Sovereign Debt Update
On July 16, 2015, the finance ministers of the 19 eurozone countries agreed to “grant in principle” a third bailout package for Greece that could total €86 billion ($94.5 billion). Those ministers were joined by their counterparts from the remainder of the 28-nation European Union (the “EU”) in agreeing to give Greece short-term loans of as much as €7 billion to meet its immediate needs. In addition, the European Central Bank (the “ECB”) expanded an emergency line of credit for Greece’s banks by €900 million, to total nearly €90 billion. Greek banks, which had been closed on June 29, finally reopened on July 20.
As of the end of July, it was far from clear that Greece would actually receive its third bailout package in five years and remain a member of the eurozone. The answer to those questions depends in part on whether the Greek government can get Greeks to stomach yet another round of wildly unpopular austerity measures and tax increases.
How did Greece find itself on the brink of a sovereign debt default?
Greece joined the EU in 1981 and became part of the eurozone currency union in 2001. Prior to the introduction of the euro, currency devaluation helped to finance the Greek government’s borrowing. After Greece adopted the euro, devaluation was no longer an option. Still, during the next eight years, Greece was able to continue its high level of borrowing because of low interest rates borne by euro-denominated government bonds.
The Greek debt crisis started in late 2009. Among its catalysts were the turmoil of the global recession, structural weaknesses in the Greek economy, and a sudden crisis in confidence among lenders. Late in 2009, revelations that the Greek government had misreported data on debt levels and deficits triggered both anger that Greece had misrepresented its way into the eurozone and widespread apprehension that Greece was incapable of meeting its debt obligations.
In February 2010, the new government of George Papandreou (elected in October 2009) acknowledged that past governments had misreported statistics. The government then revised Greece’s 2009 deficit from a previously estimated 6 to 8 percent of GDP to an alarming 12.7 percent. The deficit was later revised upward yet again to 15.7 percent, the highest for any EU nation in 2009. Estimated government debt at the end of 2009 was also increased, from €269.3 billion (113 percent of GDP) to €299.7 billion (130 percent of GDP).
Despite the crisis, Greece’s €13 billion bond auctions in 2010 were oversubscribed. High yields on the debt worsened the Greek deficit, however, leading rating agencies to downgrade Greece’s credit rating to junk status in late April 2010.
On May 2, 2010, the European Commission, the ECB, and the International Monetary Fund (the “IMF”) (collectively referred to as the “Troika”) launched a €110 billion bailout loan to rescue Greece from sovereign default and to cover the nation’s financial needs for the next three years. However, the bailout was conditioned upon the implementation of austerity measures, structural reforms, and privatization of government assets.
Greece needed a second bailout in 2011. This package (including a bank recapitalization package worth €48 billion) brought the total Greek bailout outstanding to €240 billion. A worsening recession and delays in implementing the conditions of the bailout program spurred the Troika to approve another round of debt relief measures in December 2012.
An improved outlook for the Greek economy during 2013 and 2014 (with a government surplus in both years, a decline in the unemployment rate, positive economic growth, and a brief return to the private lending market) abruptly ended in the fourth quarter of 2014, when the country once again slipped into recession.
At the end of 2014, adding fuel to the fire, the Greek parliament called a premature parliamentary election for January 2015. Syriza, the party that emerged victorious, had campaigned on a promise to disavow Greece’s current bailout agreement, including continued austerity measures. Due to rising political uncertainty, the Troika suspended the remaining aid to Greece scheduled under the existing bailout program until the newly elected government, led by Prime Minister Alexis Tsipras, either ratified the previously negotiated terms of the bailout or reached a new agreement with different terms. A Greek liquidity crisis ensued, resulting in plummeting stock prices at the Athens Stock Exchange, while a spike in interest rates effectively excluded Greece once again from the private lending market as an alternative funding source.
After the election, the Troika granted an additional four-month extension of its bailout program pending the completion of negotiations. Confronted with the threat of a sovereign default, the Tsipras government continued to negotiate throughout most of June 2015 but formally broke off negotiations with the Troika on June 26. The following day, Prime Minister Tsipras announced that, in lieu of continued negotiations, a referendum would be held on July 5, 2015, to either approve or reject the terms negotiated thus far.
On July 5, 2015, Greek voters overwhelmingly (61 percent to 39 percent) rejected the proposed terms of the bailout agreement. The result sent world markets into turmoil as the prospect of Greece’s exit—“Grexit”—from the 19-nation eurozone loomed ever larger.
