Debt, Vultures, and International Law: Argentina’s Mess of a Default

By: Guilherme Duraes

The words “Argentina” and “default” are used in the same sentence more often than anyone would like. Unfortunately, the country defaulted again on its public debt this July, the eighth time in its history. However, what is unique this time is that Argentina has “chosen” to go into default. A US court injunction mandated that Argentina pay some investors it has ignored since 2001, the so-called “vultures.” The decade-long legal battle between Argentina and the “vulture” investors presents important US and international legal issues related to investor protection, sovereign debt restructuring, and national sovereignty.

How did we get here, and who are these vultures anyways?

Economists argue that in the 1990s Argentina borrowed more money in the domestic and international markets than it could afford. In the early 2000s, this budgetary mismanagement, coupled with deeply entrenched protectionist and clientelistic practices, threw the country into one of the most severe economic depressions it has seen. In 2001, the government officially announced that it did not have money to pay its creditors, and declared a default on its debt of about US$95 billion. Following Argentina’s declaration of bankruptcy, riots broke out across the country, people were killed, the president resigned, unemployment skyrocketed in the years following, and millions of middle-class families were thrown into poverty.

In 2005 and 2010, President Néstor Kirchner made two take-it-or-leave-it deals with investors. Through exchange offers, Argentina restructured its debt and replaced the old bonds with new ones that were worth approximately only 30% of the original. While about 92% of investors accepted the offer and the steep discounts, some hedge funds wished to recover full payment, and decided to keep their bonds under the original terms, which gave them the name of “holdouts.” The holdouts have also been dubbed “vultures,” because some of them bought the Argentinian bonds in the secondary market after Argentina had already defaulted and the bonds had lost their value. Argentina claims that these hedge funds merely aim to speculate and take advantage of the country’s economic hardships. In fact, some of these funds specialize in buying bonds from countries in dire circumstances and suing for full payment.

Since the restructuring agreements, Argentina has been paying the investors who accepted the new, discounted bonds, but has not made any payments to the holdouts. Still in the early 2000s, NML Capital, Ltd. and Aurelius Capital Management, LP, two of the holdout hedge funds, took Argentina to court in New York (the bonds are governed under New York law) in order to receive full payment on their bonds.

So why did Argentina go into default this time?

NML Capital, Ltd. v. Republic of Argentina has been in court in New York for over a decade now. NML and Aurelius demand to be paid what is owed to them in full, while Argentina claims that the funds’ actions are tantamount to extortion. In 2012, Judge Thomas Griesa of the Southern District of New York ruled that Argentina could not continue to pay the creditors who adhered to the restructured bonds without paying US$1.3 billion plus interest to NML and Aurelius, which represents the full amount the country has failed to pay since 2001.

However, Argentina is concerned that other holdout funds will start litigation as well if they see that the country was forced to pay NML and Aurelius, which would obliterate the country’s economy. Moreover, the country points to the Rights Upon Future Offers (RUFO) Clause of their bonds, under which bondholders can require Argentina to disburse the same payments to them as it voluntarily disburses to others. According to Argentina, if all the holders of the restructured bonds file suit under the RUFO Clause, the country could be liable for about $150 billion, which is more than four times the country’s foreign-currency reserves. NML argues that, in paying the holdouts due to a court mandate, Argentina would not be disbursing “voluntary” payments, and the RUFO Clause would not be triggered. However, Argentina’s caution is understandable, as there is still uncertainty about how the court would interpret the term “voluntary” in the RUFO Clause.

In June of this year, Judge Griesa ordered all American financial institutions to cease disbursing payments from Argentina to its bondholders until the country pays the holdouts. Argentina deposited $539 million in a Bank of New York Mellon (the trustee for the bonds) account to pay investors by June 30, when payment on the restructured bonds was due. The bank was unable to transfer the funds due to the court injunction and the investors were not paid. Fearing additional demands for payments with which it would not be able to comply, Argentina made the difficult choice not to pay NML and Aurelius, and on July 30, after the grace period expired, the country entered “selective” default.

Argentina attempts to circumvent Judge Griesa’s orders

In order to bypass Judge Griesa’s blockage of the Bank of New York Mellon account, Argentina passed a law that allows holders of the New York-governed bonds to be paid through an Argentinian bank. In fact, the country will completely cease to use Bank of New York Mellon as its trustee and will instead use the state-owned Banco de la Nación. Bondholders will have the option of being paid in Argentina or France, and will be able to swap their bonds for bonds governed by Argentinian law.

On September 29, Judge Griesa ruled that Argentina is in contempt of court. He expressed frustration at the explicit attempts the country has made to circumvent his orders and avoid paying the holdouts. The holdouts requested sanctions on the country of $50,000 per day, but Judge Griesa stated that he would defer on making decisions on sanctions to a future date.

