Wednesday, April 24, 2013

NML Brief: Analysis and Implications



Sovereign Debt Litigation: Decoding NML Final arguments against the Republic of Argentina and why litigating so hard may be counter-effective to plaintiffs´ goals when the defaulting debt is large

Eugenio A Bruno
Director TIG Americas
Partner - Garrido Law Firm
April 23, 2013


This paper discusses the recent brief filed in the famous case NML v The Republic of Argentina which takes place before the federal tribunals of the New York, and how such filing may affect the resolution of the litigation, probably forcing Argentina to default.
We take the main arguments of NML and analyses them in lieu of Argentina´s political and financial situation as well as certain contractual limitations that prevents it to better the terms of the payment proposal it made on March 29, 2013.
Finally, we include certain remarks about the future developments under this case.



A.      The Most Famous Case in the History of Sovereign Litigation: NML v The Republica of Argentina

B.      The Most Recent NML Brief and How it May Force Argentina to Default















Sovereign Debt Litigation: Decoding NML Final arguments against the Republic of Argentina and why litigating so hard may be counter-effective to plaintiffs´ goals when the defaulting debt is large

Eugenio A Bruno
Director TIG Americas
Partner - Garrido Law Firm
April 23, 2013


A.      The Most Famous Case in the History of Sovereign Litigation: NML v The Republica of Argentina[1]

NML v Argentina is a case that takes place before the New York federal courts and as such it is a long-lasting and very demanding and stressful legal battle for the Argentine population, economy and financial as well as to the plaintiffs. As its effects may have certain significant effects to the sovereign debt markets (less than originally expected to me however) the case is also closely followed by scholars, emerging market investors, finance government officials from other countries, multinational financial institutions, among others.

Under the case, NML, four other investment funds and 13 individual investors have obtained three favorable cases, two from a district court and one from a circuit court. The former rulings were issued by judge Thomas Griesa and the latter by a panel of three judges from the Court of Appeals.

There are two main legal discussions that are happening under the case, both of which are novel - the meaning and extent of the pari passu clause and, as a way to enforce judgments against Argentina (which as a sovereign debtor receives the benefits from the protection of the U.S. Foreign Immunity Sovereign Act that, in practice, means that a sovereign bond plaintiff may obtain favorable rulings against a country but never be able to collect on those judgments and therefore be at the mercy of the debtor), the attachment of flows of payments directed from Argentina as issuer to the holders of Argentina debt bonds that is being paid by the country. Those payments are transferred through the Bank of New York.

A significant discussion under the case is whether the Bank of New York is trustee for the exchange bondholders, agent for the Republic of Argentina or both. The eventual decision about the nature of the Bank of New York will have an important effect on the outcome of the management of the debt situation by Argentina because if it is decided that said institution is effectively enjoined by the court´s decisions, Argentina would be prevented from continuing paying the exchange bondholders and therefore a risk of a new default would eventually increase unless Argentina decides to pay the court ruling (very unlikely from political and finance reasons) or it carries on an arrangement with the exchange bondholders to change the place of payment (from New York, the current place of payment, to a given country in Europe or even Argentina as some reports have indicated),[2] but which is very difficult for legal reasons.

The three rulings in favor of the plaintiffs refer to the pari passu discussion.[3] But only two of them refer also to the attachment of the payment to the exchange bondholders and both are from the court of appeals, which means that the circuit court has not issued an opinion about it yet.[4] 

What is very remarkable about the case is the determination from both parties to stick to its stances and arguments, which raise the stakes under play, presents continuous drama to the different particular legal developments under the case (including to the simplest ones) and defer to the courts the resolution of this dispute, as opposed to negotiating a potential settlement. Deferring all to the courts, which of course is in several occasions the purpose of lawsuits, may be dangerous, in these highly complicated sovereign debt cases because a negative outcome to Argentina, for example, may force the country to incur in a new default. But this eventual consequence of a negative judicial outcome against Argentina must also be analyzed from the eventual consequences to NML and the other plaintiffs under this case. It is my impression that the plaintiffs would be also facing a dire situation based on the potential fact that they will not receive the money from their eventual positive judgments as Argentina has indicated that it will not pay them.[5] It may thus be a lose-lose situation, even more under a potential chaos given by the default, unless something is worked out between Argentina and NML (which Argentina is refusing to a great extent[6]) or the U.S. Supreme Court accepts an appeal right away, which I think will happen and therefore the legal battle would continue for additional months. However, at the end of the day if Argentina ends up losing all appeals and is force to pay and it does not as its principal officers and counsel have indicated several times, NML and the other plaintiffs in this case will not collect on the judgments. We will expand the reasons of this understanding hereby. 