On July 8, 2015, Greece formally requested a three-year loan from the eurozone’s bailout fund, seeking a “light at the end of the tunnel” as time expires for the country to reach a deal with the Troika. Newly appointed Greek Finance Minister Euclid Tsakalotos submitted the request in advance of a proposal due July 9, pledging that Greece would implement tax- and pension-related reforms in exchange for the much-needed relief.
On July 16, in connection with the bailout package agreed to “in principle” by eurozone finance ministers, Greece’s parliament approved painful new austerity measures—ironically, with the support of Prime Minister Tsipras, who announced that the measures were necessary to reach a deal which would avert a humanitarian and fiscal disaster.
On July 20, Greece made a critical €4.2 billion bond payment to the ECB and repaid the IMF €2 billion in loan arrears. The money for those payments came from a €7 billion bridge loan that the EU approved on July 17.
As of the end of July, the Greek sovereign debt crisis remained very much in flux.
The long-running dispute over the payment of Argentina’s sovereign debt, on which the South American nation defaulted for the second time in July 2014, continues.
On May 11, 2015, holdout bondholders from Argentina’s 2005 and 2010 debt restructurings filed a motion with the U.S. District Court for the Southern District of New York to amend their complaint against Argentina to include $5.3 billion in BONAR 2024 bonds issued by the republic in April 2015. The amendment would bring this latest bond offering into the ongoing battle before district judge Thomas Griesa that concerned the validity of the pari passu, or “equal treatment,” clause which, according to a 2012 ruling by Judge Griesa, prevents Argentina from making payments on restructured bonds without making corresponding payments to holdout bondholders. Argentina’s Minister of Economy, Axel Kicillof, later responded to the action taken by holdout bondholders, asserting that the BONAR 2024 bonds constitute domestic debt denominated in foreign currency and thus do not fall within the jurisdiction of Judge Griesa. Kicillof also accused the holdouts of seeking to generate “uncertainty in the market to harm the Republic and the bondholders” or creditors with exposure to exchanged debt.
On May 18, 2015, one of Argentina’s federal administrative courts enjoined the Argentine branch of Citibank, N.A. (“Citibank”) to “refrain from any act” intended to fulfill a March 20, 2015, court-approved agreement between the New York-based bank and holdout bondholders whereby Citibank’s Argentine branch was authorized to make interest payments on Argentine-law bonds and to exit its custody business in Argentina. According to the Argentine court, Citibank failed to satisfy the requirements of Argentina’s Código Procesal for validating the agreement approved by Judge Griesa.
On June 5, 2015, Judge Griesa granted partial summary judgment to a group of 526 “me too” plaintiffs in 36 separate lawsuits. Consistent with his previous ruling in litigation commenced by a group of holdout bondholders led by NML Capital Ltd., Judge Griesa ruled that Argentina violated the equal treatment clause in bonds issued to the “me too” bondholders under a Fiscal Agency Agreement beginning in 1994 by refusing to make payments on their bonds at the same time it paid holders of debt restructured in 2005 and 2010. See Guibelalde v. The Republic of Argentina, 2015 BL 179208 (S.D.N.Y. June 5, 2015). The decision obligates Argentina to pay the plaintiffs $5.4 billion before it can make payments on restructured debt.
Although Puerto Rico is an unincorporated territory of the United States rather than a sovereign, the financial troubles of the beleaguered Caribbean commonwealth, which has more than $72 billion in debt, have received a great deal of attention lately.
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. In an effort to remedy this problem in part, Puerto Rican governor Alejandro García Padilla gave his imprimatur to Puerto Rican legislation on June 28, 2014, that created a judicial debt relief process modeled on chapters 9 and 11 of the U.S. Bankruptcy Code for certain public corporations, including the Puerto Rico Electric Power Authority (“PREPA”), which has $9 billion in bond debt. The Puerto Rico Public Corporations Debt Enforcement and Recovery Act (the “Recovery Act”) was intended to ring-fence Puerto Rico from potential liabilities arising from defaults by its public corporations and to give the corporations a framework for restructuring their obligations.
The new law’s obvious similarities to chapter 9 and chapter 11 of 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 affiliated with Franklin Resources Inc. and Oppenheimer Rochester Funds, which collectively hold approximately $1.7 billion in Puerto Rican debt, filed a lawsuit alleging that the legislation is unconstitutional, even though no debtor has actually attempted to restructure its debt under the law.
