


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Circuit courts of appeal have judges, not justices.

Posted by AlanVanneman | Report as abusive

This matter is heavily influenced by foreign policy/relations, much more so, it seems, than the ordinary application of commercial law, as FS touches on. For other reasons than contract law, the US government wants Elliott to lose. I’d rather see the government buy the loan and forgive it, if that’s what it wants, than see the law so tortured to attain a desired outcome. (But that kind of thinking is passé, it appears.)

OBTW: The piece IMO overstates the dilemma of the bank. There is a procedure to handle competing claims to an asset in the hands of a custodian who asserts no claim. This is actually not unusual, FS. I mean, come on ….

Posted by MrRFox | Report as abusive

Oh man!!

Are You saying that bonds issued under US law don’t have protection?

Posted by LucaT | Report as abusive

I’ll second the thought of MrRFox’s last paragraph. I assume the answer here is that BoNY would hold the money as trustee until a court told it what to do.

FISA adds a layer of complexity to the issue for sovereigns, but this sort of issue arises all the time when a borrower defaults/goes into bankruptcy. Even if BoNY as trustee passes on the payments to bondholders, for a non-sovereign borrower there’s well-established bankruptcy law concerning the ability of the bankruptcy trustee to recover cash from creditors who received preferential payments and what constitutes a preferential payment. It can take some time and legal expenses to figure out, especially in the case of a company like MF Global with lots of activity and shoddy record-keeping. That said, other than the sovereign aspect, there’s nothing novel about U.S. courts working through how to deal with money leaving an entity when other creditors claim that those funds should be theirs.

Posted by realist50 | Report as abusive

Argentina would like you to believe that this case has “enormous consequences” and “significant waterfall effects”, but the reality is far more prosaic.

The problem for the Kirchner regime is that their tactics and goals are incompatible with their bond agreements. The regime would like to simply walk away from its obligations to bondholders who were unwilling to accept the biggest “haircut” in history, but that doesn’t work when your bond agreements have strong pari passu language combined with a lack of collective action clauses (CACs).

The appellate panel is unlikely to be fooled by claims of Argentina and the assistant US attorney that the sky will fall if the panel upholds the district court. Virtually all New York-law governed sovereign bonds now contain CACs, and more importantly Argentina remains an aberration among sovereigns in dodging judgments that it has more than ample means to pay. The circumstances of this case will not be repeated.

The panel should also have no problem finding that Argentina breached its obligations. Years ago Argentina itself asserted that pari passu would be breached if a law was enacted to differentiate among creditors – and the regime then did exactly that.

Invoking the FSIA in this situation is the reddest of herrings. Argentina comprehensively waived immunity under its bond agreements, and US courts have well-recognized powers within the FSIA to order equitable relief. The specific performance ordered by Judge Griesa places no restraints upon Argentina’s assets, especially those outside his court’s jurisdiction. The FSIA does not grant immunities, it restricts them, and as Judge Raggi rightly observed, the lower court’s order has nothing to do with the FSIA’s limited immunities as to execution.

MrRFox and realist50 are undoubtedly correct that the order presents no special difficulties for BoNY. The great mystery of course is what Argentina will do, and its counsel declined to answer that question.

If a foreign sovereign enjoys the benefits of US capital markets but then disdains the judicial system on which they are built, should that sovereign still enjoy unencumbered use of the US payment system? Of course not.

Posted by anoldbanker | Report as abusive