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The NY Second Circuit Court of Appeals held its
latest hearing for the high profile pari passu litigation.
The events in the courtroom validated our
pre-existing fears that BoNY is likely to be enjoined and thus,
effectively barred from processing debt service payments to
restructured bondholders (unless, of course, Argentina unexpectedly
reconsiders complying with the order and pays holdout
creditors).
We reiterate our underweight recommendation on
sovereign debt in light of the fact that if the orders are affirmed
and BoNY is enjoined as we feared, then technical default risk is
likely to escalate once again.
A quick glance at the
boxes we checked on our "score card" (see:
Argentina: Keeping score during the Feb 27 NY court
hearing, Feb 26)
reveals a very
lop-sided result favoring holdouts. The latter seem closer than
ever to achieving their objective of imposing a 100% pro rata
formula and enjoining the one financial intermediary in the payment
chain, BoNY, that can actually force Argentina to have to play the
uncomfortable "game of chicken" with its debt service payments that
has been designed by the Court.
In a nutshell, we conclude that:
1. The Court is not
likely to grant an en banc
rehearing
At the start of the hearing the Court denied Argentina's motion for
panel rehearing. That request was nothing more than a long shot
given that panel judges had ruled unanimously on the merits. Yet we
interpret that the denial for panel rehearing anticipates that the
remote chances of an en banc rehearing are now even more remote.
2. The pro rata
formula is 100% (well, maybe in installments... but forget "cram
down")
....But if it is left unchanged it's only because
Argentina adopts an "all or nothing" stance
2.A. The Court will not
cram-down holdouts as Argentina wants
Holdouts effectively pointed out that Argentina is not a formal
counterproposal to the 100% payment formula. Yet initially the
judges seemed genuinely interested in exploring with Argentina's
ideas of how an alternative pro rata payment should be defined. But Argentina's
response (offering to reopen its 2010 debt restructuring) backfired
and this sympathy quickly vanished. Argentina's offer came across
as a gross insult to the Court because Argentina threatened that
any other formula not tailor-made to its liking and convenience
would not be complied with, and this implied default on
restructured bondholders.
The Court made it clear that it was not concerned
about the possibility of default on restructured bondholders
because that was a decision of Argentina, not the Court. It further
made the point that Argentina only wants to impose its terms while
(a) holdout creditors are not obliged to accept those terms and (b)
corporates usually place funds in escrow as evidence of good faith
and Argentina had not even done that (further underscoring the
criticism that offering a reopening of the 2010 restructuring
conditional on a specific Court ruling). To avoid any doubts the
judge mentioned that the Court "enforces contracts, does not
rewrite them."
2.B. Argentina's lack of
compromise leaves the Court empty-handed
Argentina's attempted to challenge the
injunctions on the idea that anything other than the 2010
restructuring terms would not constitute "equitable relief" (and
that paying money, 100% pro rata, in particular is not typically
considered "equitable relief"). But this did not seem to gain any
traction with the Judges. Argentina also re-hashed arguments about
the injunctions violating FSIA 1609 (but judges hardly seemed to
acknowledge this point since - from their perspective - this has
already been settled to the contrary). At one point one judge
almost appeared to be spoon-feeding Argentina the response she
seemed to be looking for from Argentina (i.e. recognizing holdout
claims in full but allowing pro rata installment payments of that
claim and therefore alleviating the burden for Argentina). However,
Argentina's response ("I cannot answer that yet') probably left
that initiative in a dead-end street. You can lead a horse to water
but you can't make him drink.
2.C. The installment payment
idea may reveal some concern over feasibility of
payments
Holdouts have argued that payments are
economically feasible comparing $1.4 billion in litigation with
Argentina's $42 billion reserves. This is not taken seriously in
the market where there is awareness of the $11.5 bn untendered
claims (which likely understates PDI claims given some bonds have
matured). That has been magnified by Argentina's claim that
contingencies (including potentially the restructured bondholders
themselves) raises the risk of payment to $43 billion. The judges
questioned holdouts whether the capacity to pay was available
pointing out that the $1.4 billion is not a number in dispute but
rather what resources Argentina has that it can use to pay might be
disputed.
