For more than a decade, Cayman-registered investment funds have led the pursuit of contractual rights under defaulted bonds issued by the Republic of Argentina, a conflict that has generated prolific public debate. Legally, pragmatically and even morally, is it right for private sector creditors to be able to hold sovereigns to their contractual commitments?
Outgoing President of Argentina Cristina Fernández de Kirchner thinks not. She shaped her political identity around the disparagement of such creditors and defiance of courts of the United States and elsewhere. Under President Fernández de Kirchner and her husband who preceded her in office, Argentina has sought to repudiate bonds whose holders declined to accept a voluntary “haircut” of more than 70 percent.
President Fernández de Kirchner’s stance against private creditors is supported editorially by the Financial Times of London, which has characterized rulings of the U.S. courts adverse to Argentina as “eccentric,” despite their being upheld through appellate and Supreme Court review. Argentina’s unsuccessful pleadings in those courts were supported by amici, including the governments of France, Mexico and Brazil, as well as others who stood to benefit more directly from Argentina’s discrimination against certain private creditors.
Argentina and its attorneys have worked diligently towards developing an infrastructure justifying and supporting the repudiation of sovereign debt. A September 2014 resolution of the United Nations General Assembly adopted “basic principles” for sovereign debt restructuring ostensibly superior to contractually-agreed terms – although Argentina selectively ignores principles supporting the rights of creditors. Under Argentine influence, Belgium recently adopted laws substantially expanding sovereign immunities and restricting creditors’ ability to seize assets.
Argentina has received a surprising degree of assistance from ostensibly respectable institutions in its efforts to evade and circumvent U.S. judicial rulings. For years, the Bank for International Settlements has provided a safe harbor for Argentina’s international reserves under the umbrella of its own immunities in Switzerland, enabling Argentina to utilize and benefit from the international payment system in U.S. dollars without fear of private creditors’ attachments. The People’s Bank of China and Banque de France have provided substantial liquidity through central bank swap arrangements to mitigate Argentina’s diminished access to credit while in contempt of U.S. justice. Major international banks have helped Argentina raise lesser sums from yield-hungry investors through bond issues that might or might not successfully skirt the U.S. injunctions arising from Argentina’s contempt of court.
Behind President Fernández de Kirchner’s unwillingness to negotiate, and implicitly justifying such assistance rendered by others, is a single criticism and rationale: that investors who speculatively acquired non-performing sovereign debts at a substantial discount in the secondary market, with the intention of collecting through litigation or other means, are somehow not legitimately entitled to fully exercise the legal rights contained in the original borrowing contracts.
This notion is legally unsupportable, logically unsound and contrary to public welfare.
The legal bases for private creditors’ claims are beyond dispute. Ownership interests in the borrowing contracts are transferable, and money judgments may be obtained from the courts specified in each contract. Subject to waivers of sovereign immunity contained in the contracts, certain assets of the delinquent borrower may be seized. Even Argentina accepts this.
Indeed, private creditors confronting a sovereign are almost entirely dependent upon the judgments and discretion of the judiciary in various jurisdictions. Any conduct less than perfectly lawful is simply not commercially viable.
In the Argentine case, controversy arose over additional relief granted by the U.S. courts. Invoking the pari passu clause in Argentina’s borrowing contracts, the courts ruled that whenever Argentina made a payment on bonds it was regularly servicing, it must simultaneously make payment on its defaulted bonds. Anyone aiding Argentina in breaching this order would themselves be in contempt.
Rather than complying with this order, President Fernández de Kirchner chose to default on essentially all of the country’s external debt. Virtually overnight, a legion of commentators arose to defend the coinciding interests of Argentina, its favored bondholders, and those who advocate the discretionary powers of governments over private economic interests.
Scholarly papers dissected the meaning and history of the pari passu clause. Dire predictions were made about the impact of the court’s decision on the viability of New York as a financial center, and the fate of other sovereigns in need of debt restructuring.
There are scant grounds to argue that the U.S. courts’ decision to grant such exceptional relief did not constitute legal due process. Seeking financing at the lowest cost and on the best terms, Argentina voluntarily submitted itself to the jurisdiction and law of New York, and agreed to certain contractual terms protecting its creditors. The court subsequently saw a recalcitrant and contumacious defendant, openly defiant of the court’s authority and unwilling to make the slightest gesture towards resolving its impasse. The court, within its discretion, ruled accordingly. While certain commentators, including the Argentine government, disparaged the mental competence of the trial judge, his ruling was fully upheld through appeal. While bondholders whose payments were interrupted raised complaints and legal challenges, it is indisputable that Argentina itself had warned them of this possible ruling before they acquired their positions.
Practical objections to the courts’ decision have similarly proven to be unfounded. More than a year after the U.S. Supreme Court declined review and more than five years after such relief was requested, there has been no trace of any of the adverse global impacts predicted by Argentina or its amici. The only other recent circumstance in which pari passu has been invoked against a sovereign by an unpaid creditor, involving Grenada, was resolved through ordinary, informal means after the U.S. courts ruled that circumstances did not warrant the extraordinary relief precipitated by Argentina’s intransigence.
