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
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.
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.
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
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.
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.
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.
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
has changed, at least for countries that issue bonds under New York law.
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