Argentina has now staked the future of its debt, and perhaps its financial fate, with the United States Supreme Court. Yes, you read that right. Argentina wants the nine justices to weigh in on a case involving its obligations to holders of its government bonds and to resolve the mess created by a handful of federal judges.
The roots of the case go back to 2001, when Argentina, in the midst of a severe economic downturn, defaulted on $80 billion of government bonds. Now, Argentina is asking the Supreme Court to throw out a lower-court ruling forcing the South American country to pay up on these bonds.
How did the Supreme Court find itself dealing with this drama?
It started in the wake of Argentina’s default. There is no bankruptcy regime for sovereign countries (at least not yet). So back in 2005 and then again in 2010, Argentina forced the debt holders into a deal offering them new bonds at 25 to 29 cents on the dollar. More than 90 percent of the bondholders accepted, given the alternative of getting nothing for the bonds.
But there were holdouts, including thousands of Italian pensioners, and more important, some hedge funds, which have been trying to get Argentina to pay the bonds in full. Since then, a number of entities, led by Elliott Management and Aurelius Capital Management, have sought to compel Argentina to pay up. This has led to some odd situations. In 2012, the hedge funds won a court order to seize an Argentine Navy ship in Ghana. And the president of Argentina, Cristina Fernández de Kirchner, no longer flies abroad on Argentine-owned planes for fear the jets will be seized.
The hedge funds have a strong incentive to take any property they can, since the bonds held by the holdouts are now worth on paper about $15 billion, with accrued interest. But it’s not so easy to collect against a sovereign nation. Most countries have “sovereign immunity laws,” which prevent lawsuits against them, as well as seizing their property.
It’s here where the United States federal judges come in.
The hedge funds also sued in federal court in New York to collect on these bonds. Normally, sovereign immunity would protect Argentina. In fact, in the United States, there is also a statute, the Foreign Sovereign Immunities Act, that would prevent the hedge funds from seizing Argentine property to collect on the bonds.
The hedge funds have argued in court that they are not seeking to seize Argentine property. Instead, they argue, when Argentina pays money through the United States financial system on its new bonds, the agents transferring that money can be ordered to simply pay the holdouts first. Since there is no attachment of Argentine funds, the Foreign Sovereign Immunities Act is not implicated. Voilà.
The lower federal courts have thought this to be a captivating argument. In a series of rulings, the federal courts in New York first held that the bond document’s pari passu clause — pari passu is Latin for equal footing and is common language in such documents to mean that investors cannot be treated differently — required that if Argentina paid any money on its new bonds, it also had to pay the old defaulted holders. Then, the courts held that if Argentina tried to pay its old bondholders first, the banks in the United States that were transferring that money would have an obligation to pay the hedge funds first.
The American judges have acknowledged that they could not order Argentina to do this, but they justified the ruling on the ground that it is affecting the conduct of the parties in the United States that are transferring the money.
Argentina has reacted with a fury to the rulings, stating in its petition to the Supreme Court that “no sovereign nation would stand idly by while a foreign court takes its citizens and other third parties hostage in order to commandeer the public fisc.” A number of Argentine officials have stated that the country will default on its current bonds if it is required to first pay the old holders.
Last week, Argentina filed a certiorari petition with the Supreme Court, asking the court to review the rulings of the lower courts. The petition is intended to garner as much outside support as possible to push the Supreme Court to consider the case. Argentina asks two big questions in the petition. First, it is asking whether under the sovereign immunities act, Argentina’s payments to its new bondholders can effectively be seized to make payments on the defaulted debt. Second, Argentina is asking the court to certify the interpretation of the pari passu clause to the New York Court of Appeals, the highest court in the state.
The second argument is a clever one. The Argentine bond documents were written under New York State law and the federal courts were interpreting that law. But the judge’s ruling was a novel interpretation and a New York State court could feel differently. Argentina is basically saying, “Look, this really should have been decided by New York State all along, and let’s just see what they say. What could be the harm?”
Furthermore, Argentina is saying to the Supreme Court that this argument may give the court an easy way out of having to decide the harder question of whether Argentina can be sued in the United States. After all, the real problem with this case is that a few judges have been upsetting settled ways of doing business in the financial markets.
What is ultimately driving the case, though, is the sovereignty argument. Given the novelty of the lower court’s ruling, the Supreme Court could step in and not only ask the New York State court what it thinks, but also look at the sovereign immunity issue if it has to.
The Supreme Court takes few cases. If it denies the certiorari petition, this would effectively turn the United States federal courts into collection agents for the hedge funds.
Knowing this, Argentina may simply live up to its word and refuse to pay the new bondholders. The result will be default yet again, where no one gets paid.
A default would be a mess. It would penalize the new bondholders, many of whom have already taken a hit. It would push Argentina out of the global financial system. It might also have an impact on the rest of the sovereign markets, though Argentina’s situation is a bit peculiar in that it is the most recalcitrant of sovereign debtors. Whether it would then bring Argentina to the table, as the funds hope, is anyone’s guess.
There is always the possibility that Argentina is bluffing. A negotiated settlement certainly makes the most sense right now, and the hedge funds have repeatedly said they are willing to negotiate. That point was made by Jay Newman, senior portfolio management at Elliott Management, in a statement. “As we have stated many times, if Argentina were willing to talk to its creditors, this dispute could be resolved quickly.”
But let’s face it, the courts in the United States have led us here, and so we await the Supreme Court to decide if the federal courts should be in the business of running Argentina’s financial affairs.