Newspaper article International Herald Tribune

Bypassing Precedent on Argentine Debt

Newspaper article International Herald Tribune

Bypassing Precedent on Argentine Debt

Article excerpt

Argentina plans to appeal the latest U.S. ruling on its debt repayment and the battle will continue.

Foreclose on a country? It sounds far-fetched, but a U. S. court is saying that Argentina must set aside $1.33 billion for some American hedge funds and others. That decision is threatening to throw the South American country and the entire sovereign debt market into turmoil.

This game of chicken is a lesson in the hazards of U. S. courts' interfering in international affairs.

The origins of the mess are rooted in Argentina's status as a sometime deadbeat debtor. In 2001, the country defaulted on more than $80 billion worth of sovereign bonds. Historically, a default like this leaves bondholders with few options. There is no global bankruptcy process and individuals cannot force a country to pay. A century or so ago, creditor countries sometimes sent in gunboats and troops to force payment.

These days, the lawyers and bankers are sent in, as a default usually leads to a restructuring of the country's debt. Typically, the creditors are forced to take a haircut -- a loss on the debt -- while the country pays something to try to maintain access to global credit markets.

This is what happened in Argentina. In 2005 and 2010, Argentina restructured its debt offering to exchange the old bonds for new bonds at 25 to 29 cents on the dollar. Argentina was able to push bondholders to accept such a low price because the offer was coupled with a new law passed by its Legislature making it illegal for the country to pay the old bonds. In other words, it was either the new bonds or nothing.

But there were holdouts, including thousands of Italian pensioners, who own what is now about $11 billion in debt.

The holdouts also included a number of hedge funds, some of which had acquired this debt as far back as the 1990s, seeing an opportunity for a big return, despite the risk. The group also includes Elliott Management and Aurelius Capital Management.

Elliott, a $20 billion hedge fund founded by Paul Singer, is one of the leaders in this field. It previously made outsize returns investing in defaulted sovereign debt and trying to force the country to pay by seizing its assets. For about $2 million, for example, Elliott bought sovereign debt with a face value of more than $30 million that was issued by the Republic of Congo. The fund was able to win a $100 million judgment in England and intercept $39 million worth of oil owned by the Republic of Congo. In the case of Argentina, Elliott recently was able to get a Ghanaian court to order the seizure of an Argentine frigate.

While the standoff over the frigate is embarrassing for Argentina, it is a sideshow to the litigation by Elliott and Aurelius in New York.

A few years ago, Elliott and Aurelius changed their legal tack. They argued in court that a clause in the bond documents required that if Argentina paid any money on its new bonds it also had to pay the holders of old, defaulted bonds. In legal terms, the provision is a pari passu clause. The Latin phrase roughly means equal footing, and the clause is intended to ensure that if a debtor issues new debt, those obligations cannot be superior to the old debt.

Lawyers for Argentina appeared in a U.S. District Court in New York and heatedly argued that such clauses required Argentina to treat bondholders legally the same way, not to make equal payments, as the funds argued.

It is an arcane legal argument, and most legal scholars and those in the market sided with Argentina, stating that this was how debt restructuring had worked for decades.

But in October, the U. S. Court of Appeals for the Second Circuit disrupted precedent, siding with the hedge funds. The court held that the pari passu clause required Argentina to pay the hedge funds on the old debt anytime it made a payment on the new debt. …

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