Recurring calls for a formal mechanism for restructuring sovereign debt, most recently by economist Joseph Stiglitz and his disciples, rest upon the same false premise, that the judicial dispute resolution mechanisms freely chosen by sovereigns in their borrowing contracts are incapable of achieving efficient and equitable outcomes. To the contrary, courts in all major jurisdictions have proven quite capable of distinguishing between opportunistic and recalcitrant debtors like Argentina and countries truly deserving debt relief, like Grenada.
Where good faith has been absent, notably with Argentina, the U.S. court sponsored a forum for negotiation through the appointment of a special master. Where warranted, courts have been equally rigorous in penalizing creditors of sovereigns for less than scrupulous behavior, for example in the case in England of Donegal v. Zambia.
The existence of tested, efficient and equitable judicial processes engenders good faith negotiation and settlement in nearly all sovereign debt restructurings. A 2013 analysis by Moody’s Investors Service (“The Role of Holdout Creditors and CACs in Sovereign Debt Restructurings”) found that over the preceding 15 years, just one out of 34 restructurings had been affected by persistent litigation: Argentina, which “remains unique in its unilateral and coercive approach.”
Another specious argument is that a bankruptcy mechanism is needed for sovereigns, just as with corporations and individuals. This is misleading in several ways. Most importantly, an intrinsic principle of bankruptcy is trusteeship, the essential function of marshalling assets and in the case of a corporation, replacing management. These are political impossibilities with a sovereign, and without trusteeship the essence of bankruptcy cannot exist.
The concept of a stay in bankruptcy is effectively always operative for sovereigns through the extensive immunities they enjoy under laws everywhere. In general, only commercial assets of a sovereign are subject to judicial enforcement, so essential state functions continue unimpeded notwithstanding the actions of private creditors.
Also dubious is the notion that a state can become truly insolvent. Even the grossest errors of fiscal and monetary governance and over-borrowing cannot take a sovereign to the heights of leverage available to commercial corporations. Sovereigns have vast asset entitlements, and can create an almost limitless variety of rights and licenses that could be monetized. One need look no further than the debt/equity swaps that enabled Latin America to exit the debt crisis of the 1980s to realize that sovereign insolvency is not insolvency at all, but rather illiquidity combined with an absence of creativity and vision.
The proposal of a bankruptcy mechanism for sovereigns is thus effectively nothing more than expressing preference for the politicized suppression of private creditors, in place of rule of law based upon contracts and commercial principles. In the larger picture, such proposals ignore the many advantages to sovereigns of participating in commercial credit markets governed by established contract law and overseen by judicial systems of tested competence and impartiality, not least liquidity and substantially lower borrowing costs for those governments prepared to honor their contracts.
Liquidity is perhaps the greatest of all virtues in financial markets, and that provided by investment funds in the secondary market for distressed, defaulted and non-performing sovereign obligations is generally overlooked and underappreciated. These private sector buyers enable those with unwanted positions in such obligations, whether they be widowed retirees, major corporations redeploying their productive assets or sometimes even other sovereigns, to exit their positions with the greatest efficiency and smallest possible loss.
Columnist Martin Wolf of the Financial Times has written that Argentina should be defended against private creditors, and allowed to abrogate contracts and circumvent U.S. courts, because creditors who invest in risky assets should be prepared to take losses. The logical flaw is that Mr. Wolf does not recognize that the original investors did indeed take their “just” losses when they sold. The buyers of the discounted, non-performing obligations are entirely separate entities, in a very different line of work.
So is this line of work estimable or detestable?
Without doubt it is lawful, and evidently without adverse collateral effects upon the desirable and necessary restructuring of debt by truly needy countries. Few would or could argue that professionalized debt collection is not an essential function as regards individuals and corporations in an efficient and equitable economy. Whether the same is true for sovereign countries is more subjective and politicized.
There are immutable preconditions for making a country a commercially viable target for speculative investment in debt recovery. The country must actually have the economic capacity to pay its debts over a reasonable period, yet be so incompetently and/or corruptly mismanaged that it operates outside the law. The country’s rulers must be so entrenched in power that they have the discretion to defy commercial norms and external law enforcement, and to organize the country’s financial affairs to evade judicial seizures.
Invariably, these are not economically or socially healthy countries.
The unusual character and harshness of the U.S. courts’ rulings against Argentina are matched by the extent to which the Kirchners unthinkingly cultivated speculation and legal recourse. While achieving an unprecedentedly disproportionate writedown of external debts, to their country’s benefit, they neglected to finish the job. Inevitably Argentine debt became the speculators’ playing field, tainted by occasional insider settlements through rent-seeking public officials.
The principal effect of the investment funds’ efforts and the U.S. courts’ rulings has been to significantly limit Argentina’s access to external borrowing. As President Fernández de Kirchner hands to her successor a country distinguished by spectacular government overspending, a completely decapitalized treasury and central bank, enormous and distortive subsidies, with major industries nearly ruined through government price manipulation and one of the highest inflation rates in the world, Argentines of every political persuasion should be thankful and relieved that Cayman-registered investment funds inhibited borrowing that would have left things far worse.
If there is any reason for regret, it should be that energies expended on excusing Argentina’s misgovernance and aiding its circumvention of judicial rulings were not instead devoted to devising more creative means for restructuring sovereign debts, monetizing idle sovereign assets rather than merely seeking to shortchange private creditors.