Info Service on Finance and Development (Mar13/03)
18 March 2013
Third World Network
Argentina and hedge fund embattled in ‘debt trial of the century'
Published in SUNS #7542 dated 11 March 2013
New York, 8 Mar (Bhumika Muchhala) -- In what has been called the
‘debt trial of the century,' the protracted court battle between hedge
fund NML Capital Ltd. and Argentina went before a three-judge appeals
panel in New York on the afternoon of 27 February.
There were strong arguments from three attorneys: Jonathan Blackman,
representing Argentina, Theodore Olson, representing NML Capital (the
hedge fund that is pursuing this litigation), and David Boies, representing
the Exchange Bondholder Group (holders of Argentina's restructured
debt), as well as Bank of New York Mellon (the financial trustee for
the restructured bonds).
The current debt trial against Argentina has shaken bond markets,
worried bankers, lawyers and diplomats, captivated financial analysts
and economic pundits and generated a vigorous debate over various
issues, including the role of holdout creditors in sovereign debt
restructuring, the pari passu clause in debt contracts which ensures
equal treatment to all creditors, and the bankruptcy concept of fairness.
According to legal analysts, the court may not rule for several months.
However, the appeal proceedings have significant repercussions on
the ability of countries to restructure their debt successfully. In
November 2012, a lower court order in New York obliged Argentina to
pay the defaulted bonds of the holdout creditors, NML Capital and
Aurelius Capital Management, amounting to a sum of $1.3 billion, whenever
it makes payments on its restructured debt.
The argument of the holdout creditors uses the pari passu clause that
enforces equal treatment to all creditors, including restructured
and holdout creditors. This parity clause is embedded in sovereign
debt agreements and is one of the key legal issues highlighted in
this ongoing case.
The federal appeals court of New York consequently froze Argentina's
payout and heard new arguments in the 2nd US Circuit Court of Appeals.
In the hearing that lasted through the afternoon, Argentina's attorney
said that the lower court's ruling violates Argentina's sovereignty,
threatens to trigger a new financial crisis in the country and quadruples
the number of Argentine bond cases in New York federal courts, rather
than resolving them. "We would not voluntarily obey such an order,"
Blackman said. "We're representing a government and governments
will not be told to do things that fundamentally violate their principles."
The ruling by US District Judge Thomas Griesa has been described by
news reports as an unusual proposal to force Argentina to pay. The
judge wanted US financial institutions, such as Bank of New York Mellon
which processes Argentina's payments to its bondholders, to become
enforcers by diverting the payments that Argentina makes to its restructured
bondholders if it doesn't first pay an equal amount to the holdout
The purpose of the judge's ruling last year was to make it impossible
for Argentina to settle any of its debts without also paying the hedge
funds, thus putting it under more pressure to abide by the court's
judgments. However, cries of protest rang out from banks, bondholders
and the US Treasury Department, who collectively argued that the judge's
solution unfairly punished bondholders who are not a party to the
dispute between NML Capital and Argentina.
More than 92% of the debt from Argentina's world record $100 billion
2001 was restructured in 2005 and 2010. Argentina gave these "exchange
bondholders" new bonds initially worth less than 30 cents on
the dollar. Over the last decade, these exchange bondholders are slowly
regaining their original investments, having been paid 71 cents for
each dollar invested.
Argentina said that a ruling in favour of the holdout creditors would
create an additional $43 billion in claims, which exceeds the nation's
$41 billion in foreign exchange reserves. A spate of capital flight
in the wake of this court case has further exacerbated the nation's
potential solvency crisis.
Meanwhile, financial market analysts have argued that Argentina has
numerous other sources of liquidity, including physical assets and
state-owned enterprises, and is a G20 economy.
THE COURT DEBATE
The central debate between restructured bondholders and holdout bondholders
is at the heart of this case. NML Capital says getting paid immediately
in full, plus interest, is more than fair, because the plaintiffs
spent millions litigating while the holders of swap bonds were getting
regular payments. The exchange bondholders counter that there's nothing
fair about taking other people's property, or getting as much as a
1,500% return on debt bought for pennies on the dollar.