B.      The Most Recent NML Brief and How it May Force Argentina to Default

The brief filed by NML and the rest of plaintiffs on April 19, 2013[7] is a sign of the utmost determination shown so far by the hold-out creditors against Argentina before courts as such brief is the last filing by them prior to the upcoming judgment from the U.S. Court of Appeals of the Second Circuit of New York, and includes important legal points relevant not only to this particular lawsuit but also to certain areas of sovereign debt litigation which have a high degree of uncertainty. Those legal points are discussed hereby, along with comments from me related to each point. This way, each argument used by NML is copied and analyzed from this author.


1) Argentina's defaulting stance and complete lack of respect to principles of rule of law, and U.S. laws and courts

This is the first argument of NML. It reads:

"With its latest submission in this Court, the Republic of Argentina continues its long and consistent pattern of defaulting on its contractual obligations, defying the laws of the United States (which its contracts expressly invoked), and showing contempt for the courts to whose jurisdiction it unreservedly submitted. The government of Argentina plainly believes the rule of law does not apply to it."

These arguments have been used several times and respond to the finance terms of the Argentine proposal, filed on March 29, 2013[8], which offered payments with large discounts compared to the moneys recognized to NML by the court judgments both from the district and circuit courts. Of course, now NML is using words that have more emotional tone perhaps, addressed probably more to the “hearts” of the three judges of the panel of the appeal court than to their minds (of course these arguments have deep legal reasoning behind them and also aim to the minds of the judges).

2) Unilateral and coercive restructurings

"Argentina undertook a 'unilateral and coercive approach to [its] debt restructuring, rejecting practices that have allowed other '[sovereign bond restructurings' to be “resolved quickly, without severe creditor coordination problems, and involving little litigation.”

I think there are three comments to make. First, I don´t agree that the restructurings were unilateral and coercive as there were consensual and voluntary agreements with more than 92% of the holders of Argentine debt in default. The defaults of sovereign debt and moreover a continued lack of payment and prolonged debt restructurings based for example in a denial to resolve the default for three years, as it was the case of Argentina, present very difficult options for the holders of said debt. Those difficult options are based on very weak contract rights under all sovereign bonds to sue and collect on the eventual favorable judgments they may obtain because sovereigns' assets are protected by the FISA and therefore attaching sovereigns' assets has proved to be a mission "almost" mission. The cases against Argentina is a clear evidence given that after ten years [9]no plaintiff has been able to collect on the more than 500 existing judgments.

This aspect, coupled with a lack of willingness to pay during three years (from 2002 to 2005, and thereafter up and until 2010 when Argentina launched the second restructuring) and a lack of capacity to pay argued by the Argentine's government, balances the bargaining power towards Argentina as debtor of the defaulting bonds against its creditors. Therefore, without effective collecting weapons, the options of the holders of Argentine defaulting bonds against Argentina to force it to pay and/or restructure vanishes. But several times this is how a sovereign default may unfold and therefore the holders of the defaulting bonds, confronted with exchange offers from Argentina (such as the ones in 2005 and 2010), must make a business decision about whether or not they would participate in the swaps. But I don´t think that the acceptance of the restructurings by 92 per cent may be considered coercive as they still had the option of rejecting them and continue litigating. This is at the end of the day a business decision. The fact that almost eight per cent rejected the swaps is an indication that some of the holders decided not to accept them. By the same token, the restructurings were not unilateral as they were not imposed by the government of Argentina by changing through an unilateral act (i.e. without the approval of the exchange bondholders), the terms and conditions of the defaulting bonds. Through a unilateral restructuring, strictus sensu, the debtor either changes the terms and conditions of the bonds or eliminate them and issue new ones, without any acceptance from the counterparties, in this case the bondholders. This is absolutely illegal, but Argentina just did not do it.

Another way to see it is an analysis of the term 'unilateral' from a negotiating standpoint. Usually a sovereign in default may approach its defaulting problem through two manners: (a) negotiating with its defaulting creditors (who act represented by steering committees for example) the terms and conditions of the new payment scheme or, (b) alternatively, designing a payment proposal unilaterally and with mere consultations with the defaulting bondholders. Both ways are legal, and the grounds for the effectiveness of either manner consist of a combination of political, economic, financial, strategic and legal reasons. In any event, it is up for the sovereign what decision to make in this respect. In the former case, the proposal would be "negotiated and bilateral", while in the former the proposal would be "not negotiated and unilateral". But from this standpoint, there is nothing illegal about which road the sovereign may elect to take. It would be a business decision from the sovereign, and the ultimate analysis would be the outcome of the offer and the eventual litigation associated with it.[10]

I agree, though, that the practices used by Argentina have not helped to resolve the default quickly, but that was the explicit aim of the Argentine government back in 2005 due to its unwillingness to pay and its own alleged lack of payment capacity. Argentina, for political and economic reasons, decided not to resolve the default quickly.

