By Bhumika Muchhala (Third World Network)
In what has been called the ‘debt trial of the century’, the protracted court battle between hedge fund NML Capital Ltd and Argentina went before an appeals panel in New York on 27 February. The debt trial against Argentina has generated vigorous debate over the role of holdout creditors in sovereign debt restructuring, the pari passu clause in debt contracts (which aims to ensure equal treatment to all creditors), and the bankruptcy concept of fairness. The court’s ruling will have substantial influence on financial stability in Argentina and on the government’s ability to fund public services. It might also become a precedent for similar cases of holdout by vulture funds.
What’s it all about?
In November 2012, a lower court order in New York obliged Argentina to pay the defaulted bonds of the holdout creditors – NML Capital and Aurelius Capital Management – a sum amounting to $1.3 billion as soon as it makes payments on its restructured debt. The judge wanted US financial institutions to become enforcers by diverting the payments that Argentina makes to its restructured bondholders if it does not first pay an equal amount to the holdout bondholders. The purpose of the judge’s ruling last year was to make it impossible for Argentina to settle any of its debts without also paying the hedge funds, thus putting the government under more pressure to abide by the court’s judgments.
However, cries of protest rang out from banks, bondholders and the US Treasury Department, which collectively argued that the judge’s solution unfairly punished bondholders that are not party to the dispute between NML Capital and Argentina.
More than 92% of the debt from Argentina’s record $100 billion default in 2001 was restructured in 2005 and 2010. Argentina gave these exchange bondholders new bonds initially worth less than 30 cents to the dollar. Over the last decade, they are slowly regaining their original investments, having been paid 71 cents for each dollar invested. Argentina said that a ruling in favour of the holdout creditors would create an additional $43 billion in claims, which exceeds the nation’s $41 billion in foreign exchange reserves. A spate of capital flight in the wake of this court case has further exacerbated Argentina’s potential solvency crisis.
The holdout creditors used the pari passu clause that enforces equal treatment to all creditors to bolster their argument. This clause is embedded in sovereign debt agreements and is one of the key legal issues highlighted in this ongoing case. The Federal Appeals Court of New York consequently froze Argentina’s payout and heard new arguments in the 2nd US Circuit Court of Appeals.
Argentina’s attorney said that the lower court’s ruling violates Argentina’s sovereignty, threatens to trigger a new financial crisis in the country and quadruples the number of Argentine bond cases in New York federal courts, rather than resolving them.
According to legal analysts, the court may not rule for several months. However, the appeal proceedings have significant repercussions on the ability of countries like Argentina to restructure their debt successfully.
What are the arguments?
The dispute between restructured bondholders and holdout bondholders is at the heart of this case. NML Capital argues that getting paid immediately in full, plus interest, is more than fair, because the plaintiffs spent millions litigating while the holders of swap bonds were getting regular payments. The exchange bondholders counter that there’s nothing fair about taking other people’s property, or getting as much as a 1,500% return on debt bought for pennies on the dollar.
The attorney for the Exchange Bondholder Group, David Boies, argued for differential treatment between restructured, legitimate creditors versus holdout creditors, saying that it is ‘inequitable’ that the holdout creditors should get multiple amounts of the face value of their debt. Boies also said that the jurors should prevent a second loss for exchange bondholders when they have already taken a haircut. “The right to payment for legitimate creditors should not be taken away when losses have already been internalized.”
The attorney for NLM Capital, Theodore Olson, counter-argued that: “Argentina has not offered any proof that it cannot afford to pay the full amount we’re asking for”. Other remarks by Olson cast the hedge fund as a ‘victim of a default’ and portrayed the country’s character as suspect. “Argentina has a lot of history in defaulting on its obligations. In fact, it goes back a couple hundred years.”
A bankruptcy concept of fairness
Argentina’s President Christina Fernandez has vowed to pay the holdout creditors nothing unless they accept the same deal as the other bondholders. In response, NML Capital has aggressively pursued Argentina’s assets around the globe, as witnessed by the seizure of an Argentine naval ship in a port in Ghana.
Argentina’s contention that ‘equal treatment’ could be provided through a new debt swap, giving holdouts the same terms that others have accepted, is based on a bankruptcy concept of fairness. This concept says that when debtors cannot pay, all creditors must suffer, accepting less so that recovery can happen more quickly. Indeed, sovereign debt relief depends on such a bankruptcy concept of fairness, and many of the legal briefs produced on the case reflect a desire that the courts invoke it while engineering a comprehensive solution to Argentina’s debt problems. Unfortunately, however, as seen by the point-blank responses of the appeals panel, the judges are more likely to base their ruling in simple contract terms, as in “they owe the money, and they need to pay”.
The worst case scenario is one where Argentina would either have to begin paying the holdouts or default on all of its restructured debts. This could trigger a new economic crisis in the country. The exorbitant payments to vulture funds are valuable foreign exchange resources that should be financing domestic development and the growth needs of developing countries.
As Argentina’s Minister of Foreign Relations Hector Timerman said in a Huffington Post article published on 14 November 2012: “This is money that should be going to build roads, schools and other poverty reduction programs. Even worse, these nations are often on the receiving end of debt alleviation and international funding – which then goes to line the pockets of said vulture funds.”