Hard cases, it has often been said, make bad law.
That is just what happened this week. The United States Supreme Court, ignoring the pleas of the governments of numerous countries, including the United States, turned the world of sovereign debt restructuring on its head.
In so doing, the court most likely damaged the status of New York as the world’s financial capital. It made it far less likely that genuinely troubled countries will be able to restructure their debts. And it increased the power of investors — often but not solely hedge funds that buy distressed bonds at deep discounts to face value — to prevent needed restructurings.
The case concerned an appeal by Argentina, a country that the United States Court of Appeals for the Second Circuit called, with ample reason, “a uniquely recalcitrant debtor.” This is a country that has made default a national habit over the last two centuries, making you wonder why anyone ever lends to it.
In the next 10 days, much attention will be focused on whether Argentina will succeed in defying the United States courts. On June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do.
Argentina’s plan is to convert the bonds on which it wants to make payment into new bonds that would not be subject to New York law. Whether it can pull that off may depend on whether there are banks and other financial institutions willing to risk the ire of American courts.
But the fate of Argentina, or its creditors, is not what makes this case important, and perhaps disastrous.
To understand why that is, consider the way sovereign debt defaults and restructurings have been handled in the past.
There is no equivalent to bankruptcy law for sovereign debtors. When Walter Wriston, the head of Citibank from 1967 to 1984, said “countries don’t go bankrupt,” he was widely mocked by those who thought he meant that countries don’t go broke and therefore don’t default on their debts. But that was not what he said.
There is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity, as there is for companies.
Instead, there has been a sometimes messy system, called “higgledy piggledy” by Anna Gelpern, a professor of international law at Georgetown. Troubled countries negotiate with lenders — banks in the old days, and bondholders more recently — to restructure the debts. That restructuring could involve reducing the amount owed, lowering the interest rate, extending the maturity of the debt or some combination of the three.
The International Monetary Fund would often be involved, providing emergency funds that were contingent on government reforms needed to put the country on a financially sustainable path for the future. It was understood that the I.M.F. money — similar to “debtor-in-possession financing” loans made to companies after they file for bankruptcy — ranked above old debts.
Bondholders could, and did, hold out. But they faced the risk that the restructuring would go through and those who agreed would get (partial) payouts, while the holdouts got none.
Sometimes, if there were a small number of holdouts, the government might choose to pay them off to avoid future problems. If not, the holdouts could go to court. Which court depended on clauses in the bonds. If it was a court in the country borrowing the money, the creditors were at a severe disadvantage. But if it was in New York, the holdouts could normally get a court order directing the country to pay.
The catch was that the order was usually unenforceable. Countries had sovereign immunity for many of their assets located abroad. A defaulting country might have an embassy on valuable property in Washington, but that was off limits.
In the Argentine case, the hedge funds suing the country have tried, generally in vain, to find assets they could seize. They managed to briefly gain control of an Argentine ship in Ghana, but that was released.
It was, said Ms. Gelpern, an “informal system that has worked reasonably well, and has allowed most governments to restructure their bonds, at more or less reasonable cost.”
Now it has changed, at least for countries that issue bonds under New York law.
The hand of holdouts has been strengthened immensely. Under the ruling by the United States Court of Appeals for the Second Circuit, holdouts cannot fare any worse than those who agree to a restructuring — and they can do much better. The Supreme Court declined to hear an appeal of that decision.
If that order can be enforced, there may be no way to restructure sovereign debts.
But can it be enforced? Perhaps it can.
The courts say that Bank of New York, the payment agent for the bonds, would be in contempt if it aided the payment to holders of restructured bonds without paying the old bonds as well. And the courts want to extend that requirement around the world. Euroclear, a company based in Belgium, says the law there would require it to transmit any payment that a customer ordered. But the American court order says Euroclear must not do any such thing for Argentina.
“Financial market service providers,” Ms. Gelpern said, “are now sovereign debt enforcement agents.”
It is at least possible that the Second Circuit opinion could, in the future, be used to keep the I.M.F. from having a preferential standing over the holdouts in any restructuring that did occur.
