International litigation instills yet more ‘ad hocery’ in the increasingly tricky debt game
A few days ago, on 1 August, credit rating agencies downgraded Argentine bonds to ‘selective default’. The country’s creditors, who accepted both the 2005 and 2010 debt restructurings that followed the 2001 default, had not received their interest payments on the expected date (30 June 2014). But this was not due to the two problems usually associated with defaults: the debtor’s unwillingness or, more commonly, its inability (due to sovereign insolvency) to repay its creditors.
Argentina is willing to repay bondholders of its exchanged bonds. The country deposited the due amount in the account of Bank of New York Mellon which is in charge of transferring the money to the rightful creditors on time. For this reason, Argentine officials insist that they did not default. But the market begs to differ. Credit default swaps have been triggered (in other words, they will start being paid to those who purchased this ‘insurance’ against default).
At the heart of Argentina’s legal saga was the unusual interpretation of a US district court judge of a common and now infamous clause in sovereign bond contracts: the pari passu clause. For Judge Griesa, it meant that Argentina could not pay the creditors of its restructured bonds without also paying NML, the plaintiff hedge-fund in a 13-year old case against Argentina. Furthermore, to pressure Argentina to negotiate with NML, the district court wrote an injunction that threatened to hold third-party banks that handle bond payments in New York in contempt if they passed on Argentina’s payments to the holders of the restructured bonds.
From Argentina’s viewpoint, negotiating with NML could make room for further claims from other ‘hold-outs’ and many more billions from creditors who accepted the previous restructurings thanks to a clause in the restructured bonds that does not allow Argentina to offer any of its creditors a more favourable deal than already negotiated until the end of this year. In effect, and notwithstanding the defiant rhetoric of the Kirchner administration, legal constraints further tied the hands of the Argentine government which realized that cutting a deal with the plaintiff in the case in question would not end – far from it – its legal troubles.
Consequently, the first lesson emerging from these disturbing developments is rather obvious: it’s all in the contract! However, some of the contract’s rather arcane clauses invite interpretations that can trigger much more confusion than is commonly anticipated in such arrangements. Moreover, insofar as these clauses are common in many other bonds, the Argentine debacle could potentially have cascading effects on future litigation. Jurisdiction matters, of course. New York has suddenly become a more complicated place to do debt business. But, to be fair, such ‘business’ has now been rendered more unpredictable everywhere; contractual terms and the ‘mechanics of payments’ will be reconsidered worldwide.
This leads to a second point: ‘ad hocery’ breeds uncertainty – the only constant, it seems, in default episodes. If this episode confounds the tactics employed by seasoned litigators, imagine how it plays out in the less agile world of IR or IPE theory! These are not places to look for tools to make sense of these developments in international negotiation. Neither reputation nor sovereignty as concepts make this story more predictable.
Indeed, the tired notion of reputational punishments is not the most relevant dynamic here. The Argentine ordeal is not about a majority of creditors ‘punishing’ a non-compliant sovereign for its default by refusing to offer new credit or charging punitive interest premiums for new loans. It is (merely) the product of litigation in US courts sustained by a uniquely resourceful and tenacious group of creditors whose high risk investment strategy consists of suing sovereign defaulters for full repayment after purchasing defaulted bonds for bargain prices.
In turn, sovereignty offers no greater solace. Long considered unenforceable because of the absence of a sovereign bankruptcy court, sovereign debts – according to legal scholar, Anna Gelpern – are now ‘enforceable in a very damaging way’ after this Argentine case. This comes about not only because of Judge Griesa’s particular legal interpretations and restraining injunctions, but also because of the fickle protection granted by the US Foreign Sovereign Immunity Act (FSIA) of 1976 to Argentina’s assets abroad.
Despite objections from the US government and other sovereigns who filed their own unsolicited opinions (amicus curiae), the US Supreme Court held in June this year that FSIA does not limit the scope of discovery available against a foreign sovereign in a post-judgment execution action. Consequently, Argentina’s ‘hold-out’ creditors can demand access to bank records and other evidence in order to locate Argentine financial assets abroad and seize them as compensation for repayment of the bond in default. In short, the sovereignty shield now features a large crack.
A third point, with both practical legal consequence and methodological weight, is the matter of Argentina’s ‘uniqueness’. Even though this protracted and mutually tenacious negotiation is an outlier in debt deals, it still sets an important precedent: given NML’s ‘victory’ (and, importantly, the presence of pari passu clauses in most New York and English law bonds), the challenge of ‘hold-outs’ is now more menacing than ever. This is likely to disturb many debt negotiations as the threat that a minority of creditors may be granted better payment terms post-litigation may discourage any debt exchange. This is so even as collective action clauses become more popular since they do not of themselves eliminate the threat of ‘hold-outs’ (a point made clear by Gelpern).
A final, and largely neglected, point concerns domestic, rather than foreign, debt. Emerging markets have recently witnessed substantial growth in domestically-issued debt relative to foreign law debt. This offers some protection from the kinds of trouble Argentina now faces because domestic debt allows room for more contractual manoeuvre by sovereigns, not to mention the reduction in exchange-rate risk. However, a very Argentine complication is the fact that, due to international litigation, Argentina has not issued bonds abroad since its 2001 default. Foreign interest in its domestic bonds challenges, however, the notion that the sovereign was shunned from international capital markets because of its ‘bad reputation’. Actually, Argentine GDP-indexed bonds paid handsomely and were much sought after.
Yet not issuing bonds abroad meant that Argentina had to find domestic sources of credit, which were then creatively fabricated. The nationalisation of its private pension funds in 2008 was, in part, a response to fiscal needs. Since then, the public pensions agency (Anses) – along with the central bank – has become one of the country’s main creditors. The bonds held by these intra-state creditors are mostly ruled by domestic law and are not subject to default, but their prices are not immune from the effects of the international disruption. Argentine companies have already been subject to ratings downgrades. Moreover, local economic difficulties are likely to demand more transfers from Anses to the Treasury, further tying debt and pensions in a rather toxic co-dependence.
All in all, despite the recurrent nature of defaults, their outcomes often defy expectations. Yet, whilst every debt crisis presents new challenges, each nevertheless makes a dent on the existing (ad hoc) structures of debt resolution in ways that seem to tilt the balance more and more against those players with the least resources to endure the threat of now bolstered creditors.