N U M B E R P B 1 3 - 1 2 M AY 2 0 1 3Sovereign Damage ControlAnna GelpernAnna Gelpern, nonresident senior fellow at the Peterson Institute for International Economics, is professor of law at American University Washington College of Law. She thanks the editors and her colleagues for comments. Portions of this Policy Brief appeared in the Capital Markets Law Journal and on CreditSlips.org.© Peterson Institute for International Economics. All rights reserved.INTRODUCTIONItaly changed its debt contracts, Belize passed a law, and Taiwan sued Grenada this year, all thanks to a string of court rulings in New York that try to make Argentina pay its debts. Th e case—NML Capital Ltd. et al. v. Republic of Argentina—has breathed new life into policy initiatives ranging from sovereign bankruptcy to marketwide contract reform.While they go to unprecedented lengths to isolate Argentina, the rulings cannot make the country pay. If upheld, they threaten collateral damage to other countries and parts of the fi nancial system. Th e impact may be felt sooner and farther afi eld, even compared with Argentina’s record-breaking 2001 default, because court action unfolds against the background of public debt distress in Europe, new emerging-market restruc-turings, and regulatory focus on clearing and payment systems.Argentina exchanged nearly $100 billion in principal and past-due interest on its defaulted foreign bonds in two waves in 2005 and 2010. Both times some creditors refused to take the deal and insisted on full payment. Among them, NML Capital Ltd., an affi liate of Elliott Associates, has been chasing Argentina in courts around the globe for years, trying to seize government property but mostly failing. Th e latest lawsuit promises to give creditors like Elliott much more potent tools to use against the debtor. Th e shift would come courtesy of one obscure debt contract term that has gained destructive power in a case where the government and its creditors are uniquely willing to test the limits of the law.A federal judge in the Southern District of New York ruled in December 2011 that the pari passu [equal step] clause in its old defaulted bonds required Argentina to pay NML and its fellow plaintiff s “ratably” any time it paid its new restructured bonds. Judge Th omas P. Griesa then ordered Argentina not to service the new debt unless NML got paid in full. He barred Argentina from rerouting payments beyond the court’s juris-diction and later threatened to sanction a wide range of third parties if they helped Argentina evade his orders. Th e Bank of New York Mellon as trustee for the new bonds, as well as clearing and payment system operators such as the Depository Trust & Clearing Corporation (DTCC), Euroclear, and the Clearing House Interbank Payments System (CHIPS) are among those in the crosshairs, because they form parts of the payment chain on the new bonds.When Argentina appealed Judge Griesa’s ruling, US State and Treasury Departments intervened on its side. Th ey argued that sovereign immunity should prevent the court from telling a foreign government how to spend its public funds. Th ey also worried that targeting restructured bonds would hinder future crisis management: What creditor would agree to reduce its claim on a government only to have its new payments caught up in holdout lawsuits?Th e US Court of Appeals for the Second Circuit dismissed these concerns in October 2012. Th e judges agreed with the lower court’s core premise, that NML and its co-plaintiff s should be paid alongside the new bondholders. But they questioned Judge Griesa’s payment formula and the eff ect of his order on third parties. His response in November 2012, and another round of appeals, triggered an avalanche of third-party briefs from investors in restructured and defaulted bonds, fi nancial institutions, and academics on all sides. At this writing, the appeal is still pending. When it is decided, one or both sides almost certainly will try to take it to the US Supreme Court.Until this case, countries could rely on sovereign immunity to gum up debt collection: Creditors might sue them but could not reach their assets. For countries, which cannot fi le for bank-ruptcy, immunity off ered a shield akin to bankruptcy protection and encouraged most creditors to compromise. Governments 1750 Massachusetts Avenue, NW Washington, DC 20036 Tel 202.328.9000 Fax 202.659.3225 www.piie.comPolicy Brief
