By Jeremy Smith & Jorge Vilches
Jorge Vilches ([email protected]) is a financial op-ed columnist based in Buenos Aires, Argentina; Jeremy Smith is Co-Director of PRIME and a barrister
When it comes to dealing with hostage-taking and ransom-paying, governments always say publicly “we will never negotiate” with terrorists and criminals, because it sets a bad precedent, and encourages other bad guys to do yet more hostage-taking and ransom-demanding.
But this logic does not seem to apply in the field of sovereign debt and vulture funds. The advice, in this field, is always “do the deal, pay up, however unfair the situation and however usurious the amount”. 
So with Argentina and the ransom demanded from its people by the US vulture funds (which themselves, let us recall, never lent a single dollar to Argentina).
The new Argentinian government, in office since October 2015, has decided to make an offer to settle with all the remaining hold-outs (on much more favourable terms than those accepted by nearly 93% of creditors in the 2005 and 2010 settlements), proposing to pay roughly 100% of the nominal principal plus interest at 50% of the principal. (Alternatively, for those who have monetary court judgments, a settlement of the value of the judgment minus 30%). The cost – to be financed, we understand, via new bonds (i.e. borrowing) and draining Argentina’s very limited foreign reserves – would be around $6.5 billion, in respect of claims estimated at $9 billion.
How we got here
A quick summary of how the mess arose (see more here). Argentina suffered a disastrous economic and financial collapse in 2001/02, after years of following the Washington consensus economic policies, backed by the IMF, and capped with a foolish peso-dollar parity policy, which had led to enormous foreign indebtedness to uphold until it had to be abandoned. (The IMF indeed criticized its own role in Argentina’s pre-crash policy and borrowing).
After this effective insolvency, and over some 10 years, successive Argentinian governments put together the largest sovereign debt settlement in history, with 92.4% of creditors signed up to a major “haircut” via the 2005 and 2010 exchange bond agreements. They refused point-blank to pay more to settle the claims for 100% of nominal principal plus interest (plus sundry other exorbitant claims for damages, fees etc.) from a set of billionaire vulture funds (notably NML and Aurelius) who had bought up distressed bonds dirt cheap on the secondary market during or after Argentina’s default.
It appears that, for example, NML (owned by Elliott Management, and registered in the Cayman Islands tax haven) paid some $50 million for bonds which, including interest (plus the array of claimed surcharges and penalties), were in 2014 valued at around $830 million – let’s call it a claim for 1600% interest. Indeed some of the old bonds snapped up by NML had effective interest rates (due to drafting quirks) of 101% per year! But whilst being the most aggressive plaintiffs, there were and are many other hold-outs, actively or passively engaged, hoping to piggyback on any gains by the vultures.
Most of the multitudinous litigation over many years has been heard by a single, now 85 year old, New York District judge, Judge Thomas P. Griesa, though he has been supported at every stage by the US appeals courts. He undoubtedly has what we may call a “Wall Street-cum-Cayman Island billionaire” perspective on the litigation, with no broader vision of the public interest in sovereign debt or its consequences in poorer countries. Yet his decisions and precedents are having a potentially profound – and negative – impact on the legal status of trillions of dollars of outstanding sovereign debt around the world.
Faced with what he saw as Argentina’s intransigent refusal to pay out on the usurious terms demanded by the vulture funds (whose basic claim in pure contract, but not the wider international public interest or in equity, was clear), Judge Griesa used what the Financial Times, in a recent editorial, calls an “creative and eccentric” interpretation of the pari passu clause in the bonds . First, to find Argentina in breach of the clause (contrary to previous understanding of its meaning), but second and more importantly, to impose an extraordinarily one-sided injunction.
The judicial blockade
This injunction prohibited Argentina from paying even current instalments of interest to exchange bond-holders unless it had paid 100% of principal and rolled-up interest (etc.) to the vultures in one go. Under the injunction, therefore, the vultures were to be treated far more favourably than anyone else – it actually imposed unequal treatment in the name of equal treatment!
