Thanks to Gordon Smith for inviting me to guest blog on The Conglomerate. Having long been a big fan of Gordon’s work, I was gratified to finally meet him at the April 2014 conference/micro-symposium on Competing Theories of Corporate Governance, hosted by my friend and wonderful colleague Stephen Bainbridge and the Lowell Milken Institute for Business Law and Policy, UCLA School of Law. (The conference was a wonderful opportunity to debate and discuss the competing models of corporate governance with the leading proponents of those models. Streaming links to the conference panels can be found here.)
Although most of my work has been devoted to federal insider trading, the role of in-house counsel, and gatekeeping, what I’d like to write about this week is . . . sovereign debt. If you’ve been paying attention to the international financial news lately, you may have noticed that on Wednesday, July 30, Argentina missed its regular bond payment and defaulted for the second time in 13 years. This second default occurred after mediated talks between Argentina and a group of hedge funds broke down. The first default occurred in 2001 after which Argentina proceeded to restructure its debt by offering a take-it-or-leave-it exchange of new discounted bonds for old ones. At the end of the day, almost 93 per cent of Argentine bond investors consented to taking writedowns in two Argentine debt restructurings. But a group of hedge funds refused to participate in the restructuring and demanded full repayment, suing Argentina in NML Capital, Ltd. v. Republic of Argentina in New York. Because it’s notoriously difficult to enforce debt collection against a sovereign state, Argentina believed that it could simply exclude these defiant holdouts from the repayments.
Not so. In 2012, Argentina’s expectations were upended, when—in a highly controversial decision—Judge Thomas P. Griesa of the federal district court in Manhattan ruled that Argentina could not continue to pay the restructured bondholders without also paying the hedge fund holdouts in full. Moreover, any bank that aided the payment to holders of restructured bonds without also paying the old bonds held by the holdouts would be in violation of the court order. Judge Griesa’s ruling was affirmed by the U.S. Court of Appeals for the Second Circuit, and in June 2014 the U.S. Supreme Court declined to hear Argentina’s appeal.
Whether you side with the hedge fund holdouts or Argentina, commentators generally agree that these rulings against Argentina have at minimum a (short-term) destabilizing impact on the sovereign debt markets. For example, Floyd Norris (NY Times), notes that by rejecting Argentina’s appeal, the Supreme Court “most likely damaged the status of New York as the world’s financial capital. It made it far less likely that genuinely troubled countries will be able to restructure their debts. And it increased the power of investors — often but not solely hedge funds that buy distressed bonds at deep discounts to face value — to prevent needed restructurings.”
Professor Tim Samples (UGA) opines in a recently released article that the current state of affairs is “… a radical departure from the traditional unenforceability of sovereign debt in favor of the opposite extreme: enforcement through potent injunctive remedies applicable to third parties” and that these decisions “create major uncertainties for sovereign debt markets.”
Professor Joseph Stiglitz (Columbia, former chief economist of the World Bank) warned: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.”
Professor Mitu Gulati (Duke): “The decision has very significant implications . . . . The world has changed.” And Professor Mark Weidemaier (UNC) warns about the expansive coverage of Griesa’s injunction: “The injunction by its terms extends to virtually the entire global financial system.”
So how did we get into this mess and what’s the long-term impact of these judicial decisions? To answer both questions, we need to focus on the particular clause in the Argentinian bonds that has been the subject of a growing body of scholarship and that has served as the legal hook for these judicial rulings: the pari passu (equal footing) clause. Now that we’re up to speed on the general factual background of the Argentinian debt litigation, in a follow-up post, I will discuss recent scholarship on the history and disputed meaning of the troublesome pari passu clause.
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