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Wednesday, June 18, 2014

NML v. Argentina, Post 4

In the spring of 2013, I wrote three posts on the litigation between NML and the Republic of Argentina which was then at the Second Circuit.   In the last one, March 31, 2013, I predicted that NML would win hands-down at the Circuit and wrote:

"Argentina will probably file a cert petition, but the issue here is really just one of state law contractual interpretation and doesn't belong in the Supreme Court at all.  I can't imagine how anyone expected anything else from Argentina.  When its senior government officials attended the oral argument at which its counsel took a hardline position, it was obvious that Argentina was perfectly happy to default on the exchange bonds as well."

And, in the wake of the Supreme Court's denial Monday of that cert petition, it appears that Argentina is indeed headed toward yet another default on its bonds.  It's important to remember that Argentina has been in default on the non-exchange bonds, the ones NML and others "fondos buitres" hold since 2003 so a default is not a new default, and apparently intends to remain in default on them forever, based on the remarks of finance minister Axel Kicillof, President Cristina Fernandez de Kirchner and their counsel.  Earlier today, according to Reuters and Clarin, the leading media company in Argentina, the Second Circuit lifted the stay of judgment that had been in effect pending the Supreme Court review, and supposedly the parties are now in chambers with Judge Griesa.  Argentina has supposedly agreed to negotiate with NML but I think that is just one of those negotiations for the sake of appearing reasonable and avoiding further sanctions than anything likely to lead to a substantive result.

A few weeks ago, a strategy memo from Argentina's law firm, Cleary Gottlieb, to Argentina's finance minister somehow made its way into the Argentine press and from there to the world at large.  Although Judge Griesa later ruled the memo remained privileged and thus outside the record, there is nothing in there that isn't otherwise in the public record or irrelevant.   The memo (1) assumes Argentina cannot or will not pay NML and other holdout bondholders, which everyone already knew; (2) observes that the exchange bonds (the ones issued to those bondholders who agreed to restructure Argentina's debt back in 2003) contains clauses requiring Argentina to sweeten their terms if it ever awards the holdouts a better deal, which clauses give the exchange bondholders the same veto over payments to the holdouts that the pari passu ruling gives the holdouts over the exchange bondholders, which again has been in the public record for years; (3) observes that three-way settlement talks among the Republic, the holdouts and the exchange holders to figure out how much NML will take to go away and then how much the exchange holders would require to allow Argentina to pay that would be cumbersome and unlikely to resolve by the June 30 coupon payment date on the exchange bonds, and (4) closes with the observation that was brought to the attention of Judge Griesa and the press that "the best option" is to "immediately restructure" all of the bonds Argentina wants to pay "so that the payment mechanism and the other related elements are outside of the reach of American courts."  Which is as obvious as it is brazen.  But Kicillof has said as much this week: "We are going to initiate a swap of debt with payment in Argentina ..."  And "La Nacion" describes that swap as "the steps the government will follow after the adverse judgment of the Supreme Court of the United States."

The one solution I could see taking place, which is not laid out in the Cleary memo, is for the holders of a very large proportion of exchange bonds, motivated to avoid a default on their own bond holdings, to buy out NML and the other major holdouts at something close to the amount owed, then exchange the acquired bonds for a combination of new exchange (or other) bonds at a much higher ratio than in the 2003 exchange, and for Argentina to pay them cash in U.S. dollars equal to the difference between the amount they paid and the face amount of the new exchange bonds.  Then, with the impasse eliminated, Argentina could do a second, new issue of bonds to replenish the foreign exchange reserves it had to pay out to get the deal done.  That would allow Argentina to save face by, formally at least, not paying NML directly, but instead paying their friendly creditors for doing them a favor, and being able to do so, ultimately, just with paper, not foreign reserves.   Because the holdout bonds are not that large an amount relative to Argentina's debt capacity, this seems economically feasible.  But the ability to pull it off hinges on one big unknown, which is whether a supermajority group of exchange bondholders can be pulled together (a supermajority being needed  to waive the clause in the exchange bonds that restricts Argentina from exchanging the defaulted bonds at a better ratio than was set in 2003.  

FT Alphaville has kept the best running tab, now up to 58 stories, on the subject.  They seem skeptical the exchange will succeed.  It faces two big hurdles, even assuming that the exchange holders want to participate at a high level:  1) obtaining legal, professional and financial assistance with the mechanics of the exchange entirely from people not subject to U.S. jurisdiction, since an intentional violation of the injunction would expose violators to the risk of prosecution for contempt of court; and 2) somehow hoping that Judge Griesa does not extend the injunction to bar holders subject to U.S. jurisdiction from tendering bonds in the exchange.

In addition, Linette Lopez at Business Insider had a sharp analysis of the political / historical context of bond defaults within Argentina this week: "The One Thing You Need to Know About Argentina is Everyone in Argentina is a Bond Geek".

There is, however,  one more thing you need to know, which Lopez doesn't address, and that is to see how the dispute arises out of the fundamental clash between the populist philosophy that Kirchners's Argentina runs on, and the rule of law, which U.S. courts run on.  I touched on this in my March 31 post, and the speech Kirchner gave this week in the wake of the cert denial exemplifies it.  When you read the speech, she constantly emphasizes how over 90% of the bondholders in 2003 exchanged into the restructuring and that the holdouts, a small minority, would make a lot of money if paid off in full. The classic populist argument  --any time a small minority makes a lot of money in finance, in and of itself, that is not morally legitimate. That they had a contract, and a freedom to decline the exchange, as would be unquestioned under Anglo-American common law, is not acknowledged as a legitimate right.  This is what Kirchner means when she says, in Lopez's translation, "it's not a judicial or legal problem; it's the result of a business model on a global scale that, if it continues, will produce unbelievable tragedies." Contract rights, the return of money borrowed, and private property are just obstacles to a populist political philosophy.  Contrary to the Anglo-American notion of individuals and minorities having inalienable rights against the state, embodied in the Bill of Rights for instance, in Kirchner's mind, nothing can be allowed to interfere with the agenda of a government once it wins an election.  This is how Argentina has been run under the Kirchners (it's also the rationale Maduro gives for everything he has done since taking power in Venezuela, including imprisoning political dissidents). They have used their electoral majority (acquired by promising unsustainable consumption subsidies to the lower earning portion of the electorate) to whittle away at all forces that might constrain their political power, like eliminating the independence of the judiciary and breaking up the largest media company, as retribution for political disagreements, after having spent the first ten years in power confiscating private property left and right, as I outlined in the March 31, 2013 post.   That's why this is an important issue of principle for the U.S. courts, because Argentina's stance is fundamentally an assault on the rule of law and on the most basic tenets of the Anglo-American legal system.

While I was typing this, the story came out that Judge Griesa said in court today that Cristina Kirchner's speech did not inspire confidence in him regarding the Republic's negotiating good faith. Quite so.  But I think the final word on the Kirchner speech deserves to go to the arbolitos, the Argentine citizens who exchange Argentine pesos for U.S. dollars in the black market in Buenos Aires, who bid the U.S. dollar up more than 4% the day after her speech.