Opinion

Felix Salmon

Elliott vs Argentina: The Second Circuit’s dangerous game

By Felix Salmon
March 4, 2013

On Friday, the Second Circuit court of appeals issued an order, aimed at Argentina. The order is worth quoting in full, because it helps to explain the reasoning by which the Second Circuit is going to end up pushing Argentina into default:

At oral argument on Wednesday, February 27, 2013, counsel for the Republic of Argentina appeared to propose that, in lieu of the ratable payment formula ordered by the district court in its injunction and accompanying opinion of November 21, 2012, Argentina was prepared to abide by a different formula for repaying debt owed on both the original and exchange bonds at issue in this litigation. Because neither the parameters of Argentina’s proposal nor its commitment to abide by it is clear from the record, it is hereby ordered that, on or before March 29, 2013, Argentina submit in writing to the court the precise terms of any alternative payment formula and schedule to which it is prepared to commit.

The court directs that, among the terms specified, Argentina indicate: (1) how and when it proposes to make current those debt obligations on the original bonds that have gone unpaid over the last 11 years; (2) the rate at which it proposes to repay debt obligations on the original bonds going forward; and (3) what assurances, if any, it can provide that the official government action necessary to implement its proposal will be taken, and the timetable for such action.

A bit of background here: at the big hearing last week, Argentina complained that it had never been given an opportunity to propose terms on which it might be willing to pay Elliott Associates, the plaintiff in the case. This is the first paragraph of the Second Circuit’s response: OK then, tell us what your proposed terms might be. And then the second paragraph contains the punch: those terms had better explain how you intend “to make current those debt obligations on the original bonds that have gone unpaid over the last 11 years”.

Argentina, of course, has no such intention. When it files its response at the end of this month, it will almost certainly propose what is essentially a second reopening of the 2005 bond exchange: it will allow Elliott to swap its old defaulted debt into new, performing bonds on more or less the same terms — including a 70% haircut — that everybody else got. In no event will it allow Elliott to be paid off in full — to be “made current” — on the original terms of its bonds.

The Second Circuit, on the other hand, clearly sees its job as being to enforce the original bond contract, which has been in default for 11 years. When Argentina proposes something roughly 4,000 days late and a billion dollars short, that’s all the provocation the Second Circuit will need to bring down the hammer and uphold the district court’s orders.

Those orders are tough indeed. Commenter “paripassuwatch”, on my original post, notes that the court’s injunctive remedy is “the most powerful enforcement mechanism in the realm of sovereign debt since the era of ‘gunboat diplomacy’. Blocking access both to the world payment system and world capital markets is as close one can get to blocking access to trade and customs duties”.

These days, as Don Henley famously said, a man with a briefcase can steal more money than any man with a gun — and the Second Circuit is going to hand over to Elliott Associates one of the most powerful briefcase-based weapons the world has ever seen. That doesn’t mean Elliott’s going to get paid, of course. But it does mean that that the hedge fund can essentially turn Argentina into a global economic outcast unless and until that happens.

The consequences for Argentina could well be very real and very painful. All governments need to fund themselves, and Argentina is no exception: what’s more, all governments borrow money from foreign investors, by issuing either foreign or domestic debt to those investors. Again, Argentina is no exception — foreign investors have long been a large part of the investor base for Argentine domestic debt. So in theory, losing access to US capital markets might be no big deal: Argentina could simply move all of its funding operations to Buenos Aires.

In practice, however, as DanielKoehler, another commenter, says, things are more complicated than that. Foreign investors tend to want dollar-denominated debt, and whenever you’re dealing in dollars, various intermediaries are going to be transferring those dollars into a US bank account. Similarly, Bank of New York, as the trustee for the bondholders who are receiving interest payments right now, would have to be involved somehow in any attempt to exchange those bonds for new domestic bonds. In both cases, US institutions could find themselves at risk of being found in contempt of court in New York, and might well refuse to cooperate with Argentina.

Just finding a bank willing to lead-manage any exchange offer would be difficult, for Argentina, given the legal and reputational risks associated with such a mandate. The New York courts are being very clear: if Argentina wants to be able to pay its current bondholders, it’s going to have to pay off its holdouts at the same time. (Or, conversely: if Argentina wants to remain in default on the holdouts, it’s going to have to default on everyone.) No one knows how this whole thing is going to play out, but New York’s jurists aren’t stupid, and are good at closing all the obvious loopholes. Argentina has very good and very expensive lawyers, but there’s no particular reason to believe that they’re going to be able to conjure up some clever mechanism which allows the country to continue paying the bondholders it wants to pay, while keeping Elliott out in the cold.

