Argentina s priority payment on its restructured sovereign debt: judicial protection accorded to holdout creditors

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1 mckennalong.com Argentina s priority payment on its restructured sovereign debt: k Nora Wouters Authors Nora Wouters is a Partner at McKenna Long & Aldridge LLP and a Member of the Brussels Bar. Argentina s external debt instruments have been a source of litigation before domestic and international courts since it defaulted in on 100 billion USD worth of bonds issued in accordance with a 1994 Fiscal Agency Agreement ( FAA Bonds ) and since it restructured more than 90% of them through its 2005 and 2010 bond exchanges. 1 The first debt swap had enabled Argentina to restructure its external debt with 76.1% of its creditors and the second debt swap with approximately 93% of them, the remaining ones being holdout creditors. 2 The debt swaps had resulted in the issuance of new bonds ( Exchange Bonds ) worth 70% less than the original bonds face value, 3 which entitled the Exchange Bondholders to a single instalment of interest on their bonds. The Exchange Bonds had been offered to the original creditors on a take-it-or-leave-it basis with no room for genuine negotiation. 4 NML Capital Ltd and 18 other plaintiffs, holdout creditors, sued the Republic of Argentina before the US federal courts. They argued that Argentina s payment of interest on Exchange Bonds without full payment of the interest and the principal on the FAA Bonds had breached the terms of the FAA in the first place. The latter Agreement stipulated that Argentina was required to pay back interest and the entire capital on FAA Bonds in the event of a default on the bonds. Moreover, the FAA called for equality of treatment between the proportion paid on FAA Bonds and the proportion paid on any restructured bonds issued after the conclusion of the FAA ( ratable payment clause ). Finally, the FAA stated that any dispute over the FAA Bonds fell within the jurisdiction of New York courts and was subject to New York law exclusively. Nicolas Croquet, PhD Nicolas Croquet is an Associate at McKenna Long & Aldridge LLP, a Member of the Brussels Bar and a Doctor of Law from the University of Oxford. In the case NML Capital Ltd et al. v. Argentina, the United States District Court for the Southern District of New York ( District Court ) had partially granted the action brought by NML Capital Ltd and 18 other plaintiffs against Argentina. The District Court prohibited the latter from paying back the Exchange Bondholders without any corresponding payment made to the plaintiffs. The United States Court of Appeals, Second Circuit ( Court of Appeals ) partially overruled and partially remanded the District Court s injunctions in its October 2012 decision. On November 21, 2012, the District Court on remand delivered amended orders 1 Karen Halverson Cross, US Supreme Court Denies Certiori and Affirms Discovery in Bondholder Litigation against Argentina (2014) 18/23 AJIL; UNSG, External debt sustainability and development (2014) A/69/ Embassy of Argentina in Washington D.C., 10 reasons why NML v. Argentina matters, available at argentinamatters.pdf. 3 Cross, supra note 1. 4 New York Times, The Muddled Case of Argentine Bonds (July 24, 2014), available at

2 Page 2 ( Injunction Orders ), which clarified the payment formula underpinning the challenged injunctions and the effects of these injunctions on third parties and intermediary banks. Argentina claimed that the Injunction Orders, by prohibiting it from paying back the Exchange Bondholders unless it made comparable payments to the plaintiffs (i.e. the original FAA Bondholders), had caused injury to its country, to Exchange Bondholders, to participants in the Exchange Bond Payment System and to the public interest as a whole. The Court of Appeals, in its decision of August 23, 2013, affirmed the District Court s Injunction Orders and dismissed Argentina s claims of abuse of discretion by the District Court. The decision of August 23, 2013 was the object of a petition for a writ of certiorari with a view to lodging an appeal before the Supreme Court of the United States ( Supreme Court ). 5 On November 18, 2013, the Court of Appeals refused to reconsider its earlier decision of August 23, 2013, which had the effect of requiring Argentina to pay approximately 1.33 billion USD to FAA Bondholders pursuant to the FAA s ratable payment clause. 6 The Supreme Court, in a decision of June 16, 2014, rejected the petition for a writ of certiorari, thereby precluding it from reviewing the lawfulness of the Court of Appeals decision of August 23, 2013 independently of the judgment on the merits. 7 The Supreme Court, in another decision of June 16, 2014, held that the Court of Appeals had not breached Argentina s immunity from execution under the Foreign Sovereign Immunities Act ( FSIA ) by subjecting Argentina s extraterritorial assets to post-judgment discovery (i.e. procedure by which Argentina was requested to disclose to the plaintiff information regarding foreign assets it owns that may be subject to execution). 