The injunction was drafted to cover virtually any financial intermediary, wherever on the globe to be found, who might have even the most tenuous tiny connection with New York. To its credit, the Argentinian government refused to be blackmailed by the court in this way and continued to refuse to pay the usurious sums claimed by the vultures… while making emphatically clear its willingness to pay the exchange bond-holders what they were due under the 2005-2010 re-structured agreements – and also to pay hold-outs on the same basis as the exchange bond-holders.
(It subsequently got worse – Judge Griesa even had the judicial nerve to find Argentina in “contempt of court” for introducing legislation into its own democratically elected Congress, with a view to making payments that were contractually due to exchange bond-holders! For a US court to intervene so crudely in another country’s democracy speaks volumes about colonialist mindsets.)
Through this extraordinary injunction, the US courts, including the Supreme Court (by its novel interpretation of foreign immunity law – but see Justice Ginsburg’s fine minority opinion) in effect imposed a blockade on Argentina to prevent it having any access whatever to the capital markets. This prevented Argentina from making any payments to exchange bond-holders, and it was then – perversely since it wished to pay them – held to be in new default. In fact, it seems to us quite wrong to say that Argentina was in “default” to the exchange bond-holders, given that it made every conceivable effort to pay them but was blocked only by force majeure on the order of the US courts. For more on this aspect, see “Did Argentina ‘Default’?” 
Then stalemate, until a new President was elected in late 2015, who hopes to resolve the problem and – for better or for worse – regain access to foreign capital markets. Hence the very recent offer to settle with the hold-outs. But will this work?
What happens next?
Already, several creditors have agreed in principle to settle – but these do not include the two most aggressive vulture funds – NML (owned by Republican billionaire Paul Singer’s Elliott Management) and Aurelius (headed by Mark Brodsky, ex of Elliott Management). They are indeed reported to have rejected the terms offered by President Macri and his Finance Minister, Mr Prat-Gay. Instead of the 1600% profit some of them have been claiming, under the new Argentine offer it would amount to only 1000%!
Even if Argentina can reach in principle agreement with many of the hold-outs, there are two conditions precedent to finally settling and paying out on the claims and disputes. First, the terms of any deal have to be agreed by the Argentinian Congress (parliament), in which the government does not have a majority it can necessarily rely on. Second, no payment can be made unless the current US court injunction is either lifted entirely, or its terms are substantially changed.
This means that Argentina is still in the position of a hostage, with its people being required by the hostage-takers to pay an exorbitant ransom. But this is state-backed hostage-taking, with any attempt to release the hostage being prevented by the modern version of gunboat imperialist blockade – the extra-territorial, all-embracing injunction.
We are not alone in calling this a case of ransom – this is how the Financial Times (editorial of 8 February) sees it:
Galling though it must be to pay ransom, Mr Macri’s government is right to make the offer. It is not yet clear how many of the holdouts, and particularly the combative Elliott Management, will accept the terms or something close to them. If they insist on full payment or a much smaller writedown, Mr Macri’s position becomes more difficult and his decision more finely balanced.
That Argentina ever came to this reflects a ruling by a judge in New York on pari passu clauses in sovereign bonds that was creative bordering on eccentric. That judgment and the extraterritorial reach of US law cut Argentina off from international bond investors.
The editorial – while encouraging the vultures to accept a deal (the ransom) along the lines offered – is realistic as to the dangers:
But there can be no doubt that paying back at full value the holdout creditors who have held Buenos Aires to ransom for more than a decade would be expensive politically as well as financially. Outside investors would also ask, with good reason, why obstreperous bondholders with superior financial and legal resources should be paid so much more than those co-operating early on.
(The highly influential Buenos Aires newspaper “Clarín” – which is politically close to the present government – favourably cites quite a lot of this FT editorial, but curiously avoids the passages referring to “ransom”, or to “why obstreperous bondholders with superior financial and legal resources should be paid so much more than those co-operating early on”. Nor does it quote the FT’s view that “Argentina should not be eager to start racking up debt again”!)
A messy situation
At present, not only have NML and Aurelius declined to accept the offer as it stands – other hold-outs are clamoring to get hold of their share of the carcass. Lawyers for a separate set of would-be “Class Action” plaintiffs have just written to Judge Griesa arguing against any move to lift the injunction unless they get paid on the same basis. Yet the person charged by the court with mediating the settlement negotiations, Daniel Pollack, denies that – as they claim – their bond contracts include the pari passu clause in the first place!
