A decade-long quest by hedge funds led by Elliott Management and Aurelius Capital Management to force Argentina to pay up on the country's defaulted debt is going to last a bit longer.
On Wednesday, the United States Court of Appeals for the Second Circuit issued a stay of a lower court's order that would have required Argentina to set aside $1.33 billion to pay holders of its old, defaulted debt if and when it made any payments on its new debt.
It's a minor victory for Argentina, but in this case it may have a ancillary effect, signaling a reversal of fortune for the country.
To understand the implications of the judicial order, a bit of history is needed.
This litigation arises out of Argentina's default on $80 billion worth of sovereign bonds in 2001. In 2005 and 2010, Argentina subsequently pushed the holders of this debt to exchange the old bonds for new ones at 25 to 29 cents on the dollar. The stick here was Argentina's steadfast refusal to pay any amount on the old bonds. Since that time, the remaining holders of the old bonds, including Elliott and Aurelius, have been enmeshed in worldwide litigation against Argentina to force it to pay.
In October, the appeals court handed the two hedge funds a stunning victory. The court ruled that the “pari passu†clause in the bond indenture for Argentina's old debt required the country to make payments on its old debt any time it made a payment on its new debt. Pari passu is a Latin phrase meaning, roughly, “on equal footing.â€
The court also held that, given Argentina's continued refusal to pay this old debt, the Foreign Sovereign Immunities Act of 1976, which prevents courts from attaching the property of sovereigns, did not prohibit a federal court from ordering Argentina to comply with the pari passu clause by issuing an injunction to such effect.
The appeals court did not hand a complete victory to the hedge funds. It remanded the case to J udge Thomas P. Griesa, the lower court judge hearing the case, to decide two issues: whether the injunction requiring Argentina to make payments on the old bonds applied to third parties, and how much Argentina would be required to pay to holders of the old bonds if it made payments to holders of the new ones.
It appears Judge Griesa had clearly grown tired of Argentina's intransigence. At a hearing earlier in November, he handed full victory to the plaintiffs. He ruled that Argentina must set aside the full $1.33 billion it owed to the plaintiffs if and when Argentina made a $3 billion payment due on Dec. 15 to holders of the new bonds.
Argentina, as a sovereign, could ignore this order, but Judge Griesa put teeth in it by applying it to third parties. He ordered the bond indenture trustee as well as the clearing systems that transmit money for Argentina to comply with this order.
The judge's actions were particularly aggressive for two reasons. First, Art icle 4-A of New York's Uniform Commercial Code provides a safe harbor for third parties from this type of injunction, the purpose of which is to ensure that only Argentina's banks are drawn into these disputes. Argentina has argued that the bond indenture trustee is not its bank and so immune from the injunction. Argentina also argues that payment system operators are immune under long-settled New York law.
Judge Griesa additionally ordered the $1.33 billion due and owing to holders of the old bonds to be paid all at once instead of pro rata over time as holders of the new bonds are paid. The judge made the order effective immediately, refusing to stay his order until it had been fully considered by the appellate court. Argentina's response was to appeal to the Second Circuit and request an emergency stay.
On Wednesday, the appeals court stayed the implementation of Judge Griesa's order, and it set up a briefing schedule for the case, to be heard on Feb. 27 by th e same judges who previously ruled against Argentina.
At first blush, this is not much of a victory for Argentina. Given what is at stake, it is no surprise that the appeals court would call a break to the confrontation to review Judge Griesa's order.
The same judges who previously ruled against Argentina will now revisit the case. Argentina has already filed a motion asking the entire Second Circuit to rehear the prior decision of these judges. That motion will probably remain in limbo while Judge Griesa's order is reviewed.
While on its face the stay is a small matter, the question now is whether it can provide a bigger opening for Argentina.
Judge Griesa's order is going to require the Second Circuit to grapple with questions about the scope of the court's authority that it may not have fully considered earlier. The United States government, third-party financial institutions affected by the judgment and even the holders of new bonds have been ene rgized by the prior ruling.
The appeals court has set a Jan. 4 deadline for the interested third parties to submit their views. Expect all of these parties to now enter the fray with briefs in support of Argentina, with many arguing that applying this injunction to third parties would upset the orderly flow of payments in many other instances.
This will require the appellate court to decide whether this injunction should apply to third parties, an issue the judges already seemed to be uneasy with in their prior opinion.
And if the judges do find that the injunction issued by the lower court should not apply to third parties, then the Second Circuit is going to have to again confront the basic question of what it is trying to do against Argentina.
The Foreign Sovereign Immunities Act of 1976 prohibits a court from legally attaching sovereign property unless It is used in commercial activity. The act has been used to prevent lawsuits against scores of countries. And even though Argentina submitted to the jurisdiction of the New York courts, it did so after passage of this act, so clearly the parties knew that these limits existed.
If the Second Circuit is unwilling to apply the injunction to third parties, then it may be required to determine how the lower court's order is not really just a legal attempt to attach Argentine property â€" a tactic that could be used against any other sovereign, something the Foreign Sovereign Immunities Act appears to prohibit.
It remains to be seen whether the Second Circuit will bite at these arguments â€" some of which it has already rejected. But expect Argentina and its allies, including the United States government, to press the court hard as they attempt to turn the February hearing into a reconsideration of the entire case.
The plaintiffs will no doubt continue to argue forcefully that Argentina is unique because of its egregious behavior and that the actions of th e three judges will not have a wider effect on the financial system. They are also likely to argue that the lower court's order is not an attachment, because Argentina can simply ignore it and refuse to pay on the new and old bonds.
The question now is whether the hedge funds can keep the court focused on the narrow issue of Argentina and the morality of its nonpayment of debt, or whether wider legal issues push the Second Circuit to reconsider the case. And that is what is really at stake in this February hearing.
