Info Service on Finance and Development (Jan13/04)
17 January 2013
Third World Network
hedge funds case threatens sovereign debt restructuring
York, 15 Jan (Bhumika Muchhala) – The ongoing legal battle between
hedge funds and Argentina over the nation’s 2001 debt default is an
urgent reminder of the need for a sovereign debt workout regime.
Dubbed by the Financial Times as the sovereign debt “trial of the
century,” the news has reported senior lawyers, fund managers and
former policy makers saying that an initial New York court ruling
against Argentina (as well as the sovereign debt crises in Europe)
highlight the weaknesses of the current ad hoc, contractual approach
to government debt workouts.
Some argue that the time has come to revisit the sovereign debt restructuring
mechanism proposed by the International Monetary Fund (IMF) in 2002,
while others call for sovereign debt resolution mechanisms supported
by an international debt court that is independent of the IMF.
The “sovereign debt restructuring mechanism” drawn up by Anne Krueger,
former senior IMF official, was envisaged as a kind of voluntary Chapter
11 for countries. Due to US opposition, it never materialized into
11 refers to the relevant part of US domestic legislation that provides
for debt restructuring for businesses in bankruptcy situations.)
was brought to court in New York by hedge funds led by Elliott Associates,
creditors who have been claiming debt payments from the nation ever
since its 2001 default. Argentina had reached an agreement with most
of its private creditors to pay 25-35 cents for every dollar owed,
in effect giving creditors about 30% of their money back in a restructured
debt deal. However, some creditors such as Elliot Associates refused
Argentina’s restructuring deal, which was in effect a steep discount
on the amount owed.
A subsidiary of Elliot Associates, NML Capital, is a US hedge fund
that pioneered ‘vulture fund’ activity by winning a case against Peru
in the 1990s, retrieving 400% what they paid for Peru’s debt. Vulture
funds purchase cheap debt from distressed companies or countries,
and then seek repayment of the full face value together with interest,
penalties and legal costs. If this repayment is not made by the borrower,
the creditor can impound assets of the country or company in an effort
to force repayment.
After years of pursuing Argentina through foreign courts, NML Capital
impounded Argentina’s naval vessel, Libertad, in the Ghanaian port
of Tema on 2 October 2012. After months of seizure, the Libertad was
recently released by an international tribunal and returned to Argentina
on 9 January 2013.
Argentine President Cristina Fernandez de Kirchner had condemned the
Libertad's seizure and clarified that there would be no negotiations
with creditors. She was quoted in a BBC article published on 25 October
2012, titled “Seized ship crew back in Argentina from Ghana,” saying
that Argentina would not bow to “blackmail by vulture funds.”
Kirchner asserted that, “As long as I am president, they can keep
the frigate but nobody is going to keep the liberty, sovereignty and
dignity of this country.”
Associates has convinced the US Appeals Court that Argentina cannot
continue to pay holders of its restructured debt while ignoring creditors
that refused to sign up to the restructuring deal. This argument is
based on an obscure legal clause that promises equal treatment to
The implication is that if and when Argentina pays off its debt to
its creditors which accepted the restructuring, it must also pay off
its debt to holdout creditors such as Elliot Associates, at 100% of
the original loan. This would require Argentina to pay $1.33 billion
to Elliot Associates if and when it made any payments on its new debt.
However, a stay was issued on the case by the US Court of Appeals
for the Second Circuit on 28 November 2012, and an appeal against
the court decision will be heard on 27 February 2013. In the meantime,
important aspects of the judgment still need to be confirmed by the
US Court of Appeals, with the possibility that the case could end
up in the Supreme Court.
If enforced, the ramifications for sovereign debt workouts are enormous.
A few creditors could prevent debt restructurings and negotiations,
threatening the ability of sovereign states to achieve debt workouts
and causing chaos in debt markets globally.
The creditors which accepted the 2001 restructuring receive payments
from Argentina via banks based in New York, because when issuing the
bonds Argentina placed itself under New York State jurisdiction. If
the court ruling is enforced, the potential implications are such
that the New York-based banks can only process payments from Argentina
if the hedge funds are also being paid, something Argentine President
Kirchner has vowed not to do. If Elliot Associates is triumphant in
the late February hearing, one possible consequence for bond issuers
is that they may prefer to go through jurisdictions such as London
or Frankfurt rather than New York.
Ultimately, if the hedge fund wins next month, the Argentine government
could face a choice of making debt payments to the hedge funds at
100% of the original loan, or be forced to default on payments to
Debt restructuring mechanism and the IMF
a sovereign debt restructuring mechanism, either inside or outside
the IMF, will require a formidable challenge in generating the political
will, in which the role of the US Treasury and Congress is pivotal.