So the situation is very, very messy. The vultures’ tactic is evident – to keep pressing for higher and higher settlement terms, while giving the impression that at some point they would be prepared to settle. Meanwhile more and more plaintiffs (the so-called “me-toos”) try to join in, piggybacking (if the metaphor permits!) on the vultures’ backs. The risk is that unless the US court relents, the Argentine government may be forced to offer more and more to get the settlement it wishes with all parties. Given the low level of reserves, it appears that, if it wishes to settle the claims, the Argentinian government will be forced to borrow once more in order to fund the settlement. And as (if) more and more parties do settle, then the remaining hold-outs get into an even stronger bargaining position.
Three causes of chaos
The chaos is down to three things above all.
First, there is the utter “liquidation messiness” of the situation, with a plethora of different bonds bearing different interest rates based on different formulae and dating back sometimes over decades – this can only lead to lengthy, drawn-out squabbling and arguing over interpretation and quantum.
Professors Juan J. Cruces and Tim R Samples (see details below) have studied some of the range of bonds held by “hold-outs”, and in the Abstract to their paper say:
We document the wide heterogeneity of holdout rates across Argentina’s 150 defaulted bonds (of which 74 still have holdout rates greater than 5 percent) and focus the subsequent analysis on the seven most held-out bonds. The bonds in our sample have holdout rates between 20 and 82 percent and account for about 30 percent of total holdout principal. We show that New York’s statutory real rate of interest on overdue interest has been 6.6 percent on average during the years affecting this suit compared to 3.1 percent during the previous forty years. As such, the New York statutory rate has become more punitive than compensatory.
We also illustrate the growth of the value of holdout claims for the seven bonds from their initial $1.7 billion in principal up to $4.3 to $7 billion in current value, depending on when holdouts obtained judgments. We analyze the sensitivity of holdout claims to different approaches to overdue interest—an issue that has become increasingly controversial in New York state law in recent years. We next assess the returns that investors would have obtained by purchasing the seven-bond basket at different times since 2002. We find that investors would have multiplied their money an average of 8 times if they obtained judgments in 2008 or 13 times in 2015. Finally, we compute the current value of Argentina’s 2005 exchange offer and find that is worth about one-half of the litigants’ claims for judgments obtained in 2008.
Second, the partiality of the US courts, using the discretionary remedy of injunction to enforce its “eccentric” interpretation of the (supposedly equitable) pari passu clause, to enforce completely unequal treatment, by discriminating in favour of the financial interests of some of America’s richest and most powerful corporations (we say America’s, though NML at least is registered in the tax haven Cayman Islands).
The key here is the so-called “ratable payment” that Argentina was required by the injunction to make – which was in the full discretion of the judge. Judge Griesa took an absurd line, requiring 100% of what was outstanding to be paid. Thus, if the exchange bond-holders were due a next stage payment of interest of say $1 million, while NML’s total claim for principal and interest came to say $1 billion, each should get exactly these amounts, representing 100% of what was then due! Yet NML would have gotten 100% of his total amount due, while the exchange bond-holder would have received just a tiny fraction of the overall amount due on its exchange bond contract, which was properly to be paid in many sequential stages of interest and principal.
Judge Griesa’s interpretation of ratable payment was thus a recipe for inequality. It reminds us of the old quip by Anatole France:
The law in its majestic equality forbids rich and poor alike to sleep under bridges, to beg in the streets and to steal bread.”
Messrs Juan J. Cruces and Tim R Samples  , in their paper “Settling sovereign debt’s ‘trial of the century’” (January 2016), also see the ratable payment as the key issue:
But adjudicating sovereign debt disputes is no easy task. Institutional voids and limited enforceability only make matters more difficult for courts. As a result, striking a balance between the legitimate restructuring needs of a sovereign debtor, the interests of innocent third parties, and the legitimate rights of creditors is a complicated goal. But at least one point is clear: Abandoning—or at least revising—the ratable payment injunctions would clear the path for settlement.
Moreover, in the Abstract to their paper (already referred to), they also point out that
[W]ith so many holdouts unaccounted for, a settlement with the NML litigants exposes Argentina to the tyranny of the next litigant as long as the current injunctions remain in place.