Again there is nothing legal or illegal about it, it is just that you need to deal with consequences, whatever they might be, and in the sovereign debt litigation and restructurings those are not clear and uniform.

I also agree that due to the Argentine stance of (a) rejecting a bilateral negotiation with a steering committee and other bondholders, (b) deferring the solution of the default, (c) and more importantly, because of the significant initial losses of its restructuring proposal (when it was formally made almost three years after the default), there was large litigation, which, of course is taking several years and probably will take many more down the road. These are some of the consequences we mentioned as the business decisions that the sovereigns may take.

In this sense, the Argentine restructuring debt situation is unique as the amount of the current defaulted bonds (summing up principal and interest) exceeds USD 20 billion. And here probably lies a big problem for the plaintiffs, because said amount appears impossible to be paid by Argentina, even in the hypothetical case the government would have “willingness to pay.” For example, if one compares the amount of the debt in default of Argentina, with the defaulting debts of all other countries that have defaulted on their external bonds, there is a difference of "several ceros" (the average of the previous holdout debts, excluding Greece, is around USD 200 million[11]). This means that NML and the other plaintiffs may have put themselves in a legal tramp, which is eventually obtaining favorable rulings, but unenforceable even if they win the discussion about the injunctions over the Bank of New York.[12] The consequence could be a lack of collection but with a potential new default (depending upon the appeal to the U.S. Supreme Court) that would prevent everybody from receiving their payments (exchange bondholders and judgment creditors). It is a gamble to force Argentina to pay their judgments (but ignoring that the "me toos"[13] would also sue under the same legal grounds so an actual payment of the NML ruling may not isolated from the other potential claims) instead of defaulting altogether if Argentina losses on all grounds. Argentina should issue a new exchange and then eventually reach an agreement with the remaining holdouts, which would be few if Argentina obtains favorable rulings regarding the injunctions on the Bank of New York.[14]

3) Pari Passu: Equal Rank Obligation and Equal Payment Obligation

"In keeping with that approach, Argentina refused to comply with its explicit commitment to treat its “payment obligations” on the bonds held by Appellees “at least equally with . . . its other . . . unsubordinated External Indebtedness".

I agree that the Lock Law[15] violated the traditional interpretation of pari passu (equal rank obligation). But the Court of Appeals went on by taking a new interpretation (equal payment obligation), of which there is a legitimate legal dispute. In this respect I am not sure about the legality of novel interpretation of the equal payment obligation. Continued litigation for sure on this topic.[16]

4) Capacity to Pay

"The district court found as fact that Argentina had ample resources to pay
Appellees, as well as the Exchange Bondholders, and that the balance of the equities overwhelmingly supported the remedy ordered."

I don´t think this has been resolved that way definitively. Besides, even though we are talking about USD 1.47 billion (as the amount of the claim as of March 31, 2013 according to NML), which by itself is a huge enough, there exists the "me toos", who were already mentioned, that increases the debt in default to more than USD 20 billion (principal plus accrued interest). Out of this amount, 2/3 is subject to New York law, while the rest is subject to European and Japanese laws. But there is a claim filed by more than 50.000 individual Italian bondholders (for more than 1.5 billion) before the arbitral tribunal of the World Bank (ICSID), whose representatives have indicated that they will enforce the lauds in the New York courts. Thus, almost 90 per cent of the defaulting debt will be subject to the jurisdiction of the New York courts.

This increases the likelihood of a "rush to the courts" from a significant number of "me toos" if NML is paid, which puts in danger the finances of Argentina, as it has less than 40 billion in reserves at the Central Bank.

The NML brief refers to this point but with an interesting degree of ambiguity, trying, probably that this topic does not turn into something relevant. They mentioned that the eventual claims from other hold outs are a matter of different cases and whose outcomes may refer to the NML decision. If NML refers to cases in New York they are exactly similar to its case.  

5) Right to reject the large "haircuts"

"The Court further held that Appellees “were completely within their rights to reject the 25-cents-on-the-dollar exchange offers” that Argentina had made in 2005 and 2010."

I think we need to discuss three points relating to this paragraph. First I agree that under New York law a voluntary exchange (restructuring swap) as the two ones carried on by Argentina, the holders that desire to holdout from them maintain such right, which may not be impaired. Therefore a voluntary and bilateral restructuring may not be converted into a "coercive and unilateral" one.  Second, this defense is of course a self-acceptance that the Argentine debt exchanges were not coercive and unilateral. And third, that the real "haircuts" suffered so far by the exchange bondholders are not 75 cents on the dollar as argued by the NML brief. The reason for this allegation is that Argentina has paid, in addition to principal and interest, significant amounts of money on account of the so called GDP warrants, which are financial derivatives that give the bondholders the right to receive additional amounts if Argentina grows more than 3.3 per cent per annum. Since Argentina has effectively growth more than that percentage during several years after 2005, the real losses are lower. In fact, the losses may only be 15 per cent.

