Ruling in favor of Argentina's holdout creditors, the US Court of Appeals for the Second Circuit took a very long time to say on August 23 precisely what everyone expected it to say on February 27: Argentina violated the promise to NML Capital Ltd. and its co-plaintiffs to rank its payment obligations equally, and must stop paying its performing bonds unless it also pays these holdout creditors in full. In other words, the lower court's maximalist injunction is upheld in its entirety. On the one hand, this decision is a huge loss for Argentina because it blocks the government's payments to creditors, who had reduced their claims by two-thirds, until it pays off its entire original debt to the plaintiffs, some of whom had bought their bonds at a deep discount and refused to restructure. On the other hand, it is a peculiar sort of win for Argentina, since the court stayed key parts of the injunction until the disposition of any appeals before the Supreme Court. The opinion even reset the Supreme Court timeline via footnote 6, potentially giving Argentina over a year of appellate and Supreme Court process to keep paying the exchange bond holders, freezing out the NML plaintiffs, and plotting its next move. That is, until Argentina apparently decided to throw it all away.
On August 26, President Cristina Fernandez de Kirchner announced that the government would offer the restructured bond holders an opportunity to swap their New York bonds for new Argentine-law bonds, designed to prevent payment disruptions from the injunctions from the Federal courts in New York. If the US courts in New York have no way of reaching payment streams on the Argentine-law bonds, they cannot block them. The announcement also contained what was described as a goodwill gesture to the holdouts—another restructuring offer, more or less the same as the two they had rejected before. In all likelihood, the announcement will be read as an attempt to circumvent the court orders, prohibited by the terms of the same orders :
The Republic is permanently PROHIBITED from taking action to evade the directives of this ORDER, render it ineffective, or to take any steps to diminish the Court's ability to supervise compliance with the ORDER, including, but not limited to, altering or amending the processes or specific transfer mechanisms by which it makes payments on the Exchange Bonds, without obtaining prior approval by the Court ...
The order covers payments on the exchange bonds, but also on "any subsequent exchange of or substitution for the 2005 and 2010 Exchange Offers that may occur in the future." Cynics might just see substitute bonds designed to pay no matter what New York courts have to say as "action to evade the directives of this ORDER." NML would naturally make a motion to the Second Circuit to lift every part of the stay right away. If the Second Circuit grants the motion, anyone helping Argentina with the domestic debt swap is at risk of being sanctioned by the courts.
The risk is high because the appeals court opinion makes it hard for Argentina and the various intermediaries around the world to get around the injunction. The opinion essentially calls the institutions' bluff: if Argentina decides to pay the exchange bond holders but not NML, and if you are caught in the middle, you may be subject to sanction—even if you happen to be abroad:
If others in active concert or participation with Argentina are outside the jurisdiction or reach of the district court, they may assert as much if and when they are summoned to that court for having assisted Argentina in violating United States law.
Translation: We do not know who you are or where you are until we are ready to sanction you, so come and talk to us then. Of course this foggy prospect of being "summoned" is precisely what firms such as the Bank of New York Mellon, Euroclear, and others are desperate to avoid. They want certainty now, not another test and another trial. To be safe, they might just as soon sever any ties with Argentina. This is just how secondary boycotts work.
The latest Second Circuit opinion also ratchets up the Argentina-is-unique rhetoric, and the president does her best to live up to the billing in her latest swap announcement. The court rhetoric originally struck me as an attempt to backtrack on (or clarify) the super-broad language in its October opinion. No matter what Argentina does next, the upshot of the decision is still that it will take more litigation to decide just how different Argentina is. I doubt Grenada is altogether relieved, no matter how many people tell them that it is nothing personal against Grenada but instead all about Argentina.
The opinion also contains a fascinating discussion of the fact that banks block payments to bad guys all the time in America. This is beyond doubt, a point highlighted in the briefs of the Clearing House Association as operator of CHIPS, the largest private dollar payment system in the world. Operating sanctions filters is burdensome and expensive, but the United States as a society has decided it is worth it. Why? All the examples the court lists involve blocking flows to countries sanctioned for terrorism and the like. If not paying debts that cannot be restructured in bankruptcy merits the same response as terrorism and the drug trade, so be it. But does it?
The appeals panel suggests that the effort is worthwhile because it will hold up the reputation of New York as a place where the courts will go the extra mile to enforce contracts, even against sovereigns. This may be true—just as the contention in some third party briefs that this will drive business from New York may also be true. But if the stay were to remain in place, NML would not see its money for years, and Argentina's government would get to pay the exchange bond holders and maintain the posture of heroic resistance to the holdouts. Now that Argentina appears poised to violate the injunction and throw away any timing advantage it might have had, the stay might be lifted, and the government might choose to default on all its debt rather than pay NML. For all the efforts of the New York courts, NML still does not get paid.
And of course the appeals court gets CACs wrong, again. Recall the term Collective Action Clauses in this case refers to supermajority amendment clauses embedded in most new sovereign bond contracts, though not the old, and not the loans. Surely a debtor that fails to get the requisite majority of its bondholders to vote for a restructuring should not get to restructure its bonds. And absent bankruptcy or aggregation, a debtor that restructures only part of its debt should not automatically get to restructure the rest. But it is a huge leap to say that the holdout debt therefore gets to block payments to those who agreed to restructure. This case is not about the level of exchange participation, but a minority remedy that targets the entire exchange.
Until the dust settles from Argentina, one thing is certain—the likes of Grenada will continue to pay legal fees.
Portions of this post also appeared on CreditSlips.org.