Bondholders spark U.S. legal drama over Argentine debt

Government supporters attend the arrival of Argentina's frigate Libertad. The ship had been held for two months in Ghana during an attempted seizure by the head of a New York hedge fund.
(Leo La Valle / AFP/Getty Images)

Collection agencies profit by buying up old debt, chasing borrowers for payment and, when all else fails, using the courts to recover as much as they can.

It’s a business model polished and perfected over decades of litigation. But what if the deadbeat is a sovereign nation of 40 million people whose fiery president has sworn never to pay?

That question now faces the U.S. 2nd Circuit Court of Appeals in New York, which has become an unlikely referee in a high-stakes grudge match pitting Wall Street investors against Argentina.


At its heart, the case tests the power of U.S. courts to force other countries to honor their debts. The outcome could hinder the ability of other struggling nations — including Greece and Cyprus — to renegotiate their commitments, potentially saddling them with crushing obligations they can’t escape.

In the button-down world of international finance, the proceedings have been nothing short of a barnburner. Each side has hired celebrity lawyers, traded insults and engaged in some bare-knuckle tactics, including the attempted seizure of an Argentine naval frigate by bondholders.

Now years of squabbling may be reaching a boiling point: A crucial ruling is expected as early as this week.

“The implications are huge,” economist and Nobel laureate Joseph E. Stiglitz said. “This court is balancing the interests of very small groups of creditors against those of entire countries.”

Though little-known in the U.S., the case is a cause celebre in Argentina, where the long battle has taken an economic toll on the nation.

At issue is nearly $100 billion in debt that Argentina defaulted on in early 2002 after a prolonged recession and a currency crisis. It was the largest sovereign default in history.

The nation eventually was able to restructure more than 92% of that debt by persuading investors to exchange old bonds for new ones worth about two-thirds less. Bolstered by an economic boom in recent years, Argentina has kept current on the new obligations to what are called the exchange bondholders.

But much of the remaining debt was snapped up at a discount by bargain-hunting investors, who took Argentina to court and demanded full value.

Leading the charge was New York hedge fund Elliott Associates, which has found a lucrative niche forcing debtor nations through litigation to pay up. The firm has won huge judgments against Peru, Republic of the Congo and other poor countries. In the developing world, such investors are dubbed vulture funds.

Elliott says Argentina is a bad actor with enough cash to fork over the roughly $1.4 billion it owes the fund and several other plaintiffs.

Elliott has made numerous attempts to help collect the debt by seizing Argentine assets, most notably a 340-foot ship, Libertad, held at port in Ghana for two months last year.

But Argentina proved a tenacious foe. Through a United Nations tribunal, it persuaded Ghana to release the ship. Still, the close call prompted President Cristina Fernandez de Kirchner to travel in a rented jet, leaving her presidential plane out of Elliott’s reach.

Frustrated after half a decade of litigation, Elliott and other holdouts tried a novel legal strategy. They argued that under a provision of its debt contracts, Argentina could no longer make payments to the bondholders who had settled unless it also paid the holdouts.

U.S. District Judge Thomas Griesa agreed. In November, the appeals court upheld the ruling and is now considering how to force payment and how much the holdouts should receive. Experts said the court could oblige Argentina to pay in full, match the deal it gave the exchange bondholders or offer something in between.

The appellate judges also are weighing whether to uphold an injunction Griesa put on Argentina’s bank, Bank of New York Mellon, that bars it from paying exchange bondholders unless holdouts also are paid. If that’s upheld, Argentina will be required to fork over something or be held in contempt.

The case is “an important test of the rule of law,” said plaintiffs’ lawyer Ted Olson, best known for representing George W. Bush in the legal challenge to the Florida vote in the 2000 election.

“Argentina believes that, no matter what its contracts say, no matter that it has more than enough to pay all of its obligations, it can simply dictate terms to its creditors,” said Olson, who became U.S. solicitor general under Bush.

Fernandez de Kirchner has blasted the rulings, mocked the judges and called the holdouts pirates who have no respect for sovereign rights. She noted that a 2005 Argentine law prohibits giving holdouts a better deal than those who settled.

That has the exchange bondholders nervous that Argentina might elect to pay nobody rather than making the holdouts whole. They have hired high-powered litigator David Boies, who was Al Gore’s counsel in the 2000 Bush vs. Gore case.

Global anti-poverty groups are also worried. They fear that if the court allows the holdouts to get more than the exchange bondholders it will create a powerful incentive for bondholders to refuse to negotiate when the next sovereign default arises.

That could make it hard for nations facing economic crises to escape crushing debt loads, said Eric LeCompte, executive director of Jubilee USA, an anti-poverty group that advocates sovereign debt cancellation. Unable to restructure debt, these countries would be required to use money otherwise dedicated for social services, education or public health to pay bondholders.

“Any precedent set here goes way beyond Argentina,” said LeCompte, noting that lawsuits mimicking Elliott’s tactic have been filed against other countries in recent months. “This will likely have the most far reaching impact on global poverty of any ruling in our lifetime.”

That opinion is shared by some influential observers, including the U.S. Justice Department. It filed a brief arguing the ruling “threatens core U.S. policy regarding international debt restructuring.”

Others contend that a more worrisome precedent could be set if the court doesn’t force Argentina to pay the holdouts. That could damage the U.S. legal system’s credibility and embolden other nations to shortchange investors, said Hans Humes, head of hedge fund Greylock Capital Management and former co-chair of an Argentine creditors committee.

“This is really a worst-case scenario,” he said.

Many speculate that Argentina may simply find a way to pay exchange bondholders outside the U.S., without a dime going to the holdouts. While critics of hedge funds might like to see Elliott thwarted, legal scholars say it’s a slippery slope.

“If Argentina doesn’t pay, nobody wins,” said Anna Gelpern, a law professor at American University who has written extensively about the case.

In Argentina, Libertad’s return to port was celebrated as a victory, and buitre, or vulture, has entered the popular lexicon.

But the nation is hurting from the battle. Cut off from international credit markets, Argentina has become a financial pariah — unable to borrow and forced to print pesos, fueling inflation.

Desperate for U.S. dollars it needs for trade and other obligations, the government has put strict limits on residents’ purchases of foreign currency. That has created a black market in which the dollar’s street price is now nearly double the official rate.

To fight inflation, many Argentines travel to neighboring Uruguay to take out dollar advances from ATMs on credit cards, while others have been buying the digital currency Bitcoins.

“It’s all connected to the unresolved debt problem,” said Matias Tombolini, an economist at the University of Buenos Aires. “The public is suffering from something it cannot control.”

No matter the outcome of the appeal, a petition to the Supreme Court is likely.

Many believe the case has helped focus attention on the shortcomings of the international sovereign debt system.

“We’ve created a totally dysfunctional sovereign debt market,” Stiglitz said. “Whether or not you like what Argentina has done, this is a question of equity.”


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