The Argentine Bond Mess Gets Messier. Payments to the holdouts ordered by a New York judge may trigger a cascade of new litigation.
By MARY ANASTASIA O'GRADY - July 13, 2014
Federal judge Thomas Griesa won accolades as a champion of the rule of law in 2012 when he decided that Argentina could not pay bondholders who had accepted a write-down after the country's 2001 default. He said those creditors could be paid only if investors who had not exchanged their bonds for new bonds and instead filed for full payment in his court were made whole.
At the center of the legal wrangling was the question of how to interpret "pari passu" clauses in bond contracts, which seek to ensure that all creditors are treated equally. The judge's ruling was upheld on appeal. But other advocates of the rule of law disagree with a wide reading of such clauses. For example, a 2005 study of the issue by the Financial Markets Law Committee of the Bank of England called it "incorrect" to use pari passu to prevent payments from insolvent debtors to some creditors if others are not paid.
Although the Bank of New York BK +0.08% is trustee for all the bonds in question, it is also unclear why holders of Argentine Euro bonds governed by U.K. law and payable outside the U.S., who are owed more than half of the interest due at the end of June, ought to be denied payment by a New York judge. What is more, complying with the judge's 2012 order could trigger a clause in the bonds requiring that all bondholders be made whole.
Welcome to the Argentine debt debacle. King Solomon had an easier case before him. The only beneficiary of the fiasco may turn out to be the International Monetary Fund, which is using the mess to revive its calls for a multilateral bankruptcy court with the power to dictate sovereign-debt restructuring.
Since 2005, 93% of the Argentine bonds that went into default in 2001 have been exchanged for new bonds. Those who participated in the exchange accepted a 65% cramdown in order to restart their interest payments. But NML Capital and Aurelius, two New York "vulture" investors, hold bonds that were not exchanged. The irony here is that Argentina only has the ability to pay off these plaintiffs who went before Judge Griesa because it so effectively stiffed the vast majority of creditors.
Argentina knows that paying some holdouts implies future legal action that could eventually require that all holdouts be paid. That could bring the price of a settlement to $15 billion, which would be difficult but still possible. President Cristina Kirchner's strategy of restricting key agricultural exports in order to hold down domestic prices has damaged the country's stock of international reserves. A cash settlement with the holdouts would vaporize more than half of the reserves left at the central bank.
It gets worse. Making holdouts whole could trigger the "rights upon future offer" (aka "rufo") clause in the new bonds. It promises to make those who took the write-down a part of any voluntary improved settlement with holdouts that is made before the end of 2014. Argentina could not support the estimated $120 billion in new debt that would be needed to comply with the rufo clause. Any effort by Argentina to argue that the court-ordered settlement with the holdouts is not voluntary would likely be challenged and lead to lengthy litigation.
Alternatively the holdouts could try to strike a deal that would delay any settlement until after the rufo clause expires. But unless Argentina agreed to a partial payment or an escrow deposit, that would require trust, which is in short supply when dealing with Mrs. Kirchner.
Judge Griesa's ruling means that if Argentina doesn't settle with the holdouts, or find a way to make the exchange-bond payments that are due, it will go into default at month's end.
Argentina remains defiant. At the end of June it sent $538 million to the Bank of New York and instructed it to make the interest payments due on the exchange bonds. On Wednesday the government ran a two-page legal notice in The Wall Street Journal explaining that it has "duly deposited" with the Bank of New York, "the amounts of interest due on the New Debt Securities," and that failure to make the payment would be a failure on the part of the bank as trustee and not a default.
The Bank of New York is unable to make the payments without crossing the judge and unable to send the money back without instructions from Argentina. It has filed a motion for clarification. Since Judge Griesa has ruled that the trustee may make payments on bonds governed under Argentine law, holders of Euro bonds have filed a motion requesting similar treatment.
This chaos is good news for those who wanted an IMF sovereign-bankruptcy court in 2001. They're back and arguing that markets, even utilizing collective-action clauses, are no match for clever vultures—so instead the world needs to put politically charged multilaterals in control of sovereign defaults. That's not a good prognosis for the rule of law.
Write to O'Grady@wsj.com