The US Treasury would have to seek congressional approval for the
necessary change to the IMF’s articles of agreement. Capitol Hill
is likely to be highly suspicious of allowing an international institution
to override, in effect, US bankruptcy proceedings. Legal experts doubt
whether the US has enthusiasm for this.
Meanwhile, Jubilee Debt Campaign activists have publicly opposed the
IMF as the institutional home of a debt resolution court or mechanism.
In a letter to the Financial Times, Nick Dearden of Jubilee UK argues
that a debt court cannot be taken seriously “if housed in one of the
biggest creditors in the world,” and that “no court of law would be
taken seriously if judge and jury were drawn from the prosecution.”
However, a comprehensive debt resolution mechanism is urgently needed.
Such a mechanism has the potential to redress the power imbalance
between debtors and creditors, which has devastated the economies
of southern Europe and many developing country economies. A fair and
development-oriented debt mechanism could also enshrine the legal
principle of ‘odious debt,’ and strive to ensure that a government’s
international duty to respect its people’s social and economic rights
is no longer subordinated to external debt payments.
The Jubilee Debt Campaign also placed an advertisement in an Argentine
newspaper, the Buenos Aires Herald, on 11 January 2013. The
advert declares support for Argentina’s right to refuse to pay the
vulture funds, condemns the decision of the New York Court which implies
that the payment of vulture funds supersedes a state’s right to protect
its people under international law, and calls for a debt audit in
Argentina to ascertain the extent of illegitimate debt which should
not warrant repayment.
Campaigners recall that Argentina was driven to debt default at the
end of 2001 after three years of economic recession, where the country
was following policy conditions attached to bailout loans by the IMF.
Over half the population, some 20 million people, were living below
the poverty line and the public debt ratio was 160% of GDP.
After its debt default, Argentina’s economy started growing out of
several years of stagnation in the matter of a few months. Subsequently,
Argentina became the fastest growing economy in the Americas. Eleven
million people were pulled out of poverty and unemployment more than
halved in the successive 5 years.
Independent Expert calls out against vulture funds
United Nations Independent Expert on foreign debt and human rights,
Cephas Lumina, has stressed that successful debt restructuring for
deeply indebted countries will be made impossible if ‘vulture funds’
are allowed to paralyze debt relief.
In a UN press release distributed on 13 December 2012, Lumina urged
world governments not to allow vulture funds, such as NML Capital,
to purchase debts of distressed companies or sovereign States on the
secondary market for a sum far less than the face value of the debt
“From a human rights perspective,” the UN expert said, “reduced
debt burdens and increased fiscal capacity contribute to the creation
of the conditions necessary for the realization of all human rights,
particularly economic, social and cultural rights.”
Lumina called on States to follow the example of the Channel Island
of Jersey and the United Kingdom, which have recently adopted legislation
to prevent vulture funds from pursuing excessive claims against heavily
indebted countries before their national courts.
The UN press release also highlighted the UN Guiding Principles on
Foreign Debt and Human Rights, which was endorsed by the Human Rights
Council in June 2012.
The Guiding Principles underscore that States, international financial
institutions and private companies have an obligation to respect human
rights, including the duty to refrain from formulating, adopting,
funding and implementing policies and programmes that directly or
indirectly contravene the enjoyment of human rights.
According to the principles, “loan agreements should impose clear
restrictions on the sale or assignment of debts to third parties by
creditors without the prior informed consent of the Borrower State
concerned. Every effort must be directed towards achieving a negotiated
settlement between the creditor and the debtor.”
They also state that, “creditors should not sell sovereign debt on
the secondary market to other creditors that have previously refused
to participate in agreed debt restructuring.” +
regime for nations urged (Financial Times, 6 January 2013)
Available at: <http://www.ft.com/intl/cms/s/0/ad3068d6-4613-11e2-ae8d-00144feabdc0.html>
by Jubilee Debt Campaign UK to the Financial Times (Financial
Times, 8 January 2013)
Available at: http://www.ft.com/cms/s/0/5eb14078-58e6-11e2-99e6-00144feab49a.html#axzz2HTSIO4ZV
funds’ should not be allowed to paralyze debt relief, says UN expert
on the eve of key ruling (Press release by the Office of the High
Commissioner for Human Rights, 13 December 2012)
Guiding Principles on Foreign Debt and Human Rights
ship crew back in Argentina from Ghana (BBC, 25 October 2012)
Available at: http://www.bbc.co.uk/news/world-latin-america-20078320
Battle With Hedge Funds, a Small Victory for Argentina (New York
Times, 29 November 2012)
Available at: http://dealbook.nytimes.com/2012/11/29/in-battle-with-hedge-funds-a-small-victory-for-argentina/