That said, the New York courts are playing a very risky game here. If Argentina does end up defaulting on everybody, it’s only going to be a matter of time before it unveils some kind of exchange offer, which would probably be open to holders of all defaulted bonds. Most likely the bondholders who are currently receiving interest payments — the exchange bondholders represented in court by David Boies — would be offered 100 cents, or maybe even slightly more than that, on the dollar, while the holdouts, like Elliott, would be offered maybe 70 cents on the face value of their claims. (Elliott is asking the court for roughly 300 cents on the dollar, thanks to the wonders of past-due compound interest.)

Such an exchange offer could easily be presented by Argentina as a good-faith effort to cure a default which was forced on it by hostile American courts. And David Boies would certainly be arguing vociferously for the right of bondholders to decide whether they wanted to accept Argentina’s offer or not. At that point, what would Judge Griesa, and/or the Second Circuit, do? They could stand firm, and essentially block the entire exchange offer — thereby keeping Argentina in default against its own will. But while they’re sworn to uphold the sanctity of contracts, they also have to have at least one eye on the ability of New York’s financial markets to function effectively. And it’s hard to see how they can do that if they’re preventing a sovereign nation’s best attempt to extricate itself from default.

So while the current situation is certainly very bad for Argentina, it could wind up being just as bad for the Southern District, and for New York’s status as an international financial capital. Which is why the Second Circuit is going to have to think very hard indeed before handing down any particularly draconian decision.

Comments
11 comments so far | RSS Comments RSS

It is simply ludicrous to suggest that one of the world’s most authoritative judicial systems should be held at fault for interpreting a contract to the disadvantage of a regime that is universally recognized to be capricious and underhanded (inflation statistics, anyone ?).

In this matter, Argentina is simply unlucky and unwise to have gambled upon achieving a total cram-down of its derisory exchange offer, when it lacked the legal and contractual tools to finish the job.

So indeed “the consequences for Argentina could well be very real and very painful”. And yet, you suggest that Argentina will put the gun to its head and pull the trigger of default once again ? Hogwash. She is bluffing, Felix, and you don’t even see it.

Bravo to the Second Circuit for standing up to Cristina’s Saddamesque threats.

Posted by anoldbanker | Report as abusive
 

Ditto what ahold said. Why are you so sympathetic to a failed crooked regime like Argentina?

Posted by QCIC | Report as abusive
 

For some of us it is not really about Argentina. The other concern is with the payment system. This concern with a court’s overreach was well stated in Kensington v Congo with Judge Tomlinson stating: “I do not regard it as an appropriate exercise of my discretion, at any rate in the particular circumstances of this case, to make an order compliance with which can only realistically be achieved by coercion of third parties. I view with disquiet in the circumstances of this case a situation in which third parties are potentially exposed to penal consequences which could never be visited upon the defendant to whom the order is actually directed.” Perhaps it was said even better there than in NML.

Still @anoldbanker your point is taken about Argentina taking a gamble. Here we have one of the most skilled defaulters Argentina pitted against one of the savviest holdout creditors Elliott/NML. Indeed there is a lot of bluster. In her recent speech(http://www.youtube.com/watch?v=87 FznzPa7yk) Cristina seemed to suggest that the expropriated grass is greener in Bolivia.

She stated ‘there is a great friend of ours, Evo Morales, who has even expropriated the grass and still gets lent money at around four percent’ however to be fair Argentina did expropriate the water (http://www.iarepor…rticles/20100818_9) even if it was in response to an emergency.

Still you have to love a case where US judges cite Borges and Argentine presidents cite Garcia Marquez. However I would rather that NML in its Labyrinth be lost trying to attach the grass in the Garden of Forking Paths, than it enjoining any participating bank in the forking paths of the international payment system.

Posted by paripassuwatch | Report as abusive
 

@paripassuwatch, the international payment system doth protest too much (if you will permit a more mundane literary citation).

To enforce the lower court’s order, those parties in concert or participation with Argentina need only refer to the small range of ISIN numbers identifying the exchange bonds, and put a hold on payments pending either the certification required of Argentina or instructions from the court. It is far easier than the attachments that they do every day.

The payment system issue should not be conflated with Tomlinson J’s dicta regarding the equities in a lower court opinion in an entirely unrelated case – one of the very few straws within attorney Blackman’s grasp.

The market’s willingness to finance Morales at four percent can only be explained as the triumph of diversification over wisdom.

Posted by anoldbanker | Report as abusive
 

@anoldbanker

The literary citation is certainly much appreciated! Mine was as much for humor as anything else.

“The market’s willingness to finance Morales at four percent can only be explained as the triumph of diversification over wisdom.” Great point, I also find this quite interesting.