8 On September 29, 2014, U.S. District Judge, Thomas Griesa, in response to Argentina s lack of compliance with the Court of Appeals decision of August 23, 2013, found Argentina to be in civil contempt of court (i.e. to have disobeyed a court s order) and reserved its decision on sanctions for a subsequent hearing. 9 Focus in this article will be on the Court of Appeals decision of August 23, 2013, which has precipitated scrutiny of the issue of sovereign debt restructuring by the UN institutions. 10 Before pronouncing on the merits of the case, the Court of Appeals had to ascertain whether the Bank of New York Mellon ( BNY ), the Exchange Bondholder Group ( EBG ), Fintech Advisory Inc. (i.e. a holder of Exchange Bonds), a group of bondholders ( the Euro Bondholders ) and ICE Canyon LLC (i.e. a holder of GDP-related securities which Argentina issued) enjoyed the right to appeal the Injunction Orders as non-parties. In this respect, the Court of Appeals ruled that the right of appeal, as a general rule, is limited to the parties to the challenged decision. Exceptionally, nonparties may exercise a right of appeal if they are bound by the content of the decision or if they can demonstrate that the decision has plausibly affected their interests. The Court of Appeals distinguished the situation of BNY from that of EBG, Fintech, the Euro Bondholders and ICE Canyon. Whereas the former was bound by the findings of the Injunction Orders in its capacity as a participant in the payment process of the Exchange Bonds and thus enjoyed appellate standing, the latter were not bound by the content of the Injunction Orders and additionally could not demonstrate that the Injunction Orders had plausibly affected their interests. The Court of Appeals arrived at this conclusion after recalling 5 According to Rule 11 of the Rules of the Supreme Court of the United States, [a] petition for a writ of certiorari to review a case pending in a United States court of appeals, before judgment is entered in that court, will be granted only upon a showing that the case is of such imperative public importance as to justify deviation from normal appellate practice and to require immediate determination in this Court S.Ct Republic of Argentina v. NML Capital, Ltd., 573 U.S. (2014). 9 According to the Cornell University Law School s Legal Information Institute, civil contempt of court under US civil procedural law is intended to coerce a party to perform an action. For more details, see: 10 NML Capital, Ltd. v. Republic of Argentina, 727 F.3d 230 (2d Cir. 2013).

3 Page 3 that, in case Argentina defaulted on its obligations owed to EBG, Fintech, the Euro Bondholders and ICE Canyon, the latter could always launch judicial proceedings against the Argentinean Government. In short, creditors interests may not be considered plausibly affected by a decision on the mere ground that the decision requires the debtor to direct its payments to another set of creditors. Although EBG, Fintech, the Euro Bondholders and ICE Canyon could not invoke any of the above two exceptions and thus did not enjoy a right of appeal, the Court of Appeals agreed that they could intervene as amici curiae in support of Argentina s grounds of appeal in the appellate proceedings. The Court of Appeals recognized at the outset that the dispute between Argentina and the plaintiffs (i.e. original FAA Bondholders) essentially raised questions of contract law even though it responded to Argentina s grounds of appeal in both legal and policy-oriented terms. On the merits of the case, the Court of Appeals first assessed whether the Injunction Orders had unjustly injured Argentina per se. The Court of Appeals rejected Argentina s claim that the Injunction Orders had infringed the FSIA. 11 The FSIA protects sovereign States from attachment, arrest and execution upon their property located on US soil subject to certain exceptions (e.g. in case of waiver of immunity by the foreign State; where the property relates to a commercial activity that has originated in the claim; where the foreign assets are used or are intended to be used within the framework of a military activity). The Court of Appeals ruled that the Injunction Orders were not in breach of the FSIA, as they did not amount to a seizing of, a forcible restraint on, or an act of legal dominion over Argentina s property. The Injunction Orders did not select the resources from which Argentina had to pay the FAA Bondholders and thus could not qualify as attachment, arrest or execution upon Argentina s property in the US. The Court of Appeals also dismissed Argentina s argument that the Injunction Orders to immediately pay the FAA Bondholders 100% of the principal and the interest on their bonds were inequitable due to Exchange Bondholders being only entitled to a single instalment of interest on their bonds. The Court of Appeals ruled that the District Court had not abused its discretion by allowing the FAA Bondholders to obtain what they had contractually agreed upon as part of the FAA despite the fact that other creditors may not have derived the same contractual benefits from