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How Argentina's Default Could Be New York's Loss

How Argentina's Default Could Be New York's Loss

Posted by Juan Gavasa on April 21, 2014

The Supreme Court on Monday hears arguments in Republic of Argentina v. NML Capital. It is a simple case. But the decision will have far-reaching implications for international finance, sovereign debt and even the position of New York City as the financial capital of the world.

The controversy began in 2001 when, amid a severe domestic economic crisis, Argentina defaulted on $80 billion in debt. The government tried to make a deal with its bondholders twice, in 2005 and again in 2010, offering them new debt worth 25 cents to 29 cents for each dollar of the bonds in default.

Many bondholders took the deal but others declined. Argentina tried to coerce the holdouts by enacting its so-called Lock Law, which prohibits the Argentine government from making any better offer to the non-tendering bondholders or complying with any U.S. court ruling requiring holdouts to be repaid.

The original debt was sold to investors with an explicit term that disputes would be resolved in New York under New York law. And in the continuing litigation, the holdouts are relying on U.S. courts to enforce a clause in the bond covenant that requires Argentina to treat all bondholders equally. This clause, known to lawyers as a pari passu clause, means Argentina cannot pick and choose among its creditors with laws like the Lock Law.

In early 2012, federal Judge Thomas P. Griesa of the Southern District of New York barred Argentina from making payments on the subsequently issued debt without paying what it owes to the holdouts. If Argentina pays the owners of the new debt 5% of what it owes them, it must also pay 5% of what is owed to the holdouts. When the new bonds are paid in full, the holdouts would be paid in full as well.

To enforce the court's judgment, Judge Griesa also allowed investors in Argentina's defaulted bonds to subpoena information from banks, including Bank of America Corp. BAC -0.46%  and Banco de la Nacion Argentina, about where Argentina is stashing its assets around the world. Judge Griesa rightfully said that his decision rested upon "the public interest of enforcing contracts and upholding the rule of law," and he was upheld on appeal.

Argentina has appealed to the Supreme Court, and the Obama administration has taken its side. The U.S. Justice Department has argued that enforcing the terms of the agreement will make future debt restructurings more difficult and undermine the U.S.'s interest "in promoting reciprocal international principles of central bank immunity." Academics have also argued that enforcing Argentina's own contracts against it might undercut debt restructurings.

These arguments are bogus. Any country that wants to restructure in the way that Argentina is trying to do simply can decline to put equal-treatment clauses in their contracts.

The way to help sovereigns is by upholding the contracts they sign. By siding with Argentina's holdout creditors, U.S. courts are helping all borrowers achieve access to credit markets on competitive terms. If courts won't enforce the promises made by borrowers, investors won't lend to them or will insist on higher rates of interest as compensation for their increased risk in case of default.

History is littered with examples of governments that renege on their promises to investors. Holding them to their promises should be regarded as a victory for international law and norms.

In support of Judge Griesa, the Second Circuit Court of Appeals has said that "in New York, a bond is a contract" and the parties' dispute "presents a simple question of contract interpretation." In the world of business, actually enforcing the terms of contracts is the way to nurture markets and generate economic growth. The claim that sovereigns are not subject to the rule of law fails to recognize that if U.S. courts decline to enforce contracts, sovereign nations and corporate borrowers will be motivated to enter into contracts in places that will enforce them.

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