As to another point “To enforce the lower court’s order, those parties in concert or participation with Argentina need only refer to the small range of ISIN numbers identifying the exchange bonds, and put a hold on payments pending either the certification required of Argentina or instructions from the court. It is far easier than the attachments that they do every day.” With this point you almost prove too much. It is precisely because the solution is so much easier than attachment that it is worrisome. Also attachment gives us some really great headlines.

As to Tomlinson’s Dicta let us not pretend that it is unrelated. In a way it is a chronicle of a litigation foretold. It too was also part of the evolution of the Pari Passu litigation strategy. Kensington v. Congo came on the heels of Elliott v. Peru. Kensington was an Elliott subsidiary. There it sought to use an injunction to achieve what the judgments against the Congo could not. In 2006 it also sought to enforce its UK judgments in New York. One of the forms of relief requested was injunctive relief based on the Congo’s violation of the pari passu and negative pledge provisions in the loan agreement.

As you said yourself attachment is much harder while blocking parts of the payment system is relatively easy. Would a New York bank really risk helping Argentina if it faces contempt? It is precisely that ease that makes the injunctive relief an ‘enhanced enforcement mechanism’ giving something that the court’s final judgement never do.

Though perhaps you are right that the system does protest too much. One imagines that there are many ways that the market and those creating payment structures can react to this. Still it is interesting seeing this all unfold.

Posted by paripassuwatch | Report as abusive
 

@paripassuwatch, you raise an interesting point regarding whether injunctive relief is or should be an ‘enhanced judgment enforcement mechanism’, which Argentina’s counsel deems out of bounds.

The distinction seems meaningless. The US government’s application of trade sanctions against Argentina is an enhanced mechanism for enforcing dishonored ICSID awards. How else can one deal with a contumacious sovereign ?

The US and UK courts get it right far more often than not. Tomlinson’s dicta was in response to Kensington’s extremely aggressive plea for a global freezing order and injunction against unnamed and unknown third parties. Here, BoNY is in direct contractual privity with Argentina. The difference in scope could not be more profound.

I think we can at the least agree that Felix makes no sense whatsoever arguing that US courts should temper their enforcement of contracts out of deference to a regime that demonstrates no concern for basic norms of sovereign behavior.

Posted by anoldbanker | Report as abusive
 

“they also have to have at least one eye on the ability of New York’s financial markets to function effectively. And it’s hard to see how they can do that if they’re preventing a sovereign nation’s best attempt to extricate itself from default.”

This sovereign nation’s best attempt to extricate itself from default would be to pay Elliot what it owes. Second Circuit has no intention to prevent that or to interfere with that. If the sovereign nation wants to dodge its responsibility, it’s their problem, and it should not be presented as something that U.S. courts must allow because it’s somehow necessary for the “financial markets to function effectively.”

Posted by Nameless | Report as abusive
 

Argentina arguably did not have the current resources in 2001 to meet all its obligations in a timely manner. However for the past several years it clearly has the cash flow and reserves to honor its obligations, particularly to those creditors including the United States that have not received debt service for more than 11 years.

The cost and consequences to Argentina of continued default are far greater than the alternative to pay its obligations and return to the norms of the international financial system. What opportunities they are missing… Why do I see Argentina as a dagger pointed at the heart of Antartica?

Posted by DavidTrevitt | Report as abusive
 

My guess is that this is going to hurt NYC as a financial center more than Argentina. It will probably take about ten years for anyone to notice, but the current global financial system has its discontent. For example, everyone in southeastern Asia remembers the IMF crisis of ’97, and they still resent it. As the US actively works towards its own decline, there are lots of others willing to pick up the pieces.

Posted by Kaleberg | Report as abusive
 

Now that I think of it, it is unusual for a bankruptcy court to consider all creditors equal. Isn’t the usual rule that contracts with corporations for goods and services are enforced, but contracts with individuals or unions for labor are irrelevant? I’m not sure what law is being used in this case, but if it attempts to give all creditors equal standing and allow one creditor to interfere with a settlement made by another, I can see serious problems in the next round of airline and municipal bankruptcies. There may be a more dangerous precedent being set here than I had originally thought.

Posted by Kaleberg | Report as abusive
 

@Kaleberg Without going into too much detail, the situation here is that, when original bonds were issued, the contract between Argentina and bondholders contained an explicit promise not to issue any debt that would be senior to these bonds (and, therefore, that all future creditors would have equal or lower standing than these bondholders): the so-called “pari passu clause”. Argentina violated it in 2005 (and then again in 2010) when it issued exchange bonds which were, by Argentinean law, designated senior to all remaining pre-exchange bonds.

Argentinean government thought that they could get away with it because, by U.S. law, holders of old bonds had virtually no recourse: they could not attach the property of a foreign government. Until Elliot’s lawyers managed to find a loophole by interfering with the flow of money from Argentina to holders of new bonds through New York banks.

Posted by Nameless | Report as abusive
 

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