Argentine debt battle will set terms of future bond issuances

Author: Michael Washburn | Published: 30 Nov 2012
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The legal struggle over Argentina’s payments to its bondholders will cast a long shadow over the country’s relations with creditors, and will shape the terms of future bond issuances in Argentina and beyond, Argentine lawyers and other sources said.

The legal and fiscal mess was ameliorated slightly, at least in the short term, by a U.S. appeals court’s surprise ruling Wednesday night to suspend a federal judge’s injunction barring Argentina from paying bondholders unless it also paid holdouts that had rejected a restructuring plan and demanded all funds they are owed.

As a result of Wednesday’s ruling, Argentina will not have to put $1.3 billion in escrow by December 15 to pay the holdouts, and arguments over payments to holdouts will be heard again on February 27. But the insistence, or some would say the intransigence, of holdouts such as the Elliott Management hedge fund underscores why the terms of this bond issuance were deeply flawed, and why debt transactions in the future are likely to include certain provisions while omitting others.

“The Argentina case is very particular,” said Diego Serrano Redonnet, a partner at Perez Alati Grondona Benites Arntsen & Martinez de Hoz in Buenos Aires. He noted that sovereign bonds typically include collective action clauses (CACs) providing that if a certain majority of shareholders approves of a restructuring of payments, the minority must abide by that decision.

“Unfortunately, in the case of Argentina, the bonds did not have this feature, and that is what made this terribly complex,” he stated. If Argentina's sovereign offering were more along the lines of Uruguay’s, for example, then Elliott Management and the other holdout shareholders, representing about seven percent of the total, would be subject to the majority’s decision under the CAC, noted Redonnet.

“I think the issue is broad and may have an institutional impact that goes beyond Argentina,” Redonnet observed.

Mariano Miranda, a partner at Brons & Salas in Buenos Aires, agreed and said he was not surprised by the appeals court’s pragmatic decision to defer the matter of the holdouts until a hearing set for next February.

“When Argentina issued these bonds, they decided to be subject to New York law. They will have to implement actions in the future to avoid the current situation,” he said.

In Miranda’s view, the repeated statements by Argentina’s president and ministers of their unwillingness to pay the holdouts is not due to a lack of funds to make the payments, but has to do with complex political issues. The Argentine government that took office in 2005 is making a point of asserting independence and resisting policies implemented by the International Monetary Fund throughout the 1990s, he said.

Those policies treat Argentina as a vassal state and are sometimes dubbed ‘economic colonialism’ by their foes.

The Argentine administration's staunchly independent stance goes hand-in-hand with big plans for bond issuances in coming months and closer economic ties to countries such as Venezuela. But Fitch Ratings’ ranking of Argentina’s international law bonds has just sunk to ‘CC,’ eight levels below investment grade, Miranda noted. In such circumstances, it is hard to envision bond issuances without a CAC providing flexibility to the issuer and lowering the risk of a default or the type of protracted mess seen in recent days.

While CACs may be a likely feature of bond issuances going forward, that does not mean they are a pat solution. In fact, they may cause as many problems as they solve.

Jay Westbrook, a bankruptcy law professor at the University of Texas School of Law, described what he sees as the serious dangers in their implementation.

"The abuse risk is that there could be a combination between certain of the bondholders, and the sovereign country, to favour these bondholders in exchange for getting this done in a way that's disadvantageous to the remaining bondholders," Westbrook said.

In a domestic bankruptcy court, a judge may well be willing to listen sympathetically to complaints from those bondholders who are in the minority, he noted. But in Westbrook's view, an even more serious possibility is that a CAC that has force under one indenture may not bind bondholders holding under a different indenture. He suggested that the district court's decision on Wednesday underscores the need for international debt resolution mechanisms that can assist countries and their creditors when debt restructuring is necessary.

Westbrook agreed with the Argentine lawyers about the far-reaching ramifications of the current legal battle.

"The implications of the case go far beyond Argentina, because these issues can come up with lots of countries finding themselves in a default position," he said.

A US sovereign debt specialist who spoke on condition of anonymity identified a further consequence for bond issuances that is likely to result from the current stalemate. Investors could shun foreign-law bonds with pari passu clauses, he noted.

“If you think that the pari passu clause strengthens the hand of the holdout creditors in a restructuring and you’re pretty sure that you would be going along with a restructuring, you don’t want the holdout to have any more weapons in hand because the money they take will be money that would have gone to you,” the specialist said.

Redonett said that although we have yet to see how events will play out between now and December 15, he finds it highly unlikely that Argentina will want to risk a technical default. So, in the absence of CACs, Argentina is still likely to find itself in a precarious position both economically and politically once again, a fact that underscores the likelihood of bond issuers incorporating CACs or similar contractual mechanisms going forward.

See also

Argentina ruling to hamper sovereign restructuring plans

Why LatAm covered bonds are set for US

Recent lessons in Brazil's bank receivership process