Earlier this year we wrote about the Argentine government’s nationalization of Repsol’s shares in YPF, warning investors in Argentina of the uncertainty of future nationalization activity in Argentina. (click here for our YPF blog entry) Holders of Argentine sovereign debt are quite familiar with the risks of investing in Argentina. However, recently the tide turned a bit in favor of those creditors. While it wasn’t the shot heard round the world, it was a shot across the bow of Argentina (or at least one of their naval ships) when The United States Court of Appeals for the Second Circuit held that Argentina had violated the “equal treatment” provision of one of their debt agreements. Affirming the District Court’s decision and injunction, the Second Circuit agreed with the Plaintiff-bondholders that Argentina had breached its promise to pay them back the debt on an equal and pari passu basis as all other debt. Earlier this week, the Republic of Argentina petitioned for a rehearing by the Second Circuit panel and a hearing by the full Second Circuit Court of Appeals (the “Petition for Rehearing”).
By way of background, Argentina issued various series of debt securities (the “Bonds”) starting in 1994 pursuant to a Fiscal Agency Agreement (the “FAA”). The FAA provided that the Bonds would be (1) direct and unsubordinated obligations of the Republic of Argentina and at all times rank pari passu as between themselves, and (2) that the payment obligations of the Republic under the bonds would at all times rank equal with other unsecured debt of the Republic (the “equal treatment clause”). Argentina defaulted on the bonds in 2001. Following the default the Argentine government enacted a law providing a “moratorium” on repayment of the bonds (referred to as the “Lock Law” in the relevant court papers). In 2005 and then again in 2010, Argentina proposed exchange offers, whereby holders of the Bonds would agree to exchange into new bonds at a rate of 25-29 cents on the dollar (collectively, the “Exchanged Bonds”). After the issuance of the Exchanged Bonds, Argentina made periodic payments on the Exchanged Bonds but not on the original Bonds. Ultimately, certain of the holders of the Bonds that did not exchange commenced a suit in the Southern District of New York on the grounds that the payments on the Exchanged Bonds violated the equal treatment clause of the FAA. The District Court agreed with the Plaintiff-bondholders and, in addition to delivering a judgment in their favor, entered a broad injunction prohibiting Argentina from making payment on the Exchanged Bonds without a comparable payment on the original Bonds.
Argentina appealed the injunction, arguing, among other things, that (1) the terms of the Exchanged Bonds did not render them senior to the original Bonds and, therefore, the payments on the Exchanged Bonds did not contravene the equal treatment clause, and (2) the injunction deprived Argentina of control over its property in violation of the Foreign Sovereign Immunities Act (the “FSIA”).
As to the first point, the Second Circuit noted that the equal treatment clause prohibited the “de facto” subordination (and not just stated legal subordination) that had occurred as a result of (1) the regular payments to the Exchanged Bonds and not the original Bonds as well as (2) the legislation which prohibited payment on the original Bonds, even though they had been in default for years. Essentially, the Exchanged Bonds did not have to be labeled senior to the original Bonds to violate the equal treatment clause; Argentina’s actions, including passing legislation prohibiting the payment on the original Bonds, rendered the bonds subordinate.
The Second Circuit rejected Argentina’s FSIA arguments as well, noting that the injunction did not attach or arrest any of the sovereign’s property, but only ordered that Argentina comply with its contractual obligations by making comparable payments on the original Bonds if it made payments on the Exchanged Bonds. This portion of the decision is a step towards a more limited view of the scope of the FSIA, and counter to the controversial Allied Irish decision earlier this year by the same court which held that the FSIA barred plaintiff-noteholders from bringing a cause of action against their issuer on the grounds that the issuer had been nationalized by the Irish government (click here for our Allied Irish blog entry).
In its Petition for Rehearing, Argentina argues that the Second Circuit decision (1) conflicts with settled FSIA precedent, and (2) threatens future sovereign debt restructurings.
While we are supportive of restructuring-favorable precedent, the second argument fails to acknowledge that the original Bonds are still outstanding, in default and have never been compromised or restructured in any way. We view the goals of restructuring to include a (somewhat) equitable allocation of value, a negotiated revised arrangement and a continuation of the company as a going concern. Restructuring should not be about an issuer, even if it is a sovereign, unilaterally deciding to never distribute value to debt that has been in default for over 10 years (and in fact pass legislation prohibiting such a payment), while paying other debt in the ordinary course.
If we analogize this to a public bond exchange offer by a company, the company sets the requisite participation threshold—generally around 95%—and accepts that the non-exchanging 5% will need to be paid pursuant to the terms of their original contracts. What Argentina has done is the equivalent of benefitting from the new terms for the 95%, and ignoring its obligations to the remaining 5%. Sovereignty has its benefits, but those benefits should not include the unilateral repudiation of obligations for borrowed money. At the very least, Argentina should have proposed that the non-exchanging debt be treated the same as the Exchanged Bonds, a sort of de facto collective action clause. Stay tuned for further updates from the Second Circuit or news on arrested Argentine warships . . .