6) The new Argentine proposal contemplates losses of 85 per cent

"Argentina offers to eliminate those obligations in return for new, deeply-discounted, potentially unenforceable, and unmarketable paper, payable decades hence. Indeed, according to Argentina’s own math, those new securities would be worth less than 15% of what Argentina owes on the FAA Bonds.”

I think the explanation is correct because against a ruling of USD 1.47 billion (due to accrued interest since November 22, 2012), in cash in one installment, Argentina offered the bonds mentioned by NML, and therefore the proposal is below the judgment amounts.

Argentina, however, was never in position to make a payment proposal with a value higher than what was offered in its proposal. The reason is the application of a clause included in the terms and conditions of the exchange bonds denominated "Most Favored Creditors.”[17]. Any offer with better terms to plaintiffs, would need to be offered to the exchange bondholders. Who would pay that bill?

7) Contempt Threat

"Argentina’s response manifests yet again its contempt for its obligations, the laws of the United States, and the orders of U.S. courts....Argentina’s counsel declared that Argentina would not “voluntarily obey” any order “other than” the one it proposed. This is exactly how Argentina has dealt with creditors for the last decade: unilaterally dictate pennies-on-the-dollar “exchange offers,” and threaten to pay nothing if the offer is rejected. Argentina has now treated the Court the same way; that is the very antithesis of “good faith.”

Regarding this paragraph one should distinguish the substance from the form. From a substance standpoint, Argentina has legal limitations to offer holdouts better conditions than the 2005 and 2010 restructurings. Additionally, Argentine counsel received political instructions not to make a better proposal as well. On the contrary, if one looks at certain forms used, perhaps certain words expressed by Argentina counsel in the hearing that took place in February 27, 2013[18] probably were not necessary and the cause was the "heat" of the moment. But the legal limitations do exist.

8) Is it the best strategy by NML?

The strategy probably will not get NML to where they want: get paid, all and now. Why? Because Argentina does not have the financial resources to deal with the 20b of claims. The average judicial claim collected through courts against sovereigns (from Peru to Brazil, touching Africa) is USD 200, several ceros lesser.

We still believe that the discussion of the ratable payment[19] will favor NML, but that there are legal uncertainties about the decision on the injunctions and may not rule out that the Bank of New York is not enjoined by them.







CONTACT INFORMATION:

Eugenio A Bruno
Garrido Law Firm
Tel 00 54 11 4 850 4000






[1] For a discussion and analysis of this case please see my upcoming book “Sovereign Debt and Sovereign Debt Restructuring”, Eugenio A Bruno, Globe Law and Business Ed. London, 2013 as well as my article Argentina Sovereign Debt: Inside the judicial labyrinth and how we may leave it, but not yet”, Eugenio A Bruno, SSRN, April 22, 2013. The lower court case is NML Capital Ltd. v. Republic of Argentina, 08-cv-06978, U.S. District Court, Southern District of New York (Manhattan). The appeal is NML Capital Ltd. v. Republic of Argentina, 12-00105, U.S. Court of Appeals for the Second Circuit (New York).

[2] Financial Times, March 31, 2013, “Argentina hints at payment rerouting”, Jude Webber.
[3] Chapter Argentina: effects of the pari passu clause on future sovereign debt restructuring”, book “Sovereign Debt and Sovereign Debt Restructuring”, Eugenio A. Bruno, Globe Law and Business, London, 2013.
[4] See not 4 above.
[5] See note 2 above.
[6] See note 2 above.
[7] NML Capital Ltd. v. Republic of Argentina, 08-cv-06978, U.S. District Court, Southern District of New York (Manhattan). And NML Capital Ltd. v. Republic of Argentina, 12-00105, U.S. Court of Appeals for the Second Circuit (New York).
[8] See note 7 above.
[9] The first judgment against Argentina was granted by judge Thomas Griesa on April 5, 2003.
[10] In an upcoming, new paper we will discuss which way is better depending upon the grounds of each and the purpose the sovereigns in default desire to reach.
[11] Book “El Default y la Reestructuración de la Deuda”, Eugenio A Bruno (Nueva Mayoría, 2004).
[12] See note 1 above.
[13] The term “me toos” refer to other holders of Argentine defaulted bonds with the ability to sue Argentina under those bonds.
[14] See note 1 above.
[15] See note 1 above.
[16] See note 1 above.
[17] See note 1 above.
[18] U.S. Court of Appeals Hearing, NML Capital Ltd. v. Republic of Argentina, 12-00105, U.S. Court of Appeals for the Second Circuit (New York).
[19] See note 1.

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