The United States government told lower courts that this could create big problems. It could lead to countries choosing to borrow under English law, rather than New York law, and thus diminish the role of New York as a world financial center. That, the government said, could have “a detrimental effect on the systemic role of the U.S. dollar.”
The ruling, added the government, “could enable a single creditor to thwart the implementation of an internationally supported restructuring plan, and thereby undermine the decades of effort the United States has expended to encourage a system of cooperative resolution of international debt crises.”
The Second Circuit opinion, by Judge Barrington D. Parker, brushed aside such worries, suggesting that Argentina was a uniquely bad borrower and saying that enforcement of the rule of law would make New York more attractive for international lenders. And, he added, most international bonds issued in the last decade have “collective action clauses,” allowing a supermajority of bondholders to force holdouts to accept a restructuring, meaning the problem had already been solved.
Countries including Brazil, France and Mexico told the Supreme Court that was nonsense. First, there are still plenty of old bonds without such clauses. Second, collective action clauses normally operate bond issue by bond issue. So it may be possible for holdouts to buy enough of one small issue to block a restructuring that an overwhelming majority of creditors supported.
What would happen then? In a brief submitted to the Supreme Court, Joseph Stiglitz, the Columbia University professor who was formerly chief economist of the World Bank, offered a warning: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.”
What did the Supreme Court think of those arguments? Evidently, not much. It declined to hear Argentina’s appeal, or even to ask the United States government for its views.
The court did decide a related, but far less important, case. That decision will make it easier for the hedge funds suing Argentina to force it to reveal information on assets it owns around the world, in hope that vulnerable assets will be uncovered.
It is hard to muster much sympathy for Argentina, which chose to cram down a brutal restructuring plan years after defaulting, when it reasonably could have been more generous. But this decision is likely to hurt countries whose financial problems are much more serious. It may lead some of them to try to get out from under an American court system that appears to be committed to the 21st-century equivalent of a debtor’s prison for countries confronting an oppressive debt burden.
That is not the way Judge Parker would put it. “We believe,” he wrote, “that the interest — widely shared in the financial community — in maintaining New York’s status as one of the foremost commercial centers is advanced by requiring debtors, including foreign debtors, to pay their debts.”
That is just what happened this week. The United States Supreme Court, ignoring the pleas of the governments of numerous countries, including the United States, turned the world of sovereign debt restructuring on its head.
In so doing, the court most likely damaged the status of New York as the world’s financial capital. It made it far less likely that genuinely troubled countries will be able to restructure their debts. And it increased the power of investors — often but not solely hedge funds that buy distressed bonds at deep discounts to face value — to prevent needed restructurings.
The case concerned an appeal by Argentina, a country that the United States Court of Appeals for the Second Circuit called, with ample reason, “a uniquely recalcitrant debtor.” This is a country that has made default a national habit over the last two centuries, making you wonder why anyone ever lends to it.
In the next 10 days, much attention will be focused on whether Argentina will succeed in defying the United States courts. On June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do.
Argentina’s plan is to convert the bonds on which it wants to make payment into new bonds that would not be subject to New York law. Whether it can pull that off may depend on whether there are banks and other financial institutions willing to risk the ire of American courts.
But the fate of Argentina, or its creditors, is not what makes this case important, and perhaps disastrous.
To understand why that is, consider the way sovereign debt defaults and restructurings have been handled in the past.
There is no equivalent to bankruptcy law for sovereign debtors. When Walter Wriston, the head of Citibank from 1967 to 1984, said “countries don’t go bankrupt,” he was widely mocked by those who thought he meant that countries don’t go broke and therefore don’t default on their debts. But that was not what he said.
There is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity, as there is for companies.
Instead, there has been a sometimes messy system, called “higgledy piggledy” by Anna Gelpern, a professor of international law at Georgetown. Troubled countries negotiate with lenders — banks in the old days, and bondholders more recently — to restructure the debts. That restructuring could involve reducing the amount owed, lowering the interest rate, extending the maturity of the debt or some combination of the three.
The International Monetary Fund would often be involved, providing emergency funds that were contingent on government reforms needed to put the country on a financially sustainable path for the future. It was understood that the I.M.F. money — similar to “debtor-in-possession financing” loans made to companies after they file for bankruptcy — ranked above old debts.