The third issue leading to the present chaos is the absence of a fair and independent international process for dealing with sovereign insolvency – fair in the sense of properly balancing the interests of creditors and debtors. While individuals and corporations can go bankrupt – and have their unpayable debts written off – that is not true of states. And when we talk of states, we mean people, the vast majority of whom are not rich. The particular evil of vulture funds is that their business model, devoid of any social merit, largely targets poor people in poorer countries.
Absent a formal international process, a settlement between a sovereign state and at least a large majority of creditors is the next best thing – which inevitably means creditors accepting a significant haircut. It is absurd and against the public interest that – with the matter left to individual contract law – a small percentage of hold-outs and vultures should be able to destroy the integrity of a settlement process agreed to by an overwhelming majority of creditors.
The ordinary courts have, however, shown themselves unfit to resolve such issues. The “Wall Street” mindset of Judge Griesa was demonstrated when he sought to justify his injunction – which explicitly offers more favourable treatment to the vultures – in the following terms:
In accepting the exchange offers of thirty cents on the dollar, the exchange bondholders bargained for certainty and the avoidance of the burden and risk of litigating their rights on the FAA Bonds. [They] made the choice not to pursue the route which plaintiffs [i.e. the vultures] have pursued. Moreover, it is hardly an injustice to have legal rulings which, at long last, mean that Argentina must pay the debts which it owes. After ten years of litigation this is a just result.”
The injustice in fact goes deeper, since the vultures’ business model could not work unless the overwhelming majority of creditors accept a deep haircut, thus laying the financial basis for the payment of a huge ransom.
As we have previously argued,
This is really quite breath-taking in its intellectual audacity and paucity. [T]he judge is telling the exchange bond-holders in effect that since they took the “safe” route out of the problem by agreeing to the debt sustainability restructuring, they have only themselves to blame for ending up worse off than the hold-outs!
No mention of the fact that most of the hold-outs buy up their bonds dirt cheap and take their speculative chances in enforcement. No hint of a thought that an orderly settlement of a debt crisis to enable a country to return to debt sustainability might just be in the public interest. No. Just unadulterated judicial support for the Cayman Island billionaire vulture funds.” (p.16).
So despite all the official talk of CACs (collective action clauses) and improved contractual terms for future bond issues, the case for a formal independent, fair process for resolving sovereign insolvency issues remains as strong as – if not stronger than – ever. Unless the courts see their task to protect the world’s poor as well as to enrich its wealthiest billionaires, the vultures will continue to prey.
The injunction must be lifted
There is only one just outcome now – and that is for the New York Court to lift the injunction and enable any agreed settlements between Argentina and its remaining hold-out creditors to be made, if that be the democratic will of Argentina’s Congress. What must be made clear is that the US courts will cease to act as the hostage-takers’ enforcer, and the vulture funds must see that from now on, they are on their own.
If the US courts continue to back the vultures to the last, then the Argentinian government will indeed be in a very tricky spot – in the FT’s words, it would be “expensive politically as well as financially”. In our view, it would be time to call the bluff of the vultures and the courts, refuse to pay an “exorbitant ransom”, and mobilise a wide international political move against the imperial blockade.
 And in the view of some “experts” of questionable neutrality, keep all offers a secret from your own people so that the Wall Street hostage-takers are not embarrassed – see Charles Blitzer in FT Alphaville, and a retort from PRIME.
 Roughly speaking, though it is the subject of much legal debate, “pari passu” means on the same footing. It had been very widely seen as mere “boilerplate” wording carried across from commercial bond contracts, where it relates to legal ranking in case of legal insolvency. For more on this, Professor Rodrigo Olivares-Caminal’s 2013 article for the Bank of International Settlements (BIS) “The pari passu clause in sovereign debt instruments: developments in recent litigation” offers an interesting and helpful introduction.
 “Did Argentina default?” by Jorge Vilches and T Sabri Öncü, first published in the Indian journal, Economic and Political Weekly, 24 January 2015, and cross-posted on the PRIME website
 Professor of Finance and Economics at the Universidad Torcuato Di Tella Business School, and Assistant Professor of Legal Studies, Terry College of Business, University of Georgia, respectively.