This is pretty significant...

The case in question is a long-running legal battle between Argentina and several so-called vulture funds that refused to join the 93 per cent of creditors that agreed to the punitive restructuring that followed the country’s 2001 default. The US courts have ruled unexpectedly harshly against Argentina, rattling markets and throwing money managers, lawyers and analysts into a spasm of speculation.

“This has the potential to break the paradigm of the sovereign debt world,” says Hans Humes of Greylock Capital Management, a fund that specialises in emerging markets. Mr Humes co-chaired the committee of Argentina’s bondholders and sat on Greece’s creditor committee during its restructuring this year.

“Creditor rights have been methodically stripped away in recent years, but this may bring us back,” he says.

Elliott Associates, the main hedge fund plaintiff, is run by Paul Singer, the US billionaire, and has made extracting money from defaulting governments its calling card. Elliott won the Argentine case through an arguably novel interpretation of a Latin phrase: pari passu. It means “on equal footing” or “in equal step” and is a venerable legal clause in bonds and loans.

In corporate bankruptcies, pari passu creditors rank equally in the queue when companies are dissolved, the assets are sold and proceeds disbursed to lenders. Although countries do not go into bankruptcy, the clause has long featured in government bonds and loans even though lawyers disagree on the clause’s meaning and importance, says Mitu Gulati, a law professor at Duke University and former lawyer at Cleary Gottlieb, Argentina’s counsel.
Argentina’s long-festering wound

Argentina has struggled to manage its money throughout its two centuries as an independent nation – and was once so hard-up it tried to swap the Falkland Islands for its debt, writes Jude Webber.

It received its first loan, from Britain, in 1824 but had defaulted by 1890. In 1949 it declared itself debt-free and was even a creditor to Italy, Finland, Belgium and Romania, which had been devastated by war. But by 2001 it had racked up the world’s biggest sovereign default by halting payment on nearly $100bn of foreign debt.

Elliott and Aurelius Capital, its co-plaintiff, founded by a former Elliott trader, successfully argued that the pari passu clause in their defaulted bonds meant that Argentina could not continue to ignore them while paying the holders of its restructured debt.

But District Court Judge Thomas Griesa went further than just finding in favour of the hedge funds. Lawyers say he broke new ground in how widely the clause can be interpreted, and how far creditors can go in seeking redress from defaulting countries.

Lenders can win legal cases against countries, but winning compensation is trickier. Most overseas government assets are protected by sovereign immunity. Vultures typically try to create such legal bother that countries eventually pay them to go away.

But this so-called holdout strategy depends on extreme patience and deep pockets. Argentina, for example, has largely been able to thumb its nose at creditors for almost a decade. Elliott has proved a dogged adversary and even seized an Argentine navy training ship in October after it docked in Ghana. But despite this forceful demonstration of willpower, Elliot has so far failed to extract a single peso from Buenos Aires.

By contrast, Judge Griesa has backed up the bark of his ruling with a sharp bite that may bolster the hedge funds in their showdown with Argentina. The injunction prohibited third parties from “aiding and abetting” any violation of his order.

This was primarily aimed at Bank of New York Mellon, the conduit of Argentina’s payments to the holders of its restructured debts. Unless the appeals court intervenes, Argentina must pay Elliott and the other plaintiffs more than $1.3bn by December 15, BNY Mellon will breach the injunction if it transfers regular payments to Argentina’s lenders due on the same date.
BNY Mellon is unlikely to defy the court, so this essentially means that unless Argentina pays the vulture funds it could default on its international debts once more. Lawyers say that Judge Griesa’s legal dragnet leaves little room for escape, though Argentina and holders of restructured bonds have filed emergency appeals. It also applies to parties in the payments system – the economy’s circulatory system – including overseas clearing houses such as Euroclear.

This has far-reaching implications, says Anna Gelpern, a law professor at American University and Georgetown, previously of the US Treasury and Cleary Gottlieb.

“Grabbing a ship in Ghana is serious, but still a serious nuisance. In contrast, the ability of holdouts to seize money in the payments system is of systemic importance,” Ms Gelpern says. “Gunboats could target individual countries but targeting the payments system is an entirely different kettle of fish.”