Argentina's Stunning Pari
Passu Loss
I have to give it to Reynolds Holding on this one: he called it, I was wrong, and today I paid him $5 in settlement of our bet. To the astonishment of almost everybody I know (except Ren), the Second
Circuit sided with Elliott Associates and ruled unanimously against Argentina today. It's a hugely important decision, which will certainly have unintended
consequences for many years to come.
You can see the market reaction most clearly in
Argentina's credit default swaps, which gapped out to a whopping 1,325bp. That's up 350bp on
the day, and it's a clear sign that the markets are extremely worried the
unexpected ruling will cause the very thing it's ostensibly trying to cure: an
Argentine default.
This isn't the end of the story - but it is the
beginning of the end. Argentina is making noises about appeals, but at this point it's not
obvious that higher courts will even accept the case. And while it's true that
the Second Circuit did end up punting on the one bit of the original ruling
which actually had teeth, all of their language implies that they'll ultimately
uphold it.
Here's the problem facing the US courts.
Everybody agrees - even Argentina is happy to agree to this - that Argentina
owes Elliott Associates lots of money. Everybody agrees that Argentina has a
contractual obligation, under New York law, to pay lots of money, to Elliott,
right now if not sooner. But of course Argentina has made no such payment. And
so it's very easy for Elliott to go to a New York judge (in this case, Thomas
Griesa), and get that judge to hand down a judgment telling Argentina in no
uncertain terms that it owes Elliott lots of money. And Argentina will in turn
treat that judgment with exactly the same respect it gives to the original bond
contract. In fact, for tactical reasons, Elliott has chosen not to become a
judgment creditor: if it just had a court judgment, and not a bond contract,
then it would find it much harder to argue arcane legal points about various
bits of legal boilerplate in the contract.
Which is why, in February, Griesa came up with
an order which carried much more force than a simple judgment. The order comes
with a real punch:
Within three (3)
days of the issuance of this ORDER, the Republic shall provide copies of this
ORDER to all parties involved, directly or indirectly, in advising upon,
preparing, processing, or facilitating any payment on the Exchange Bonds (collectively,
"Agents and Participants"), with a copy to counsel for NML. Such
Agents and Participants shall be bound by the terms of this ORDER as provided
by Rule 65(d)(2) and prohibited from aiding and abetting any violation of this
ORDER, including any further violation by the Republic of its obligations under
Paragraph 1(c) of the FAA, such as any effort to make payments under the terms
of the Exchange Bonds without also concurrently or in advance making a Ratable
Payment to NML.
This is very cunning stuff. Remember that
Argentina is happily current on its outstanding bonds: what that means in
practice is that every time a coupon payment is due, it pays that money to the
bondholders' Trustee, Bank of New York (BK), which in turn divvies it up between all the
current bondholders. As you might guess from its name, Bank of New York is very
much under the jurisdiction of New York courts. And Griesa, with this order, is
taking aim directly at Bank of New York. If Argentina tries to pay its existing
bondholders without at the same time paying Elliott Associates and the other
holdouts, then Bank of New York will be aiding and abetting a violation of his
order. And there's no way it wants to do that.
The problem here, from a legal perspective, is
that once Bank of New York has the money, the money belongs to bondholders, not
to Argentina. And so it's difficult for Griesa to tell the bank it's not
allowed to remit the money to the bondholders who have every legal right to it.
In terms of the meat of Griesa's order, it's
this part about "aiding and abetting" which really gave Elliott hope
that it might finally be able to collect on what it was owed. And, just to drag
things out a bit longer, that's the one bit of the order that the Second
Circuit felt uncomfortable about:
We do have concerns about the Injunctions' application to banks acting as
pure intermediaries in the process of sending money from Argentina to the
holders of the Exchange Bonds. Under Article 4-A of the U.C.C., intermediary
banks, which have no obligations to any party with whom they do not deal
directly, are not subject to injunctions relating to payment orders…
Oral
argument and, to an extent, the briefs revealed some confusion as to how the
challenged order will apply to third parties generally. Consequently, we
believe the district court should more precisely determine the third parties to
which the Injunctions will apply before we can decide whether the Injunctions'
application to them is reasonable.
This gives a sliver of hope to Argentina - but
only a sliver. The Second Circuit remanded the case back down to Griesa to
clarify his order a bit, and they're really only asking for clarification
rather than evisceration. The whole point of the order is that it includes US
actors as well as Argentina itself, and there's no way that Griesa will reword
things so that Bank of New York is suddenly magically excluded.
Once Griesa's clarification makes its way back
to the Second Circuit, the judges there have made it abundantly clear that
they're well-disposed towards the lower-court judge, and very ill disposed
towards Argentina. As JP Morgan's Vladimir Werning says of the request for clarification:
"While this may generate a perception that the Appeals Court can change
its mind if the District Court clarifications do not satisfy it, we doubt this
is likely to happen."
I'm sure that Argentina and its lawyers have
been working for a while on contingency plans which they could put in place
were the Second Circuit to uphold the lower court's decision: those plans have
now taken on extra urgency, but it's really not obvious what Argentina can do,
especially if it wants to avoid yet another event of default. There's paying
off the holdouts, of course, but that would be politically incredibly
dangerous, and it's hard to imagine Cristina Kirchner ever signing off on such
a thing. She might not be the world's most principled politician, but her
hatred for Elliott and the holdouts is real. And as Werning's excellent note
says, none of the alternatives are particularly appealing - or particularly
likely to avoid the countries CDSs being triggered.
