CAC-handed

November 27, 2012 | Argentina, Bonds, Capital markets, Collateral, Equitable principles, Global news, Law, Recapitalization, Sovereign bankruptcy, Theory, Workouts

By:David A. Smith


Though virtue often has to be its own reward, every now and then
standing up for principle and not knuckling under to sovereign coercion is sometimes acknowledged even if not rewarded, and that is rare enough to be celebrated even if it is only an interim victory, as reported recently in the Wall Street Journal (November 21, 2012):

 

Don’t cry at me, Argentina

 

U.S. Orders Argentina to Pay All Creditors

 

Argentina suffered a setback in its decade-long battle with creditors over the country’s 2001 debt default as a U.S. judge ruled that the country has to swiftly pay creditors that never negotiated new terms for their debt alongside those that did, raising fears the South American country will refuse to pay.

 

As we saw a while back, Argentina strong-armed most of its creditors into acquiescing in having their bonds unilaterally cut, but a few entities, most notably an American hedge fund, rejected the coerced settlement and have stuck to their guns.

 

How could I be a dictator, when I smile so broadly?

 

The holdouts can do so because the bonds lack a ‘collective action clause’ (CAC) under which a supermajority of bondholders can bind all bondholders.  In the abstract, CACs make sense – if there is a restructuring that is overwhelmingly in the bondholders’ interest, one wants to nullify the ‘holdout problem’ where those who don’t consent exploit those who do.  Of course, CACs complicate life for a bond buyer, because that bond buyer must now evaluate whether its rights can be compromised by others (like public-government buyers or major local employers) who are subject to non-economic coercion. 

 

For that reason, CACs are much more dangerous when the issuer is a sovereign government, because when it cheats, its word is lawat least on its home turf – so the creditors are thrown back on extra-national courts, like those in the US, to compel the sovereign to pay attention.

 

U.S. District Judge Thomas Griesa late Wednesday barred the country from making a coming $3 billion payment to investors who own restructured bonds unless it also coughs up some $1.3 billion to be held for investors who never struck a deal and want full repayment.

 

Do I look sympathetic to deadbeat nations?

 

Although only a district judge, Judge Griesa is 82, and in the southern district of New York (Manhattan) district court judges see all kinds of leading-edge or large-impact cases; though I have not read the decision, I expect it will be difficult to overturn.

 

The ruling was the worst possible outcome for Argentina, said Eugenio Bruno, an attorney at Argentine law firm Estudio Garrido, which represents several creditors that accepted the offers.

 

Argentine Economy Minister Hernan Lorenzino called the ruling “judicial colonialism” on Thursday and vowed the country would appeal, to the U.S. Supreme Court if necessary. But he didn’t say whether the country would bend in its insistence that it won’t pay the holdouts a dime.

 

Of course Minister Lorenzino didn’t make any commitments, because his position is legally indefensible and economically unsustainable – Argentina cannot afford to cut off all its assets from the US capital markets.

 

But if we pay the bonds, how will I be able to shave?

 

Or cut my hair?

 

The price of Argentine bonds plunged Thursday, reflecting greater fears that the country would refuse to pay. In Buenos Aires, dollar-denominated warrants fell 14% to 70 Argentine pesos ($14.54) in afternoon trading, while the peso-denominated warrants fell 7.6% to 14.90 pesos.

 

The decision will be upheld unless Argentina appeals the decision, and they have to go to the U. S. Court of Appeals, where it is hard to see them winning.  (Appeals Courts can reverse only on points of law, not matters of fact; those determinations are solely judgments for the trial court.) 

 

If Mr. Griesa’s ruling is upheld in coming weeks, U.S. courts could block payments to creditors who restructured, a ruling the judge said he hoped would pressure Argentina to pay the holdouts.

 

Don’t buy from me, Argentina

 

If Argentina refuses to do so, that would trigger a technical default on some $24 billion in debt issued in the 2005 and 2010 deals.

 

Ah-ha!  Now we discover the hidden trap door, and it opens up vistas of connivance.

 

Default is both a financial concept and a legal one.  When it comes to actual money, default is financial, but when it comes to recovering against collateral, default is legal.  One can be in monetary default – at least as normal people understand the term, meaning that the creditors aren’t fully paid – and yet not be in legal default: for instance, because the creditors have not filed a piece of paper putting the borrower on notice that it has failed to pay.  These legal notices almost certainly have to be filed by a bond trustee, who acts for all the bondholders, and trustees (who have the courage of a banana) will virtually never act unless directed to by a majority of the bondholders.

 

See it now?  Argentina default, but it arm-twists the large bondholders not to direct the trustee to declare a default, so the outliers are in the worst world – unpaid and unable to move against whatever collateral or enforcement mechanisms in the bond documents.

 

And there are probably credit-default-swaps pending on Argentina’s bonds

 

This was the trick the European Union played with Greek bondholders, in their waste of a perfectly good betrayal. The creditors had default and enforcement provisions – which they could not invoke!  They were cowed into not invoking them.

 

The legal battle is attracting wide attention because it could reshape future debt defaults by countries, as well as the strategy investors take in dealing with them. Some investors may be reluctant to enter into debt negotiations with countries if their money could be held up or delayed in order to pay holdouts.

