Sovereign Debt Update
Argentina—The long-running dispute over the payment of Argentina’s sovereign debt has been particularly active in recent weeks and months.
Events Leading Up to Argentina's Default
On June 30, 2014, Latin America’s third-largest economy failed to make a scheduled $539 million payment to bondholders after U.S. District Court judge Thomas Griesa ruled that the payment could not be made unless holdout bondholders from restructurings in 2005 and 2010 were also paid. Under the governing documents, Argentina—which has about $200 billion in foreign-currency debt, including $30 billion of restructured ("exchange") bonds—had a 30-day grace period after the June 30 default to make the payment.
On July 28, 2014, Judge Griesa authorized Argentina to make a one-time payment on Argentine law-governed exchange bonds because those securities cannot be distinguished from Argentine bonds issued to Spanish oil company Repsol SA earlier in 2014 in compensation for the expropriation of its local subsidiary. The Repsol settlement bonds are not part of the long-running dispute between Argentina and the holdout bondholders. "The court cannot enjoin payment on the dollar-denominated exchange bonds without also upsetting the Repsol settlement," Judge Griesa wrote in his ruling. However, the judge directed the parties to find a way to distinguish between the Repsol and exchange bonds before the next interest payment.
On July 29, 2014, holders of Argentina’s euro-denominated exchange bonds urged Judge Griesa to issue a last-minute stay of his June 30 debt ruling, which risked toppling the South American country into default. According to the exchange bondholders, "A default would undo much of the work this Court has accomplished over the last ten years and extend litigation here and around the world for years on end." The bondholders also disclosed that they had been in touch with other bondholders who, like them, would be willing to waive the "rights upon future offers" (RUFO) clause that prevents Argentina from settling with holdout investors on terms better than those accepted by the exchange bondholders.
On July 30, 2014, Argentina defaulted on its sovereign debt for the second time in approximately 13 years when the 30-day grace period expired following the payment default that occurred on June 30. Earlier that day, Standard & Poor’s Ratings Services downgraded Argentina’s foreign-currency credit rating to "selective default," meaning that the country is meeting its obligations on some bonds but not others, as the clock ran out on efforts to craft a last-minute deal to avert the country’s second default.
Ramifications and Aftermath
On July 31, 2014, Argentina’s government, asserting that the collapse of negotiations with the holdout bondholders was due to the "malpractice" of the U.S. judiciary, denied that it had defaulted on its sovereign debt. At a news conference in Buenos Aires, Jorge Capitanich, Argentina’s Chief of the Cabinet of Ministers, blasted the U.S. courts for a lack of impartiality and criticized the performance of court-appointed mediator Daniel A. Pollack for failing to facilitate reasonable deal conditions that could be agreed to by both Argentina, as a sovereign nation with legal and constitutional restrictions, and hedge funds holding bonds worth $1.5 billion.
On August 1, 2014, the International Swaps and Derivatives Association, Inc. ("ISDA") announced that its Americas Credit Derivatives Determinations Committee (the "Determinations Committee") resolved that a failure to pay credit event had occurred with respect to Argentina. This means that sellers of credit default swaps ("CDSs") with a net exposure of around $1 billion must now pay out to investors who hedged against Argentina’s sovereign debt default. ISDA announced on August 14, 2014, that it would organize an auction on August 21 to settle CDSs that reference nearly $1 billion in Argentine debt. However, on August 19, the 15-member Determinations Committee voted unanimously to postpone the auction until some time in September 2014. According to the Determinations Committee, the auction will cover only CDSs related to 11 Argentine debt issues with maturities in 2017, 2033, and 2038. Further information regarding the auction is posted on ISDA’s website, http://www.isda.org/credit.
On August 1, 2014, Argentina informed Judge Griesa that the nation had lost faith in the mediator appointed to resolve the dispute, claiming that the mediator’s pre-default statement that Argentina was in "imminent default" was "harmful and prejudicial" and asking that he be replaced. Judge Griesa rejected the request and said talks would have to continue. The judge also upbraided Argentina at the hearing, saying that the country’s obligations to pay holdout bondholders must be resolved. According to the judge, Argentina’s pronouncements ignoring the facts amount to "half-truths" that are "false and misleading" and "do not comply with the law, which requires disclosure of facts."
On August 6, 2014, Judge Griesa issued an order barring Argentina from making payments on euro-denominated exchange bonds as part of a larger decision that forbade Argentina from paying holders of dollar-denominated debt. Certain holders of euro-denominated bonds, claiming that their debt is not covered by U.S. law and that Judge Griesa exceeded his authority in blocking their payments, appealed the order to the U.S. Court of Appeals for the Second Circuit on August 19.
