Settling Sovereign Debt's "trial of the Century"

• Citation: Vol. 31 No. 1
• Publication year: 2016

Settling Sovereign Debt's "Trial of the Century"

Juan J. Cruces

Tim R. Samples

SETTLING SOVEREIGN DEBT'S "TRIAL OF THE CENTURY"

Juan J. Cruces^* Tim R Samples^**

ABSTRACT

NML v. Argentina, the "trial of the century" in sovereign debt, is finally poised for settlement negotiations. International experience, incentives for the parties themselves, and even statements by the presiding federal judge, all suggest that it is high time for a settlement between the parties. However, major challenges remain. In this Article, we analyze a subset of the key economic and legal factors underlying this litigation, with a particular emphasis on issues relevant to a potential settlement. We document the wide heterogeneity of holdout rates across Argentina's 150 defaulted bonds (of which seventy-four still have holdout rates greater than five percent) and focus the subsequent analysis on the seven most held-out bonds—which have holdout rates between twenty and eighty-two percent and account for about thirty percent of total holdout principal. We show that New York's statutory real rate of interest on overdue interest has been 6.6% on average during the years affecting this suit compared to 3.1% during the previous forty years. As such, this rate has become more punitive than compensatory. We also illustrate the growth of the value of holdout claims for the seven bonds from their initial $1.7 billion in principal up to $4.3 to $7 billion in current value, depending on when holdouts obtained judgments. We analyze the sensitivity of holdout claims to different approaches to overdue interest—an issue that has become increasingly controversial in New York state law in recent years. We next assess the returns that investors would have obtained by purchasing the seven-bond basket at different times since 2002. We find that investors would have multiplied their money an average of eight times if

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they obtained judgments in 2008 or thirteen times in 2015. Finally, we compute the current value of Argentina's 2005 exchange offer and find that is worth about one-half of the litigants' claims for judgments obtained in 2008. Our analysis offers a framework for potential settlement negotiations. However, with so many holdouts unaccounted for, a settlement with the NML litigants exposes Argentina to the tyranny of the next litigant as long as the current injunctions remain in place. We close by underscoring the benefit of modifying or lifting these injunctions as Argentina begins negotiating in good faith to reach a reasonable settlement with its holdout creditors.

Introduction.................................................................................................7

I. Argentina's Holdout Litigation...................................................10

A. Default and Restructuring ........................................................... 10
B. The Evolution of NML Litigation, 2002-2014 ............................ 12
C. A Bond-by-Bond Look at NML Claims ....................................... 15

II. The Value of Holdout Claims.......................................................18

A. Pre-judgment Interest Under New York Law .............................. 18
B. Argentina's Extraordinary Interest Liabilities ............................ 22
C. Hypothetical Bondholder Returns ............................................... 25

III. The Current Value of the 2005 Restructuring Offer..............27

A. Returns on Participation ............................................................. 28
B. The Holdout Trust ........................................................................ 30
C. Reinvestment of Intermediate Cash Flows .................................. 32
D. Results ......................................................................................... 33
E. Haircut of a Hypothetical Offer................................................... 36

IV. Towards a Reasonable Settlement..............................................37

A. Adjudicating Sovereign Debt Disputes ........................................ 38
B. Settling Sovereign Debt Disputes ................................................ 41
C. Ratable Payment Injunctions versus Negotiated Settlement........ 42

Conclusions..................................................................................................44

Appendix.........................................................................................................45

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Introduction

All eyes are once again on NML v. Argentina (NML) as sovereign debt's "trial of the century" has entered the endgame phase.¹ Talks between Argentina and holdout creditors were even a prominent storyline at the 46th World Economic Forum in Davos, Switzerland.² After a hostile standoff with U.S. courts under the Kirchner administration, the recently elected Macri government pledged to negotiate a settlement and quickly put forth an offer.³ The outcome of Argentina's debt dispute has critical implications for sovereign debt markets, which are a systemically important component of the global economy.⁴ Recent events—including crises in Greece, Puerto Rico, and Ukraine—underscore the implications of sovereign debt markets for policymakers, financial systems, and ordinary citizens alike.⁵