their own bargaining process (e.g. the first and the second debt swaps entered into by Argentina). In other words, the plaintiffs could not be blamed for having better negotiated the terms of their bond transaction than the creditors which accepted the exchange offers as part of Argentina s foreign debt restructuring. Second, the Court of Appeals found ill-grounded Argentina s claim that the Injunction Orders had caused injuries to Exchange Bondholders by inflicting on them unreasonable hardship or loss in their capacity as third parties. The Court of Appeals pointed out that Argentina had expressly refused to provide any formal assurance to Exchange Bondholders, prior to their accepting the exchange offers, that the dispute over the FAA Bonds would not impact upon the payments required by the Exchange Bonds. In any event, even if Argentina did default on the Exchange Bonds, Exchange Bondholders would still be in a position to launch judicial proceedings against Argentina. Third, the Court of Appeals dismissed Argentina s and the amici curiae s contention that the Injunction Orders, by targeting participants in the international financial system through which Argentina makes payments to Exchange Bondholders, had been founded on a lack of personal jurisdiction, had breached the principle of comity 12 and had infringed upon non-parties due process rights. The Court of Appeals ruled that any District Court s injunction U.S.C According to the Cornell University Law School s Legal Information Institute, comity under US civil procedural law refers to [t]he legal principle that political entities (such as states, nations, or courts from different jurisdictions) will mutually recognize each other s legislative, executive, and judicial acts. For more details, see:

4 Page 4 automatically binds persons who are in active concert or participation with the direct parties to the decision by virtue of Rule 65(d) of the Federal Rules of Civil Procedure. 13 It found that the District Court, by delivering its Injunction Orders, had not lacked personal jurisdiction since it had merely warned payment system participants that their liability could be engaged should they provide any assistance to Argentina in disobeying the Injunction Orders. In no way did the Injunction Orders place a direct prohibition on the payment system participants. The Court of Appeals also ruled that the Injunction Orders had not breached the principle of comity since the District Court, as any other federal court, may enjoin conduct that has or is intended to have a substantial effect within the United States. When addressing the relevance of comity to the case at hand, the Court of Appeals clarified that the Injunction Orders had not imposed a prohibition on any foreign entity aside from Argentina: the reference to specific foreign payment participants was only meant to acknowledge the applicability of Rule 65(d). As regards the question of whether the due process rights of non-parties had been denied, the Court of Appeals held that, in the event that persons actively assisted Argentina in breaching the District Court s Injunction Orders pursuant to Rule 65(d), they would be given notice and be granted the right to be heard in subsequent proceedings. Fourth, the Court of Appeals dismissed Argentina s claim that the Injunction Orders would have an adverse impact on the capital markets and on the global economy. The Court of Appeals ruled that Argentina s claim was premised on speculative and exaggerated consequences. In particular, the Court of Appeals took the view that the Injunction Orders would not dissuade other bondholders from entering into future sovereign debt restructurings (contrary to Argentina s claim) since more recent bond arrangements tend to stipulate collective action clauses, which enable a qualified majority of bondholders to extend the effects of a restructuring plan to holdout or recalcitrant creditors. The Court of Appeals also held that the Injunction Orders would not keep bond issuers away from the New York financial market. Whereas New York law in no way precludes borrowers and lenders from freely negotiating financial transactions, borrowers (including foreign debtors) shall be held liable for any breach of the terms of transactions they have agreed upon. Requiring any debtor to pay back the bonds it has issued is essential to preserving New York as one of the leading financial platforms worldwide. Following the Contempt Order, Argentina filed an application instituting contentious proceedings against the United States before the International Court of Justice ( ICJ ), alleging that the US federal decisions in the case NML Capital Ltd et al. v. Argentina had breached the principles of national sovereignty and of State immunity as guaranteed under public international law. 14 The US Government has not officially consented to the ICJ s jurisdiction over the above contentious proceedings, and Argentina may not be able to rely on any US pre-existing declaration or treaty commitment accepting the ICJ s jurisdiction. Even if the ICJ were competent to adjudicate upon this case, it