Bondholders could, and did, hold out. But they faced the risk that the restructuring would go through and those who agreed would get (partial) payouts, while the holdouts got none.
Sometimes, if there were a small number of holdouts, the government might choose to pay them off to avoid future problems. If not, the holdouts could go to court. Which court depended on clauses in the bonds. If it was a court in the country borrowing the money, the creditors were at a severe disadvantage. But if it was in New York, the holdouts could normally get a court order directing the country to pay.
The catch was that the order was usually unenforceable. Countries had sovereign immunity for many of their assets located abroad. A defaulting country might have an embassy on valuable property in Washington, but that was off limits.
In the Argentine case, the hedge funds suing the country have tried, generally in vain, to find assets they could seize. They managed to briefly gain control of an Argentine ship in Ghana, but that was released.
It was, said Ms. Gelpern, an “informal system that has worked reasonably well, and has allowed most governments to restructure their bonds, at more or less reasonable cost.”
Now it has changed, at least for countries that issue bonds under New York law.
The hand of holdouts has been strengthened immensely. Under the ruling by the United States Court of Appeals for the Second Circuit, holdouts cannot fare any worse than those who agree to a restructuring — and they can do much better. The Supreme Court declined to hear an appeal of that decision.
If that order can be enforced, there may be no way to restructure sovereign debts.
But can it be enforced? Perhaps it can.
The courts say that Bank of New York, the payment agent for the bonds, would be in contempt if it aided the payment to holders of restructured bonds without paying the old bonds as well. And the courts want to extend that requirement around the world. Euroclear, a company based in Belgium, says the law there would require it to transmit any payment that a customer ordered. But the American court order says Euroclear must not do any such thing for Argentina.
“Financial market service providers,” Ms. Gelpern said, “are now sovereign debt enforcement agents.”
It is at least possible that the Second Circuit opinion could, in the future, be used to keep the I.M.F. from having a preferential standing over the holdouts in any restructuring that did occur.
The United States government told lower courts that this could create big problems. It could lead to countries choosing to borrow under English law, rather than New York law, and thus diminish the role of New York as a world financial center. That, the government said, could have “a detrimental effect on the systemic role of the U.S. dollar.”
The ruling, added the government, “could enable a single creditor to thwart the implementation of an internationally supported restructuring plan, and thereby undermine the decades of effort the United States has expended to encourage a system of cooperative resolution of international debt crises.”
The Second Circuit opinion, by Judge Barrington D. Parker, brushed aside such worries, suggesting that Argentina was a uniquely bad borrower and saying that enforcement of the rule of law would make New York more attractive for international lenders. And, he added, most international bonds issued in the last decade have “collective action clauses,” allowing a supermajority of bondholders to force holdouts to accept a restructuring, meaning the problem had already been solved.
Countries including Brazil, France and Mexico told the Supreme Court that was nonsense. First, there are still plenty of old bonds without such clauses. Second, collective action clauses normally operate bond issue by bond issue. So it may be possible for holdouts to buy enough of one small issue to block a restructuring that an overwhelming majority of creditors supported.
What would happen then? In a brief submitted to the Supreme Court, Joseph Stiglitz, the Columbia University professor who was formerly chief economist of the World Bank, offered a warning: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.”
What did the Supreme Court think of those arguments? Evidently, not much. It declined to hear Argentina’s appeal, or even to ask the United States government for its views.
The court did decide a related, but far less important, case. That decision will make it easier for the hedge funds suing Argentina to force it to reveal information on assets it owns around the world, in hope that vulnerable assets will be uncovered.
It is hard to muster much sympathy for Argentina, which chose to cram down a brutal restructuring plan years after defaulting, when it reasonably could have been more generous. But this decision is likely to hurt countries whose financial problems are much more serious. It may lead some of them to try to get out from under an American court system that appears to be committed to the 21st-century equivalent of a debtor’s prison for countries confronting an oppressive debt burden.
That is not the way Judge Parker would put it. “We believe,” he wrote, “that the interest — widely shared in the financial community — in maintaining New York’s status as one of the foremost commercial centers is advanced by requiring debtors, including foreign debtors, to pay their debts.”
