Last updated: December 28, 2012 4:09 pm

Bondholders add twist to Argentina debt spat

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A group of funds caught in the middle of Argentina’s latest debt saga has asked New York state’s highest court to define the meaning of a pivotal clause in a high-profile legal dispute that has sparked fears of a fresh sovereign default.

The request to spell out the meaning of the pari passu – or equal step – clause, was submitted late on Thursday to the Second Circuit Court of Appeals, a federal court, by so-called “exchange bondholders” (EBG), a group of holders of debt issued in 2005 and 2010 when Argentina restructured its defaulted bonds. The group includes Gramercy and hedge fund Brevan Howard.

The submission came on the eve of a Friday deadline for Buenos Aires to submit its arguments to the Second Circuit court in New York. EBG will also file its brief.

Argentina and funds led by Elliott Associates – which bought the country’s debt after the crash – are embroiled in a legal tug-of-war that has not only raised worries of another default, but also concerns that New York’s hallowed place at the heart of the world financial system could be at risk and questions whether sovereign restructurings could prove harder to pull off in future.

The New York Court of Appeals has the final say on questions of New York law.

The Second Circuit court sent shockwaves through markets in October when it upheld an earlier ruling by Judge Thomas Griesa that the pari passuclause in the nearly $100bn of bonds on which Argentina defaulted in 2001 meant that defaulted creditors who rejected the restructurings had the right to be repaid when Argentina paid the EBG.

That left Argentina staring at the prospect of paying everyone, including the funds such as Elliott that it blasts as “vultures”, or no one, and tumbling into technical default despite being willing and able to continue servicing its restructured debt.

On November 21, Judge Griesa ordered Argentina to pay $1.33bn into escrow for the so-called “holdouts”, led by Elliott, though the Second Circuit court froze that order pending its review of the judge’s clarification of two key issues: how the payment mechanism would work, and its impact on third parties.

Judge Griesa had given his order teeth by requiring parties handling payments to the EBG, including Bank of New York Mellon, not to help Argentina circumvent the ruling by diverting payments. The Second Circuit court has scheduled a hearing on February 27 after all sides have had a chance to air their arguments in writing.

“At the heart of the instant appeal is the issue of how to interpret under New York contract law a pari passu clause in an unsecured debt instrument – in this case, an international bond indenture issued by a sovereign debtor,” the EBG said in its filing.

“Now that the district court has decided how payments should be made pursuant to the pari passu clause – an interpretation that has enormous consequences for New York’s pre-eminent financial services industry – the state’s highest court should be given an opportunity to ensure that this court’s review of the injunction is undertaken ‘with a correct understanding of the controlling principles of New York law’,” it added, citing a Second Circuit ruling from this year.

Elliott slammed the latest move. “This is just one more brazen, yet frivolous, stunt pulled by exchange bondholders who, in an attempt to curry favour with the Argentine government, are taking extraordinary steps to assist Argentina in evading its contractual obligations to holders of defaulted Argentine debt,” a spokesman said.

Elliott and other holdouts reject fears that future sovereign restructurings could be affected. But the US Treasury and State Departments said earlier this month that as things stood, the ruling “may adversely affect future voluntary sovereign debt restructurings, the stability of international financial markets and the repayment of loans extended by international financial institutions” and could be problematic under the Foreign Sovereign Immunities Act.

Thomas Laryea, a partner at SNR Denton, the law firm, and a former assistant general counsel at the International Monetary Fund, called the latest move made by the EBG “an interesting strategic twist. My sense ... was that Argentina’s lawyers have been at pains to keep some federal law [eg, foreign sovereign immunity issues] in play,” he said.

The Second Circuit court is not obliged to refer the pari passu question; nor is the New York Court of Appeals obliged to accept it, though if it does the case would return to the Second Circuit for other issues to be decided once the pari passu interpretation had been decided, lawyers say.

“In theory the meaning of a contractual clause is a matter of state law and hence in theory the procedure is available in this case. But in practice I’d be pretty surprised – actually, astonished – if the federal court made the reference. Seems more like a delaying tactic to prolong the litigation,” said Matthew Parish, a partner at Holman Fenwick Willan, a law firm.

Argentina, which has floated, in vague terms, the notion of offering a third swap of defaulted for new debt as a fairer solution, is expected to stress that Judge Griesa’s ruling prevents the EBG’s trustee, BNY Mellon, from delivering cash that belongs to the bondholders.

The government of Cristina Fernández, who has often vowed never to pay “vultures” who bought defaulted bonds at a discount, won a breather when Judge Griesa’s order was frozen.

“They got the impression they could win this,” said Eugenio Bruno, a former holdout lawyer.

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