By Bodo Ellmers
The long litigation odyssey between the government of Argentina and holdout creditors continues. Debt justice campaigners in Argentina and the USA are enraged about a new ruling by the New York appeals court in favour of the vulture funds NML Capital Ltd and Aurelius Capital, which sued for full payment of US$1.3 billion of holdout debt. The New York court upheld the previous ruling that Argentina must repay the vulture funds every time it repays the creditors that participated in the debt swap of 2005. Enforcement is still on hold until the US Supreme Court has made a decision to take the case. If it is upheld in this last instance, Argentina would face the choice between paying vulture funds that speculated on the country’s bankruptcy after the financial crisis of 2002, which is forbidden by Argentine law, or defaulting on the restructured debt too.
Flawed interpretation of equal treatment
The US court rule is mainly based on the pari passu (parity) clause in bankruptcy proceedings, which says creditors should be treated equally and without preference. On this basis, the US court decided that, when Argentina pays the creditors that participated in the debt restructuring, it has to pay the vulture funds that expect full payment too. But, as Jubilee USA put it, “their interpretation of the parity clause is deeply flawed”.
This view is shared by the international community, as the relevant international organisations find that vulture funds undermine inter-creditor equity. The United Nations’ responsible lending and borrowing principles are that “lenders should be willing to engage in good faith discussions with the debtor and other creditors to find a mutually satisfactory solution”. That has certainly not happened in this case. Argentina has recently offered an alternate payment plan to holdout creditors that was essentially the same deal taken by the 92 percent of creditors that participated in the debt restructuring after Argentina’s debt crisis in the early 2000s. But the holdout creditors rejected the plan. Offering them full payment would put Argentina in a difficult position, as the UN principles do not approve of arbitrary discrimination among creditors.
Devastating implications for debt crisis management
The US court ruling might have severe consequences for the functionality of the international financial architecture. A recent paper on sovereign debt restructuring by International Monetary Fund (IMF) experts said that the impacts are already being felt. The IMF finds that “litigation against Argentina could have pervasive implications for future sovereign debt restructurings by increasing leverage of holdout creditors … the ongoing Argentina litigation has exacerbated the collective action problem”. The US court decision would undermine future debt restructuring as it gives new leverage to holdout creditors suing for full payment. In consequence, “holdouts will multiply and creditors who are otherwise inclined to agree to a restructuring may be less likely to do so due to inter-creditor equity concerns”.
Jubilee USA reports that the IMF’s Managing Director Christine Lagarde planned to file an amicus brief to the US Supreme Court in support of Argentina, but she was stopped from doing so by intervention from the US Treasury. The USA is the IMF’s largest shareholder and is endowed with a de facto veto right over its decisions. European governments such as France supported Argentina in this case. German courts had previously declined to accept vulture fund claims.
New dangers for financing development and poverty eradication
The US judges said that the ruling would not have implications elsewhere because “Argentina has been a uniquely recalcitrant debtor”. However, Eurodad research has shown that vulture funds are a permanent annoyance for debt restructuring that is made in good faith, including for the world’s poorest countries. The African Development Bank (AfDB) states that 11 heavily indebted poor countries have been targeted in 46 law suits. The costs could amount to 13 per cent of each affected countries’ Gross Domestic Product (GDP). It finds that “vulture funds grind down poor countries in cycles of litigation, a practice referred to as ‘champerty’ and largely unknown in African legal systems”. The problem became so severe that the bank had to set up the African Legal Support Facility to help poor countries defend themselves before foreign courts. The facility diverts scarce resources from the AfDB’s core businesses in financing development and poverty eradication.
Vulture fund law suits are obviously good business for the law firm industry in financial centres such as New York and London. However, in order to make sure that aid can be used for more important purposes, Eurodad calls on governments to enact legislative changes at the national level to prevent vulture funds from using national courts to pursue their claims in the first place. Such legislation should make profiteering in defaulted sovereign debt illegal.
Vulture funds have also caused troubles for Greek debt restructuring. While 100 per cent of sovereign bonds covered by Greek law could be restructured, the holdout ratio was 44 per cent in the case of Greek government bonds issued under English law. Such holdouts have created tremendous extra costs for Greece, and for all the European taxpayers who are ultimately backing the EU’s bail-out instruments currently applied in Greece. Jubilee Debt Campaign UK has called on the British government to enhance the law, but this has not yet happened.
The US court ruling has once again unveiled both the ineffectiveness and unfairness of the current debt governance regime. The US court rejected the view that it would give too much leverage to creditors and suggested that governments should use collective action clauses (CACs) that would bind bondholders to majority decisions. Indeed, given the Greek experience, the EU recently introduced the rule that all new Eurozone bonds contain such clauses. But the IMF finds that such clauses are of limited use: “the court’s confidence in the salutary benefit of CACs appears somewhat optimistic given the ability of holdout creditors to take blocking positions in individual bond issuances”.
The IMF suggested a new statutory debt workout mechanism as a more effective alternative. However, according to information obtained by Eurodad, the US representative vetoed the proposal in the IMF’s Executive Board, condemning the IMF to pursue piecemeal second-best reforms. Meanwhile, the UN took over the development of new debt workout mechanisms.
In a comment on the US court ruling, Jubilee South Argentina stressed that attention needs to be paid to the origins of Argentina’s debt. Even if rolled over in later times, much of the debt built up originally took place during the time of the military dictatorship and the ‘dirty war’ in which more than 30,000 people were killed. It would therefore qualify as ‘odious debt’. Moreover, Jubilee South questioned whether New York courts are a competent jurisdiction to rule over Argentine debt and accused the Argentine government of acting unconstitutionally. They demand that a thorough debt audit should be conducted and claim it is necessary that “both the international community and the government of Argentina recognize that the country has every right and all the required evidence to denounce and nullify both the illegitimate debt contracts that have been imposed against the will and rights of the Argentine people, as well as the renunciation of sovereignty and jurisdiction”.
According to Jubilee South, a new strategy on sovereign debt restructuring must put “the defence and promotion of human rights over the claims of capital, as relevant domestic and international law demands”.