The Recovery Act was dealt a severe blow on February 6, 2015, when a federal district court judge struck down the law as unconstitutional. In BlueMountain Capital Management, LLC v. García-Padilla, No. 14-01569 (D.P.R. Feb. 6, 2015), the court ruled, among other things, that “[b]ecause the Recovery Act is preempted by the federal Bankruptcy Code, it is void pursuant to the Supremacy Clause of the United States Constitution.” The ruling, which was appealed by Puerto Rico to the U.S. Court of Appeals for the First Circuit, was a setback not only for PREPA and other public corporations attempting to restructure their bond debt (e.g., the Puerto Rico Aqueduct and Sewer Authority and the Puerto Rico Highways and Transportation Authority), but also for Puerto Rico itself.
On February 11, 2015, Resident Commissioner Pedro Pierluisi, the Commonwealth of Puerto Rico’s representative in Congress, reintroduced a bill, the Puerto Rico Chapter 9 Uniformity Act of 2015 (H.R. 870), to allow Puerto Rico’s public agencies to be debtors under chapter 9. The bill is nearly identical to one Pierluisi introduced in 2014. The House Judiciary Subcommittee on Regulatory Reform, Commercial and Antitrust Law held a hearing on H.R. 870 but has taken no action since then on the bill. U.S. Senators Chuck Schumer of New York and Richard Blumenthal of Connecticut introduced companion legislation in the U.S. Senate on July 15, 2015.
On June 28, 2015, Governor Padilla announced that the island cannot pay back its $72 billion in debt, which he characterized as a “death spiral.” The announcement set the stage for an unprecedented financial crisis that could shake the municipal bond market and lead to higher borrowing costs for governments across the U.S. However, Puerto Rico avoided defaulting on July 1, 2015, when it paid back $645 million of general obligation bonds as well as a short-term bank loan of about $245 million. In addition, PREPA made a $415 million bond payment.
More bad news for Puerto Rico came on July 6, 2015, when the First Circuit affirmed the district court’s ruling that the Recovery Act is unconstitutional. In Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico, 2015 BL 215414 (1st Cir. July 6, 2015), the court of appeals ruled that the district court had not erred in striking down Puerto Rico’s own municipal bankruptcy laws because such laws are preempted by section 903(l) of the Bankruptcy Code. In its opinion, the First Circuit wrote:
In denying Puerto Rico the power to choose federal Chapter 9 relief, Congress has retained for itself the authority to decide which solution best navigates the gauntlet in Puerto Rico’s case. The 1984 amendment ensures Congress’s ability to do so by preventing Puerto Rico from strategically employing federal Chapter 9 relief under § 109(c), and from strategically enacting its own version under § 903(1), to avoid such options as Congress may choose. . . . We must respect Congress’s decision to retain this authority.
In a concurring opinion, circuit judge Juan Torruella stated that the 1984 amendments to the Bankruptcy Code, which for the first time prohibited Puerto Rico’s instrumentalities from seeking bankruptcy protection, appear to lack a rational basis and may be constitutionally invalid. According to Judge Torruella:
Not only do [the 1984 amendments] attempt to establish bankruptcy legislation that is not uniform with regards to the rest of the United States, thus violating the uniformity requirement of the Bankruptcy Clause of the Constitution, . . . but they also contravene both the Supreme Court’s and this circuit’s jurisprudence in that there exists no rational basis or clear policy reasons for their enactment.
On July 8, 2015, Judge Francisco A. Besosa of the U.S. District Court for the District of Puerto Rico, in light of the First Circuit’s ruling that the Recovery Act is unconstitutional, permanently enjoined government authorities from attempting to enforce the restructuring law. See BlueMountain Capital Management LLC v. García-Padilla, No. 14-01569 (D.P.R. July 8, 2015), and Franklin California Tax-Free Trust et al. v. Commonwealth of Puerto Rico, No. 14-1518 (D.P.R. July 8, 2015).
The government of Puerto Rico announced on July 9, 2015, that it would seek to appeal the First Circuit’s ruling to the U.S. Supreme Court. In a written statement, Justice Secretary César Miranda explained that “[w]e are turning to the Supreme Court because we believe that the First Circuit Court of Appeals decision was wrong in that it validates an irrational action by Congress to exclude Puerto Rico from the application of Chapter 9 of the U.S. Bankruptcy Code.” Miranda further noted that “[t]his action—without any basis in legislative precedent—continues to seriously hurt Puerto Rico’s interests.”