The attorney for the Exchange Bondholder Group, David Boies, argued
for differential treatment between restructured, legitimate creditors
versus holdout creditors, saying that it is "inequitable"
that the holdout creditors get multiple amounts of the face value
of their debt. Boies also said that the jurors should prevent a second
loss for exchange bondholders when they've already taken a haircut.
"The right to payment for legitimate creditors should not be
taken away when losses have already been internalized."
In response, one of the three appeals judges, Judge Reena Raggi, sharply
clarified that "We're just here to enforce the existing contracts,
not rewrite them."
Meanwhile, the attorney for NLM Capital, Theodore Olson, claimed that,
"Argentina has not offered any proof that it cannot afford to
pay the full amount we're asking for. Lack of ability to pay has not
been addressed", adding that, "This is not 2001. Argentina
has sufficient resources now, based on the amount of their foreign
Other remarks by Olson cast the hedge fund as a "victim of a
default" and the country's character as suspect. "Argentina
has a lot of history in defaulting on its obligations. In fact, it
goes back a couple hundred years," Olson said.
(The two attorneys, Boies and Olson, have some shared history, having
argued against each other in the litigation that decided the US presidential
2000. Olson had represented Republican George W. Bush and Boies represented
Democrat Al Gore.)
Meanwhile, Argentine President Christina Fernandez has vowed to pay
the holdout creditors nothing unless they accept the same deal as
the other bondholders. In response, NML Capital has aggressively pursued
Argentina's assets around the globe, as witnessed by the seizure of
an Argentine naval ship, The Libertad, in a port in Ghana. Argentina
and the hedge fund have been warring each other in court since 2004;
however, last week's case was being watched closely by the international
media, bankers, lawyers and other financial actors because of its
potential impact on unrelated debt disputes.
A BANKRUPTCY CONCEPT OF FAIRNESS
Argentina's contention that "equal treatment" could be provided
through a new debt swap giving holdouts the same terms others accepted,
is based on a bankruptcy concept of fairness. This concept says that
when debtors can't pay, all creditors must suffer, accepting less
so that recovery can happen more quickly.
Indeed, sovereign debt relief depends on such a bankruptcy concept
of fairness, and many of the legal briefs produced on the case reflect
a desire that the courts invoke it while engineering a comprehensive
solution to Argentina's debt problems. Unfortunately though, as seen
by the point-blank responses of the appeals panel, the judges are
more likely to base their ruling in simple contract terms, as in,
"they owe the money, and they need to pay."
The worst case scenario is one where Argentina would either have to
begin paying the holdouts or default on all of its restructured debts.
This could trigger a new economic crisis in the country. With this
awareness, both the Obama Administration and Argentina have argued
that the judge's remedy could make debt relief harder for troubled
economies, dooming their citizens to more years of poverty than necessary.
A White House brief highlighted that this ruling could damage US foreign
policy, threaten US assets overseas and even harm the dollar by persuading
nations to take their bond business elsewhere.
THE SPECTRE OF VULTURE FUNDS
Argentina's government officials have publicly named the holders of
the defaulted debt as ‘vulture funds'. Although the country's legislature
passed a law barring payment of such funds in 2005, the government
has spent the past decade opposing claims brought forth in US courts
by holders of the defaulted bonds.
In these legal cases, many holders of the defaulted Argentina bonds
have won US court rulings requiring the country to pay them. But despite
the favourable rulings, courts have generally prevented the holders
of defaulted debt from moving to seize the country's assets, citing
the Foreign Sovereign Immunities Act, which limits the ability of
plaintiffs to sue foreign countries in American courts.