On August 7, 2014, Argentina asked the International Court of Justice ("ICJ") in The Hague to hear a lawsuit it wants to commence against the U.S., claiming that decisions by U.S. courts in the dispute over payment of its restructured and nonrestructured debt have violated its sovereignty. However, in order for a lawsuit to move forward, the U.S. would have to consent to the ICJ’s jurisdiction, and since the tribunal began operating in 1946, permission has been granted by the U.S. in only 22 cases. The U.S. is unlikely to grant the request in the absence of any bilateral treaty that would require the U.S. to accept the ICJ as a venue to resolve disputes with Argentina.
At a hastily convened hearing on August 8, 2014, Judge Griesa again chastised Argentina for publicly denying that it had defaulted on its debt, threatening a contempt order if more "false and misleading" pronouncements follow.
On August 11, 2014, a U.S. magistrate judge granted the request of holdout bondholder NML Capital Ltd. ("NML") to obtain information from numerous companies that the hedge fund claims are hiding $65 million embezzled from Argentina’s coffers, ruling against 123 Nevada entities the judge described as shell companies. The judge directed the companies to provide information concerning their finances, or to provide a deponent, so that NML can attempt to locate funds which were allegedly embezzled by the current Argentine President, Cristina Fernández de Kirchner; her late husband; and associate Lázaro Báez.
On August 19, 2014, President Fernández de Kirchner announced in a nationwide address that, in an effort to sidestep the U.S. court ruling which blocked payments on restructured debt and caused the nation to default for the second time in 13 years, the government will submit a bill to the Argentine Congress that lets overseas debt holders swap into new bonds governed by Argentine law with the same terms. Payments will be made into accounts at the central bank instead of through Bank of New York Mellon Corp. ("BNY Mellon"), the current trustee.
At a hearing held on August 21, Judge Griesa sharply criticized the proposal, stating that it violates prior court orders and is therefore illegal. He also said he was "absolutely appalled" that Argentina had not notified its lawyers about the proposal before it was made public. However, the judge denied an emergency request by holdout bondholders to hold Argentina in contempt, emphasizing that imposing such a sanction would not push the parties any closer to a settlement.
Argentina’s government on August 22, 2014, accused Judge Griesa of making imperialist comments against the nation. At a press conference in Buenos Aires, Argentine Cabinet Chief Capitanich stated that the judge’s unfortunate and even imperialist statements constitute an undue interference with Argentina’s sovereignty.
On August 26, 2014, Argentina’s exchange bondholders sued BNY Mellon in London Chancery Court, seeking to gain access to interest payments owed to them. Later the same day, Argentina revoked BNY Mellon’s permission to operate a local representative office in Argentina after the bank refused to make interest payments owed to participating bondholders in July due to Judge Griesa’s order prohibiting the payments.
On August 29, 2014, the International Capital Market Association ("ICMA"), a group of banks and investors, announced a proposal designed to reduce the ability of holdout bondholders to undermine sovereign debt restructurings. The plan was created after meetings convened by the U.S. Treasury Department in the aftermath of Greece’s debt restructuring and comes on the heels of the second Argentine debt default. Under ICMA’s proposal, "pari passu," or equal treatment, clauses would be interpreted to bind all bondholders to the terms of any debt restructuring agreement approved by at least 75 percent of the bondholders. The International Monetary Fund was set to propose similar guidelines in late September.
ISDA on September 3, 2014, announced the completion of an auction to settle CDSs referencing Argentine debt. The auction established a final price of 39.5 cents on the dollar for the Argentine debt, meaning CDS sellers will have to pay 60.5 percent on approximately $1 billion in wagers made by investors who hedged against Argentina’s sovereign debt default.
On September 4, 2014, in an effort to end-run Judge Griesa’s orders prohibiting Argentina from making interest payments on exchange bonds without also paying amounts owed to holdout bondholders, Argentina’s Senate passed a bill authorizing its government to bypass U.S. courts and pay its bondholders through local channels. The proposal was approved by Argentina’s lower legislative body, the Chamber of Deputies, on September 11, 2014. The legislation also authorizes the removal of BNY Mellon as the trustee under the bond indentures, with bond payments being made instead through state-backed Banco de la Nación Argentina.
