The Chicken Littles are out in force. The U.S. Court of Appeals for the Second Circuit’s ruling in NML v. Argentina has caused an outcry. Some have suggested that the decision will impede efforts to restructure sovereign debt in Europe and elsewhere. Others argue it unfairly violates sovereign immunity, or wrongly implicates third parties to the dispute.
Let’s put aside the hyperbole and look at the facts.
Argentina has given U.S. courts and the plaintiffs the runaround for years since defaulting on $81 billion in 2001. As Latin America’s third largest economy with significant reserves, the nation has the means to repay its creditors in full. Yet it has staunchly refused. Federal courts have numerous times noted Argentina’s “appalling record of keeping its promises to its creditors.”
While Argentina has been making regular interest payments to exchange bondholders who agreed to accept pennies on the dollar in 2005 and 2010, it has refused to pay a grouping of holdouts and even passed the infamous “Lock Law” to slam the door on future negotiations.
The New York courts have found fault with Argentina’s approach. Recently, the Second Circuit affirmed a lower court ruling that the pari passu clause contained in the original FAA Bonds prohibits Argentina from discriminating among its creditors. In other words, if Argentina makes payments to the exchange bondholders, it must also make payments to the holdouts.
In its recent ruling, the Second Circuit dismissed the impact on future sovereign debt restructurings and suggested that sovereign debtors can avoid Argentina’s predicament by including collective action clauses (CACs) in their bondholder agreements. Under CACs, all creditors are bound by a restructuring agreement provided that a large majority of creditors (usually set at 70 to 80 percent) reach agreement on a settlement.
Virtually all sovereign bonds issued under New York law since January 2005 have included CACs. Moreover, the European nations most frequently cited as candidates for future debt restructuring—Greece, Portugal, and Spain—have issued bonds not governed by New York law at all. And the EuroZone has adopted a treaty that requires all future bond issues to include CACs.
Some argue that CACs won’t do the trick, as there will always be holdouts who, under the Second Circuit’s ruling, could insist upon payment in full, despite a CAC clause. Noting that most debtor nations have issued numerous series of bonds, they allege that a buyer could amass a sufficiently large percentage of one of the smaller bond offerings and thereby gum up the entire works. But this criticism is greatly overblown, as most CACs contain an aggregation feature, which allows majority amendment across multiple bond series.
But let’s say a debtor nation is unable to obtain the requisite bondholder consensus for its debt restructuring across all of its bond series. That simply suggests that either the debtor is offering insufficiently attractive restructuring terms or the bond series where the holdouts are concentrated involves a sufficiently small amount of indebtedness that a restructuring can go ahead, without including those bonds.
Critics are not taking into account the unique aspects of the pari passu clause contained in the FAA bonds that are at issue in this case. This clause requires “equal” treatment for all bondholders. Such specific language is uncommon in most sovereign debt documents.
Some say the Foreign Sovereign Immunities Act (FSIA) is implicated here. But given Argentina’s abysmal payment history, lenders required it to waive all sovereign immunity claims, and to consent to application of New York law, before anyone would agree to purchase the bonds in question. Furthermore, the district court’s ruling is an injunction requiring equal payment, not an attachment upon a foreign government’s asset, which might otherwise violate FSIA.
The impact of this case on third parties is limited. The district court understandably took exception to Argentina’s scheme of defiance and directed the trustee responsible for making payments to the exchange bondholders to ensure that its actions “are not steps to carry out a law violation.”
That trustee, Bank of New York Mellon, does not expose itself to liability to the exchange bondholders by complying with the court; its indenture states that it is not expected “to do anything which may be illegal or contrary to applicable law.” As for intermediary banks (i.e, the banks through whose hands money passes on its way to the exchange bondholders), the district court explicitly exempted them from the terms of its injunction.
The only parties truly at risk are the plaintiffs. Argentina has demonstrated time and again it has no intention of complying with its legal obligations and is not serious about negotiation. To this point, on December 28, Argentina told the Second Circuit it would “reopen” the swap and offer plaintiffs the nominal value of the 2010 exchange deal.
Argentina’s offer is bizarre for a host of reasons. Argentina wants to portray itself to the court as a reasonable party willing to compromise; yet it does so by offering bondholders pennies on the dollar—a deal worse than the ones they have repeatedly refused in the past. It essentially asks the Second Circuit to impose a “compromise” to its liking by judicial fiat and ignore the order of the district court.
The Second Circuit should be applauded for determining that Argentina must be bound by its contractual commitment to treat creditors equally. Requiring sovereigns to comply with such commitments, and barring American financial institutions from assisting sovereigns in defying federal court orders, will do nothing to disrupt debt markets. As the Second Circuit has recognized, the intransigent Argentina is a unique case. Despite critics’ shallow protestations, the sky will not fall.
Richard A. Samp is chief counsel (litigation) at Washington Legal Foundation.