3. BoNY will not
escape the injunctions
BoNY's defense to avoid being enjoined was based
on claims that it (a) was not in active concert with Argentina, (b)
was not served due process, and (c) that it was not an intermediary
bank
3.A. BoNY is not being denied
due process
The judges repeatedly insisted that the pro-rata
payment orders provided significant notice so that if BoNY
processed payments it would be acting in "acting in concert" with
Argentina and subject to contempt under Rule 65. Judges further
challenged BoNY to admit that if it were not specifically
identified in the order it would probably not process the payment
as it would be want to avoid being in contempt. Given BoNY
suggested the opposite a judge reacted characterizing that response
as "reckless." Furthermore, BoNY's attempts to distinguish "acting
in active concert" from acting passively also failed.
The Court did not seem convinced by BoNY that
proof of aiding Argentina required more than just processing a
payment (objective), it required an intention to help Argentina
breach the orders (subjective), and to do so due process had to be
served. Finally, the Court explained that the injunction was
directed to Argentina (the order to pay) and that BoNY was not
enjoined unless Argentina did not pay holdouts and it continued
processing payments. The Court implied that given that contingency
surrounding the injunction there was no due process had been
missed.
3.B. BoNY is simultaneously a
bondholder trustee AND an agent for Argentina
The judges inquired whether BoNY was more than an
indenture trustee; whether it was playing a "dual" role. Despite
bonholders claims that BoNY was a custodian for bondholders and
could not exercise discretion over funds transferred by Argentina
the Court revealed suspicions that BoNY was in effect an agent for
Argentina. The Court is accusing BoNY of "wearing two hats" and
concluded that BoNY receives fees from Argentina for its services
(rather than discounting fees from the coupon payments bondholders
receive BoNY receives its fees from a grossing-up of coupon
payments sent by Argentina). Holdouts also claimed that the need to
extinguish obligations means that pari passu is breached when BoNY
processes the payments and not only when Argentina initially pays
BoNY.
3.C. The Court is not worried by
the Anti-Constitutional arguments of bondholders
Exchange bondholders sought to convince judges
that they and BoNY were one and the same. It follows that enjoining
BoNY would imply enjoining bondholders. In that case the injunction
on BoNY was an injunction on the beneficiary holder of restructured
bonds and it constituted a "taking" of property of a private party
to satisfy another private party (the anti-constitutional
argument). But the judges challenged third parties on the grounds
that (a) their rights were subject to pari passu (payment) rights
of holdout creditors, (b) that no condition is placed on their
contractual payments if Argentina pays as ordered, and that (c) in
participating in the restructuring they knew the risks of pari
passu clause rights and the potential impact of ongoing
litigation.
Holdouts made a strong case that the
orders do not tell Argentina not to pay restructured bonds, but
only to pay holdouts ratably and, if so, then there should be no
claims of suffering irreparable harm. Holdouts attacked
restructured bondholders portrayal of themselves as victims,
highlighting that they promoted the imposition of the Lock Law that
contributed to the subordination of holdouts. Judges seemed
sympathetic to these positions: they seem t believe that
injunctions (and namely, the Court that issues them) cannot be held
responsible for default because that is a decision Argentina makes
or not.
4. The CDS conspiracy: Another
remand? Seriously?
A judge asked holdouts about a potential conflict
of interest in the accusation on record that holdouts hold CDS
positions which allow them to profit from a disruption of markets
that an Argentina default would entail. The judge even asked if
this issue might warrant sending the case back for remand. Was it a
joke or a genuine question? We don't expect this to lead to a
remand as the judge did not pursue the inquiry... but the
impression made by this unexpected question on the audience was
visible.
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