Argentina goes global in its fight against the holdouts

In August, Argentina filed a complaint at the International Court of Justice (ICJ) against the United States, claiming that the U.S. court’s decision to bar the country’s payment to investors violates Argentinian sovereignty. Specifically, Argentina claims that the court’s decision interferes with Argentina’s right and decision to restructure its sovereign debt. Since the U.S. opted out of the ICJ’s compulsory jurisdiction in 1986, when the Court determined that the US involvement in the Nicaraguan war was illegal, the Court can only hear the complaint if the U.S. chooses to submit to its jurisdiction. The United States has not yet officially refused to litigate at the ICJ, but it is highly unlikely that it will submit itself to the Court’s jurisdiction on this matter, especially because this is a contractual dispute rather than a dispute based on a treaty. Investment contracts set forth rights and obligations between the parties, and they often establish the specific jurisdiction for litigation. The bonds here in dispute are governed by New York law and, by contract, should be litigated in New York. Bilateral investment treaties are signed between nation states and establish an international court as the forum for arbitration.

In September, on Argentina’s and Bolivia’s request, the Group of 77 Plus China presented to the United Nations General Assembly a proposal to draft a multilateral legal framework to restructure sovereign debts. The proposal aims to help struggling developing countries restructure their sovereign debt in a fair and sustainable way. At the Assembly, Argentinian Foreign Affairs Minister asserted that “we must prevent more people paying with hunger and misery for the speculation of these sinister gentlemen of opulence: the vulture funds.” The proposal was passed by overwhelming majority: 124 countries voted in favor, 41 abstained, and 11 voted against it, including the United States, the United Kingdom, Japan and Germany. With this resolution, the General Assembly sent out the clear message that debt repayment in struggling countries is an important issue which should be addressed on an international scale. However, though the majority supported the resolution, it is not binding, and countries are not required to help elaborate the framework or abide by it.

The implications of Argentina’s default on international and US law

Judge Griesa’s decision to hold Argentina in contempt of court is virtually unprecedented. It is an established principle of international law that nation-states are immune from judgment at another state’s tribunals. International law also dictates that property belonging to nation states is immune from attachment.

Article 24 of the United Nations Convention on Jurisdictional Immunities of States and Their Property provides that:

(1) Any failure or refusal by a State to comply with an order of a court of another State enjoining it to perform or refrain from performing a specific act or to produce any document or disclose any other information for the purposes of a proceeding shall entail no consequences other than those which may result from such conduct in relation to the merits of the case. In particular, no fine or penalty shall be imposed on the State by reason of such failure or refusal.

Therefore, the extent of Judge Griesa’s power is uncertain, and it is difficult to envision how he could enforce his judgments on Argentina. If attaching property or demanding payments prove difficult enough, imposing non-monetary sanctions on another state, to which the court has alluded, is nearly impossible. Doing so would create a disastrous impasse in foreign relations between the U.S. and Argentina.

In fact, Argentina claims that being held in contempt of a foreign court is an affront to a state’s sovereignty. That is the central argument of a letter that the Argentinian Foreign Affairs Minister wrote to US Secretary of State John Kerry on September 29, ahead of the hearing that ultimately ruled that Argentina is in contempt. Argentina argues that the court’s decision is in violation of international law and urges the US executive branch to interfere in the judiciary’s decision, claiming that a government is responsible for the decisions and omissions of all its organs. It reiterates that it is willing to take the United States to the ICJ for breaching Argentina’s sovereign right to restructure its public debt.

The heart of the matter is that the two countries will remain at an impasse. The United States will not submit to the ICJ’s jurisdiction, and Argentina cannot be forced to pay up. If the United States does end up seizing any property of the Republic of Argentina within the United States or abroad, it runs the risk of causing undesired results from a foreign policy perspective. It could generate uncertainty for other countries and fear that their property could be seized anywhere if a US court so ordered. It could also compel other countries to seize American property within their borders. Moreover, fearing that a couple of US hedge funds could always have the power to push a country into default, other states could choose not to issue bonds under US law anymore, causing capital to leave the country.

On the other hand, if the United States shows that it is not able to enforce its laws on other nation-states, it sends the message to its citizens who invest in the public debt of foreign countries that they cannot trust the power of the law to solve disputes related to those bonds. Investors would feel that they have no protection when pitted against another country. It has been suggested that one way the US Congress could solve this impasse in the future is to require foreign countries to post a collateral when they issue public debt under US law, so as to guarantee that investors are paid.

In Argentina’s case, the best bet is probably to reach a compromise with the US court in order to revert the blockage of payments to the holders of the restructured bonds. Argentina could accomplish this by demonstrating a good-faith effort to negotiate with the holdouts in order to pay them after January of 2015, when the RUFO Clause expires and the country will not have to worry about 93% of bondholders riding on NML’s litigation.

Guilherme Duraes is a J.D. Candidate at Berkeley Law. He is a student contributor for Travaux.

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