Argentina does have time - a fair amount of
time, too, if this ends up being successfully appealed to the Supreme Court.
After all, the US government argued on Argentina's side; I'm no lawyer, but
I've got to imagine that SCOTUS tends to at least hear the cases which would
otherwise go against the government's wishes.
What's more, the Second Circuit has given the
Supreme Court an interesting third option: rather than completely upholding the
original order, or striking down completely, the Supremes could basically go
just as far as the Second Circuit did today, and then ultimately reject the
extra step of including Bank of New York and/or other blameless intermediaries.
I don't think that will happen, however: in many
ways it would represent the worst of both worlds. It would still be a huge
change to international law, and would amount to a very significant weakening
of the Foreign Sovereign Immunities Act . The US government, in other words,
would suffer a massive loss. And at the same time it would in practice let
Argentina off the hook - and no one has much sympathy for Argentina here, a
country which has been thumbing its nose at the US courts for years.
So the base-case scenario at this point has to
be that Elliott will ultimately win. I can hardly believe I'm writing these
words: I've been writing about holdouts, or vultures, or whatever you want to
call them, for a good dozen years now, and although they've had victories here
and there, there's been nothing remotely as big or precedent-setting as this.
When push comes to shove, governments make laws, and the official sector is
generally good at closing ranks and making sure that sovereign rights and
immunities are protected.
Except, that doesn't seem to be the case any
more. The part of the Second Circuit's argument dealing with sovereign immunity
is probably the weakest bit, but the court certainly doesn't pay much if any
deference to the United States and its arguments here:
The Injunctions
at issue here are not barred by § 1609. They do not attach, arrest, or execute
upon any property. They direct Argentina to comply with its contractual
obligations not to alter the rank of its payment obligations. They affect
Argentina's property only incidentally to the extent that the order prohibits
Argentina from transferring money to some bondholders and not others. The
Injunctions can be complied with without the court's ever exercising dominion
over sovereign property. For example, Argentina can pay all amounts owed to its
exchange bondholders provided it does the same for its defaulted bondholders.
Or it can decide to make partial payments to its exchange bondholders as long
as it pays a proportionate amount to holders of the defaulted bonds. Neither of
these options would violate the Injunctions. The Injunctions do not require
Argentina to pay any bondholder any amount of money; nor do they limit the
other uses to which Argentina may put its fiscal reserves. In other words, the
Injunctions do not transfer any dominion or control over sovereign property to
the court. Accordingly, the district court's Injunctions do not violate § 1609.
A lot of the oral arguments surrounded this point, and it seemed, to
me at least, that Argentina's side was much more convincing. It's true that
"the Injunctions do not require Argentina to pay any bondholder any amount
of money," but if Argentina wants to stay current on its bonds - and
that's a perfectly reasonable thing to want to do - then they absolutely do
require Argentina to pay holdout creditors at the same time. Which seems like
an override of Argentina's sovereign will to me. Conversely, if Argentina
chooses not to pay the holdouts, it will be in the odd position that it can do
anything it wants with its money - it is a sovereign nation, after all - except
give it to the very creditors it made a solemn promise to pay in 2005 and 2010.
The result is a very weird and scary world, for
all sovereigns, including the US - and for the markets, too. Sometimes, markets
are secretly cheering the vultures: after all, the more money vultures make,
the healthier the bid for bonds when countries tumble towards default. But in
this case, the decision is clearly bad for markets. For one thing, by emboldening
holdouts, it makes future sovereign debt restructurings much more difficult.
(The Second Circuit tries to say that it doesn't, thanks to something called
Collective Action Clauses, but as Anna Gelpern says, that argument doesn't hold water.)
More broadly, this ruling is just one more step
towards a world where the old verities about sovereign risk simply don't hold
any more. It used to be that sovereigns were sovereign: that was bad news if
they unilaterally decided to default on you, but other than that it was pretty
good news. Now, however, they're at the mercy not only of unelected technocrats
at places like the IMF or the ECB; they're also at the mercy of unelected
judges in New York. Sovereigns have less freedom of movement now than they have
done in a very long time, and we're only beginning to grok the implications of
those constraints.
As far as Argentina is concerned, it might just
have to pay the holdouts. No one knows how much money that might entail spending:
the figures range from $1.3 billion at the low end (large, but manageable) to
$12 billion at the high end. That would cause real economic damage. Again,
Werning is good on this. And whether or not Argentina pays the holdouts, the
risk of a credit event in the CDS market are seriously high right now: there's
a hundred ways that things could go wrong and the CDS could get triggered. In
fact, this being Argentina, it's entirely possible that the government could
deliberately trigger the CDS, after various important people had loaded up on
protection.
The upshot is a significant rise in uncertainty,
in an asset class which could really do without such a thing right now. The
Second Circuit's narrow and constructivist view of some long-ignored legal
boilerplate could end up having very profound effects on global markets and
economics. Maybe that's what the letter of the law demanded. But I sure wish it
didn't.
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