Vulture funds are a type of highly profitable financial investment,
in which a fund buys sovereign debt cheaply and then sues to enforce
it. Benefiting from tax and jurisdiction loopholes, vulture funds
create obscure societies or task forces to lobby for their interests
in tribunals, legislative bodies and the media. Many of the nations
that face vulture fund lawsuits are Heavily Indebted Poor Countries,
including several countries in sub-Saharan Africa.
Vulture funds purchase debt claims as a secondary lender. This means
that vulture funds are not primary lenders, but rather entities that
have purchased the debt from some other source, such as a bank. Generally,
these funds purchase debt involving highly distressed countries. Sellers
are usually more than willing to rid themselves of these debts, because
many of these debts may soon come into default or face restructuring
The vulture funds purchase this debt as it is about to be written
off. Then, they sue the debtor or borrower for the full value of the
debt, plus interest and penalties. The lawsuits occur in national
courts, often in the United States, Paris, or Brussels. Through litigation
and negotiation, vulture funds have been able to secure a payout greater
than the cost of the vulture fund's purchase.
One of the primary reasons why vulture funds are successful is because
courts have been willing to enforce a vulture fund's right to collect
the full value of the debt. Nations such as Zambia, Peru, and Argentina
have all lost lawsuits to vulture funds.
The most important (and successful) argument justifying full enforcement
is the standard pari passu clause in many sovereign debt agreements.
These clauses require that all creditors be treated equally. Accordingly,
a prominent Brussels court has held that pari passu clauses forbid
states from paying only the restructured portion of their national
debt without paying the vulture funds as well.
Therefore, if there is not enough money to go around, all creditors
receive a pro-rata share and debtors are not allowed to pay off one
creditor in full while leaving others unpaid. Because these clauses
contractually prohibit a state from paying off one creditor before
other holdouts, these clauses act as the key enforcement tool in the
hands of holdout creditors.
States are thus forced to choose between appealing against court decisions
that stop the restructuring because of the pari passu clause, or pay
up in a settlement agreement with the vulture fund so that national
debt restructuring can take place.
The tactics of vulture funds are deeply disruptive to debt restructuring
processes that facilitate economic recovery in countries. The threat
of a holdout may discourage other creditors from agreeing to a restructuring
because creditors now can collect the full amount of the debt by suing,
and because restructuring may be stopped by the courts under the pari
Vulture funds put sovereign states in a difficult double bind. If
a state chooses not to pay the vulture fund, that fund could call
a default. On the other hand, when the state is prevented from paying
the other creditors by a vulture fund, those other creditors may call
for a default.
The likelihood of debt default may prompt a rush to grab the country's
limited foreign exchange reserves, as creditors will attempt to get
at whatever they can before a state goes into default. Most importantly,
the ability to call a default by a vulture fund can trigger cross-default
clauses in other debts.
The hedge fund holdout creditor in the Argentine case, NML Capital
Ltd., is a subsidiary of Elliot Associates based in the tax haven
of the Cayman Islands.
The head of Elliot Associates is conservative financier Paul Singer,
who is widely credited for enacting some of the most aggressive litigation
cases against countries. In 1996, Singer won a lawsuit against the
Peruvian government for a
400% profit. Subsequently, he sued the Republic of Congo for $400
million for a debt he acquired for $10 million. He ended up with $127
million from the litigation. One of the ways in which Singer's fund
secures political support is through the American Task Force Argentina
(ATFA), a lobby group that targets the US Congress to take sides with
its litigation cases.
ARGENTINA'S POST-DEFAULT EXPERIENCE
The exorbitant payments to vulture funds are valuable foreign exchange
resources that should be financing domestic development and growth
needs of developing countries. As the Argentine Minister of Foreign
Relations, Hector Timerman, said in a Huffington Post article published
on 14 November 2012, "This is money that should be going to build
roads, schools and other poverty reduction programs. Even worse, these
nations are often on the receiving end of debt alleviation and international
funding - which then goes to line the pockets of said vulture funds."
