2nd Circuit - Argentina Must Pay Creditors on Defaulted Bonds

On October 26, 2012, the 2nd Circuit rejected arguments made by Argentina in its continued attempts to avoid repaying $1.33 billion in defaulted bonds to creditors including NML Capital, Ltd.

At issue in this case was interpretation of the "Pari Passu" Clause in the FAA bonds issued by Argentina and bought by NML and other creditors beginning in 1998.

The "Pari Passu" Clause, also referred to as the Equal Treatment Provision, states:

[t]he Securities will constitute . . . direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness . . . .

The trouble began in 2001 when Argentina defaulted on the FAA bonds. Argentina issued a temporary moratorium on principal and interest payments on more than $80 billion of its public external debt including the FAA Bonds. Each year since then, Argentina has passed legislation renewing the moratorium and has made no principal or interest payments on the defaulted debt.

In the meantime, Argentina offered holders of the FAA bonds new Exchange Bonds in 2005 and 2010 at a rate of 25 to 29 cents on the dollar. In exchange for the new debt, participants agreed to forgo various rights and remedies previously available under the FAA. Importantly, to induce participation in the restructuring, Argentina stated in the prospectus that "[e]xisting defaulted bonds eligible for exchange that are not tendered may remain in default indefinitely."

Argentina continued to make payments to holders of the restructured Exchange Bonds but failed to make any payments to holders of the defaulted FAA Bonds, who opted not to participate in the restructuring.

Creditors of the defaulted bonds brought this suit against Argentina to enforce the terms of the agreement, and in particular, the Equal Treatment Provision. According to court records, these creditors estimated that, collectively, their unpaid principal and prejudgment interest amounts to approximately $1.33 billion.

Lower Court Ruling

In December 2011, the district court granted plaintiffs partial summary judgment holding that Argentina had violated the Equal Treatment Provision by making payments on the Exchange Bonds but refusing to make payments on the defaulted bonds. Additionally, the court found that Argentina violated the provision when it enacted the "Lock Law" in 2005 which prevented any type of settlement with the defaulted bond.

In February 2012, the district court granted the creditors injunctive relief, ordering Argentina to specifically perform its obligations under the Equal Treatment Provision. The Injunctions provided that whenever Argentina paid amounts due to the Exchange Bonds, it must "concurrently or in advance" pay holders of the defaulted bonds the same fraction of the amount due to them.

The injunctions also required notice to and compliance by all parties "involved, directly or indirectly, in advising upon, preparing, processing, or facilitating any payment on the Exchange Bonds,” and prevented Argentina from changing its payment mechanisms for the Exchange Bonds without approval by the Court. This would effectively prevent Argentina from making payments on the Exchange Bonds without having made payments on the defaulted bonds.

Argentina appealed the rulings to the 2nd Circuit Court of Appeals making numerous arguments, including that it had not violated the Equal Treatment Provision because the defaulted bonds and Exchange Bonds still had the same legal rank, that the injunctions issued violated the Foreign Sovereign Immunities Act, there was no irreparable harm to holders of the defaulted bonds since any remedy would be monetary, and the injunctions would thrust Argentina into an economic crisis.

Violation of the Equal Treatment Provision

The court rejected Argentina's arguments that the holder of the defaulted bonds were still of the same legal rank as the Exchange bonds. The court analyzed the provision, and concluded that the two sentences of the Pari Passu Clause protect against different forms of discrimination: the issuance of other superior debt (first sentence) and the giving of priority to other payment obligations (second sentence).

The court rather easily found that Argentina had violated that provision by ranking its payment obligations on the defaulted debt below its obligations to the holders of its restructured debt.

Interestingly, the court commented that it was not deciding the issue whether a policy of preferential payment to multilateral organizations like the IMF would breach Equal Treatment Provisions like the one present here. In fact, the court noted that even NML, one of the creditors, stated in its brief that such a policy "would not violate the Equal Treatment Provision for the simple reason that commercial creditors never were nor could be on equal footing with the multilateral organizations."

Appropriate Injunctive Relief

In reviewing the injunction, the Court noted that it may affirm an order of specific performance so long as it achieves a "fair result" under the "totality of the circumstances."

Rejecting multiple arguments made by Argentina, the Court was most persuaded that monetary damages would not be sufficient, because Argentina would simply refuse to pay, and it had continued to do so.

Secondly, the injunctions did not violate the Foreign Sovereign Immunities Act because they did not attach sovereign property; they simply directed Argentina to comply with its contractual obligations. Argentina had also waived immunity from jurisdiction in the lower court.

The Court went on to conclude that nothing in the record supported Argentina's assertion that the injunctions would "plunge the Republic into a new financial and economic crisis," as Argentina claimed. Further support of the Court's conclusion was that the district court had made a specific finding that Argentina had sufficient funds, including over $40 billion in foreign currency reserves, to pay plaintiffs the judgments they are due.

Arguments made by the U.S. government were also not persuasive. "Nor will the district's court's judgment have the practical effect of enabling 'a single creditor to thwart the implementation of an internationally supported restructuring plan,' as the United States contends."

Questions Remaining

Still unresolved by the 2nd Circuit's ruling was practical implementation of the orders issued by the lower court. The case was remanded to the district court so that the district court could further clarify how the payment formula would operate and how the injunctions would apply to third parties and intermediary banks.

After the clarification by the lower court, the case will immediately go back to the 2nd Circuit Court for the panel to further consider the merits of the remedy.

The case is NML Capital, Ltd. v. Republic of Argentina.