The Examiners: Paul Leake on Argentina and Distressed Investors

As Argentina finds itself on the verge of a second default, what blame, if any, does the distressed investing community hold?

As Argentina edges closer to a second default on its sovereign debt in little more than a decade, commentators have been warning of a potential recurrence of the devastation wrought by the Great Argentine Depression of 1998-2002. Many have been quick to lay the blame for Argentina’s current financial dilemma on “vulture fund” investors who refused to take part in Argentina’s 2005 and 2010 debt restructurings and are owed roughly $1.5 billion. However, as with every controversy, there is more than one side to the story.

The holdout bondholders’ $1.5 billion claim arises under a bond indenture that contains an “equal treatment” clause prohibiting Argentina from making payments on subsequently issued debt without also making payments on any pre-existing obligations. Argentina defaulted on its debt in 2001. After implementing exchange offers in 2005 and 2010, it has continued to make payments to holders of the exchange bonds, but pursuant to a “temporary moratorium” renewed each year, has not made payments to bondholders who refused to participate in the exchange.

A federal district court and the Second Circuit Court of Appeals have ruled (on more than one occasion) that Argentina’s refusal to pay holdout bondholders while paying exchange bondholders is illegal. In June, the U.S. Supreme Court declined to review or disturb those rulings. Thus, from one perspective, Argentina has repeatedly defied every court that has vindicated the contractual rights of holdout bondholders.

On the other side of the debate, certain commentators insist that, given the dire consequences of a second default, Argentina, with South America’s third-largest economy, should not be held hostage to speculators who acquired their holdings at a steep discount and who in some cases, by reason of large positions in credit default swaps, have a vested financial interest in seeing Argentina default. Based on principles of contract interpretation and sovereign immunity, these commentators say that Argentina should not be forced to pay holdout bondholders.  They further argue that, by insisting on payment in full, the hedge fund holdouts will only make future sovereign debt restructurings or bailouts more costly for the International Monetary Fund and the World Bank.

Some of those who are critical of the holdout bondholders’ strategy seem to be suggesting that a different code of commercial conduct should apply when creditors deal with sovereign debtors. However, few creditors would be willing to invest in sovereign debt if their contractual rights and remedies in the event of default were so easily thwarted.

Paul Leake is a partner in Jones Day’s New York office and the global practice leader of the firm’s business restructuring and reorganization practice.