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.

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