On September 9, 2014, the United Nations General Assembly passed a resolution to begin an "intergovernmental negotiation process aimed at increasing the efficiency, stability and predictability of the international financial system." That process would include negotiations toward the implementation of a global bankruptcy process for sovereign debtors. The resolution passed by a super-majority vote of 124-11 with 41 abstentions. The U.S. voted no, along with 10 other countries. Such a bankruptcy process could make it more difficult for holdout bondholders to prevent countries from successfully restructuring their debts and could limit future defaults.
Puerto Rico—Although Puerto Rico is an unincorporated territory of the United States rather than a sovereign, the financial troubles of the beleaguered Caribbean commonwealth have received a great deal of attention lately.
On June 28, 2014, Puerto Rican governor Alejandro García Padilla gave his imprimatur to legislation that creates a judicial debt relief process for certain public corporations, including the Puerto Rico Electric Power Authority (PREPA), the Puerto Rico Aqueduct and Sewer Authority (PRASA), and the Puerto Rico Highways and Transportation Authority (PRHTA). The new law is modeled on chapters 9 and 11 of the U.S. Bankruptcy Code (with certain important distinctions) and is in all practical respects a non-federal bankruptcy law.
Under the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, an eligible public corporation may pursue two alternatives, simultaneously or in sequence. The first is a "consensual debt relief transaction" akin to a prepackaged or prenegotiated chapter 11 case.
To commence such a proceeding, an eligible entity must file a notice of a "suspension period," which stays collection actions by all identified creditors for up to 360 days, unless the entity elects not to seek court approval for specified debt relief. If such approval is requested, the stay remains in place until either: (i) any court order approving debt relief becomes final; or (ii) 60 days after denial of such relief.
Debt relief may be approved by the court only if: (a) creditors holding at least 50 percent of the amount of debt within a class of substantially similar obligations participate in a vote or a consent solicitation for a proposed amendment, modification, waiver, or debt exchange; and (b) the proposed relief is approved by creditors in the class holding at least 75 percent of the amount of the debt represented. Upon approval by a class of creditors, the applicable debt relief would be binding on all creditors within the applicable class.
The second avenue for debt relief involves the filing of a petition with the court by or on behalf of an eligible public corporation, which triggers an automatic stay banning creditor collection efforts. This avenue, similar to the rules for chapter 11 plans, provides that the court may approve a debt adjustment plan if at least one class of impaired debt votes to accept the plan. A class is deemed to approve a plan if: (i) creditors in the class holding at least two-thirds of the amount of the debt involved vote on the plan; and (ii) of the class members who actually vote, the holders of more than one-half of the debt in the class approve the plan.
All impaired creditors must receive at least as much under a debt adjustment plan as they would have received if all creditors had been allowed to enforce their claims on the filing date of the petition. Also, each impaired creditor must receive its pro rata share of 50 percent of the debtor’s positive free cash flow, if any, after payment of certain specified expenses, during the 10 fiscal years following the first anniversary of the plan’s effective date, until creditors are paid in full.
The new law’s obvious similarities to chapter 9 and chapter 11 or the Bankruptcy Code, as well as the fact that the legislation was not enacted in accordance with Article I, Section 8, of the U.S. Constitution, immediately provoked attacks on its constitutionality. Bond funds (collectively, the "Bond Funds") affiliated with Franklin Resources Inc. and Oppenheimer Rochester Funds, which collectively hold approximately $1.7 billion in Puerto Rico debt, filed a lawsuit on June 30, 2014, alleging that the legislation is unconstitutional, even though no debtor has actually attempted to restructure its debt under the law. The Bond Funds filed a summary judgment motion in early August, arguing that the undisputed facts require the court to declare the law void, regardless of the specific circumstances under which it might be applied. The court directed Puerto Rico to submit by September 12 pleadings supporting its claim that the law is constitutional.
Due to its status as an unincorporated territory of the U.S., Puerto Rico is barred from seeking either protection under the Bankruptcy Code or international financial assistance. Puerto Rico has claimed that section 903 of the Bankruptcy Code, which arguably preempts any attempt by Puerto Rico to enact its own debt relief law, does not apply to the commonwealth because it is barred from filing for chapter 9 protection or, in the alternative, that the section is unconstitutional because it unfairly discriminates against the island territory.
On August 15, 2014, PREPA announced that it had reached an agreement with creditors to delay repayment of bank loans until March 2015. It remains to be seen whether the court will be inclined to issue what would amount to an advisory opinion on the Bond Funds’ claims that the new debt relief law is unconstitutional.