Ultimately, the overwhelming danger of vulture fund litigation cases
is the risk of countries falling into financial crisis and economic
recession. Conversely, equitable debt restructuring plays a significant
role in enabling countries to recover from economic recession and
prioritise their first duty to the welfare and rights of their own
citizens over that of international financial actors and markets.
After Argentina defaulted over a decade ago, it reversed the austerity
measures promoted by the International Monetary Fund, re-nationalised
key productive sectors like aviation, pensions and most recently oil,
increased social protection and income transfers to the poor, and
reduced poverty substantially.
The ratio of debt service payments to exports fell to less than 20%.
Unemployment decreased from around 22% to close to 7%. Real wages
increased, and wage inequalities narrowed. As the nation became one
of the fastest growing economies in the world, it demonstrated that
its debt default and restructuring enabled a pathway out of economic
recession and increasing poverty, and into domestic economic and social
NGO SUPPORT FOR ARGENTINA
On 27 February, the day of the appeals hearing, the US arm of the
global Jubilee debt campaign and Third World Network held a vigil
outside the New York Court building. The two organisations issued
a joint press release to the media, titled "Arguments End in
‘Debt Trial of the Century': 2nd Circuit Court of Appeals to Rule
on Vulture Funds and Argentine Bonds," that included statements
by both organisations.
The statement by the Jubilee debt campaign said, "If the judges
rule in favour of these hedge funds, it will mean these funds will
more aggressively target poor countries in fragile financial recovery.
If they rule with Argentina, it will mean that it will be harder for
these types of funds to exploit countries in financial distress. The
actions of NML Capital and Aurelius Capital hurt legitimate investors
and poor people."
Third World Network said, "This case has huge implications for
the international debt system precisely because it determines the
ability of sovereign states to restructure their debt without being
taken to court and held ransom by holdout creditors. Debt restructuring
plays a significant role in enabling countries to recover from economic
recession and prioritise their first duty to the welfare and rights
of their own citizens over that of international financial actors
"Currently, there is no international debt restructuring mechanism,
the absence of which allows hedge funds such as NML Capital to take
Argentina to court. Vulture funds such as NML Capital speculate on
the misfortune of countries and saddle developing countries with huge
debt loads, depriving them of valuable financial resources badly needed
for domestic development and growth."
THE NEED FOR A DEBT RESTRUCTURING MECHANISM
Various proposals on debt restructuring, including the IMF's sovereign
debt workout mechanism (SDRM) proposed by Anne Krueger in 2001, have
circulated in international organisations and within sovereign states.
One particular proposal is to establish a statutory sovereign debt
restructuring mechanism by drawing on three key principles of Chapter
11 of the US bankruptcy law. First, is the enactment of temporary
standstills on external debt, whether debt servicing difficulties
are due to solvency or liquidity problems. The decision for a standstill
should be taken unilaterally by the debtor country and sanctioned
by an independent panel rather than by the IMF because the countries
affected are among the shareholders of the Fund, which is itself a
This sanction would provide an automatic stay on creditor litigation.
Such a procedure would be similar to safeguard provisions in the World
Trade Organisation that allow countries to take emergency actions
to suspend their obligations when faced with balance-of-payments difficulties.
Debt standstills would need to be accompanied by regulations to stem
A second principle is debt restructuring, including rollovers and
write-offs, based on negotiations between the debtor and creditors,
and facilitated by the introduction of automatic rollovers and Collective
Action Clauses in debt contracts. This would essentially comprise
a combination of voluntary and statutory mechanisms. However, if the
debtor and creditors fail to reach agreement, there should be a process
of fair and independent arbitration.
A third principle is that of automatically granting seniority status
to debt contracted after the imposition of the standstill (the so-called
debtor-in-possession financing in US law). Any lending into arrears
provided by international financial institutions should be oriented
towards trade financing, not the financing of debt payments or capital
outflows. It should also be accompanied by the above principle of
temporary standstills. +