 

Why, yes; that’s how it works, and how it should work. 

 

Geez, why this stubborn insistence on property anyhow?

 

“What does this do for future debt restructurings?” asked Alberto Bernal, head of research at Bulltick Capital Markets.

 

It strengthens the creditors, as it should.

 

Argentina’s battle with the holdouts, which it calls “vulture funds,” stems from its default on about $100 billion in 2001. A vast majority of creditors took part in two restructurings in 2005 and 2010 that gave them about 33 cents on the dollar.

 

It’s pretty pathetic to default in 2005, then keep going to the capital markets.  And it’s pretty gullible of the capital markets to treat that first default as never going to happen to us.

 

No way, Jose

 

The rest waited –

 

Wrong; the rest didn’t wait.  They sued.

 

– preferring to chase Argentina in court, seeking full repayment.

 

I haven’t read the filing, nor the documents themselves, so let us presume that this is a normal collateralized bond.  The indenture (note the term – indenture, as in servitude and shackles, and that’s what it should connote) normally says that the creditors have a claim on certain assets.  In real estate transactions, the assets are properties and the security is a mortgage.  In sovereign finance, the assets could well be cash flow streams or ownership interests that the government has in businesses, commodities, or other items of value, such as cash flow payments from external sources. 

 

The bond documents further will normally say that if the debtor interrupts its normal payments, and then receives cash from one of the collateralized sources, that cash flows into the trust account (and the trustee is authorized to claim it directly from the payors), and is then paid out, ratably, to all bondholders. 

 

Now you’re a bondholder, and Argentina defaults, so you expect to get your share of payment.  But your fellow bondholders are gutless, or they’re coerced/ extorted by the debtor – which is, after all, a government, and has many powers of coercion – so they crumple.  The debtor decides to reward them for crumpling, and to punish you for sticking to your principles.  So it pays the crumplers and stiffs you.

 

We crumpled you, because we can

 

If those are the facts, it’s extremely hard to see how such behavior can comport with your bond documents, or anybody else’s bond documents.  It is, in short, an invented distinction.


In judicial filings, the holdouts argue they aren’t trying to take all the money from the restructured investors but want to be paid alongside everybody else—that Argentina should simply make a larger payout in December and in the future.

 

Of course a debtor can default, meaning fail to pay its bonds, in which case the collateral can be seized.  But when the debtor fails to pay some of its bonds and not others, that’s discrimination, which is a default, and the defaulted bondholders (i.e. those not being paid, who didn’t knuckle under) can sue – and get the collateral streams.

 

In addition to pitting Argentina against holdout creditors, the case also pits different creditors against each other, including some of the biggest names on Wall Street.

 

Creditors who struck a deal with Argentina say the strategy of the holdouts and the U.S. judge is unfair because it uses them as leverage.

 

They’ve got some nerve to say that.

 

The holdouts are led by billionaire Paul Singer, and his Elliott Management Corp.’s NML Capital Ltd. After seven years of court battles, the holdouts got a recent boost when an Argentine naval ship was seized in Ghana on court orders.

 

What am I bid for this flagship?

 

They have also won a string of recent legal victories.

 

Naturally, when you have the law on your side, and you are in a forum of law, you’re likely to win a string of victories.

 

 

A spokesman for NML Capital declined to comment.

 

“I’m outraged,” said David Martinez, a Mexican financier whose company, Fintech, owns about $1 billion of the restructured bonds. “The judge is exasperated [with Argentina], but he can’t keep third parties hostage. Argentina is not going to pay, so he’s only going to harm us.”

 

Just how are you being harmed?  Compared with the bondholders who didn’t give in?  You’re assuming fixed pie and collaborators getting more of a fixed pie.  More likely, being forced to pay will make the Argentinian government find assets.

 

Bonds are like credit cards, aren’t they? I don’t pay them either

 

“Given Judge Griesa’s obvious frustration with the Republic of Argentina, we expected this ruling. What we did not expect was the disregard of innocent exchange bondholders’ due-process rights,” said Sean O’Shea, a lawyer representing several investors who restructured.

 

Mr. Griesa also said the trustee charged with processing the bond payments, Bank of New York Mellon Corp., and other financial institutions that are involved in the payment process are bound by his order.

There’s the key lever – financial institutions in the US that flowed money to Argentina under other contracts would be charged with acting, in effect, as fences of stolen property.  They won’t risk that.

 

What’s a little risk, anyway?

 

Earlier this week, the Federal Reserve Bank of New York argued in a letter to the court that the possibility of an injunction seizing funds transferred from intermediary banks to investors could “impede the smooth and efficient operation” of the U.S. payments system.

 

Sure – and what’s wrong with that?  We shouldn’t launder drug money, and we shouldn’t facilitate thug money.

 

We’re the original thugs; all others are pale copies

 

“No one in his right mind” would accept a restructuring deal if with time, money and a good attorney they can collect 100%, added Mr. Lorenzino, the economy minister.

 

Senor, you should have thought of that before you started stealing the bondholders’ money.

 

Just stop posting, okay?

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