would likely dismiss the application on the merits on the ground that the case pertains essentially to the interpretation and application of New York contract law in a US procedural context and thus raises no issue of public international law prima facie. It is indeed unclear how the principles of national sovereignty and of State immunity would have been breached as a result of the US litigation given that Argentina had deliberately subjected itself to New York courts and New York law as part of the FAA, that the Court of Appeals decision of August 23, 2013 did not place any direct prohibition on foreign entities other than Argentina and that the decision did not order any form of attachment, arrest or execution on Argentina s foreign assets located in the US. 13 Fed. R. Civ. P. 65(d). 14 International Court of Justice (7 August 2014) Press Release No. 2014/25, available at

5 Page 5 The NML Capital Ltd et al. v. Argentina litigation raises the questions of how to impose a foreign debt restructuring scheme accepted by a majority of bondholders upon a minority of recalcitrant bondholders in the absence of inclusion of a collective action clause in the bond exchange offers and of how to protect the integrity of a foreign debt restructuring scheme from actions for full recovery of their receivables launched by holdout bondholders. As the UN Secretary-General ( UNSG ) pointed out in his Report of July 22, 2014 ( UNSG s Report ), whereas more recent bond agreements have stipulated collective action clauses, an important number of older bonds that have not yet expired do not include such clauses. 15 The UNSG rightly signaled that the US decisions in NML Capital Ltd et al. v. Argentina may discourage bondholders not bound by a collective action clause from entering into a foreign debt restructuring scheme given the absence of guarantee that they will not be superseded by holdout creditors who will have maintained their original title to the full amount of their bonds. Failing the adoption of an international treaty governing the restructuring of a State s foreign debt and as the US Court of Appeals decision of August 23, 2013 has shown, the modalities of reimbursement of foreign debt instruments will remain a matter of private law (i.e. contract law, commercial law and/ or financial law). In the current state of affairs, the law applicable to the implementation of a foreign debt restructuring scheme is not necessarily that of the issuing State if the bond agreement stipulates a foreign law clause. In addition, the competent forum may supplement the applicable law agreed upon by the parties to the bond agreement with other sources of law in order to account for the special status of the defaulting entity. In light of these circumstances, the legal regime governing foreign debt restructuring is not uniform and hinges on the nature of the bond agreement and on domestic courts or international arbitration bodies interpretation and application of the chosen law. It must be agreed with the UNSG s Report that what is currently missing in the international financial sector is an international debt workout that would obviate the absence of clear sovereign insolvency procedures. 16 As a follow up to the UNSG s Report, the UN General Assembly ( UNGA ), in its Resolution of September 17, 2014, called for the adoption by the end of 2014 of a multilateral legal framework for sovereign debt restructuring processes designed to enhance the international financial system s efficiency, predictability and stability. 17 Based on a draft UNGA Resolution put forward by Bolivia, an ad hoc committee, in whose work all UN Member States and observers could participate, would have to be instituted. 18 This committee would be tasked with elaborating an international legal framework regulating sovereign debt restructuring processes following a process of inter-governmental negotiations. 19 The committee would give consideration to the views and comments submitted by UN Member States, inter-governmental organizations, regional commissions, academics, the private sector and NGO s External debt sustainability and development, supra note 1, ibid. 48, UNGA, Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes (2014) A/ RES/68/ UNGA, Modalities for the intergovernmental negotiations and the adoption of a multilateral legal framework for sovereign debt restructuring processes (2014) A/c.2/69/L ibid. 20 ibid. McKenna Long & Aldridge LLP is an international law firm with more than 500 attorneys and public policy advisors in 15 offices and 13 markets. The firm is uniquely positioned at the intersection of law, business and government, representing clients in the areas of complex litigation, corporate law, energy, environment, finance, government contracts, health care, infrastructure, insurance, intellectual property, private client services, public policy, real estate, and technology. For more information, visit mckennalong.com. Albany l Atlanta l Brussels l Denver l Los Angeles l Miami l New York l Northern Virginia l Orange County l Rancho Santa Fe l San Diego l San Francisco l Seoul l Washington, DC