Argentina's debt saga began with an $81.3 billion default in 2001, the largest-ever sovereign default at that time.⁶ A number of "holdout" creditors—with bonds worth $6 billion at face value—sat out of Argentina's 2005 and 2010 debt restructurings, with many opting instead for litigation.⁷ After years in the Second circuit, NML finally hit a boiling point in 2014.⁸ Following a string of losses in federal courts and a failed petition to the U.S. Supreme Court, Argentina again slipped into default as payments to exchange creditors were blocked by a court injunction.⁹ Argentina's debt imbroglio offers valuable

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examples and lessons at various stages in sovereign finance—issuance, default, restructuring, litigation, and post-litigation. This Article focuses on the post-litigation stage.

NML ignited widespread commentary in academic, policy, and industry circles. Building on a substantial body of existing literature involving sovereign debt restructuring and litigation,¹⁰ scholars explored the significant implications of Argentina's default and the NML fallout.¹¹ Reactions followed from institutions such as the United Nations (U.N.) and the International Monetary Fund, among others.¹² NML has also prompted feedback from industry organizations representing various constituencies in international financial markets.¹³

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Between scarce currency reserves and political sensitivities surrounding the holdout situation, Argentina's government faces a delicate balancing act.¹⁴ Finding a reasonable value for settling the claims that the holdouts will accept and Argentina can afford—financially and politically—will not be easy.¹⁵ Serious challenges remain, including structural questions about Argentina's settlement offer and issues of inter-creditor equity among the holdouts.¹⁶ Initial reactions to Argentina's preliminary offer illustrate the complexity and gravity of inter-creditor issues for a potential settlement.¹⁷ The role of injunctions in the NML litigation is still critical—even at the settlement stage.¹⁸

In this Article, we address economic and legal factors underlying Argentina's holdout litigation with an emphasis on key issues for settlement negotiations. We contribute original financial data and legal analysis to the NML debate, which has critical implications for the broader world of sovereign finance. Specifically, our quantitative analysis illustrates holdout rates by bond, outstanding defaulted bonds by currency and applicable law, the current value of holdout claims compared to Argentina's 2005 exchange offer, and returns for hypothetical holdout creditors under various investment scenarios. We close by evaluating legal and policy factors related to a potential NML settlement.

This Article is organized as follows. Part I reviews Argentina's holdout litigation stemming from the 2001 default. Part II addresses the valuation of holdout claims, including an analysis of interest liabilities and an illustration of investment performance for hypothetical bondholders under different scenarios. Part III illustrates the current value of the 2005 offer depending on different allocations of the cash flows paid on Argentina's exchange bonds and GDP-linked warrants between 2005 and 2015. Part IV considers legal and public

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interest factors at play in a potential NML settlement, including the role of ratable payment injunctions in the settlement phase of the NML litigation. We then offer concluding observations.

I. Argentina's Holdout Litigation

This Part breaks down Argentina's debt saga in detail across three key stages: default, restructuring, and litigation. This Part will first explain the dimensions of Argentina's remarkable default and restructuring process, which set the stage for the extraordinary amount of holdout litigation facing Argentina. This Part then traces the evolution of the NML litigation in U.S. courts and provides a detailed bond-by-bond look at holdout claims.

A. Default and Restructuring

Following a devastating economic crisis, Argentina's 2001 default was epic in both proportion and complexity.¹⁹ In a short but traumatic period, Argentina's economy contracted dramatically as unemployment topped twenty percent and half of the population fell under the poverty line.²⁰ At that time, Argentina's $135 billion default was the largest sovereign debt default to date.²¹ The complexity of the default was also staggering with 150 different bonds, denominated in six currencies under the laws of eight different jurisdictions, and a highly fractured creditor base of over half a million bondholders.²²

But a record default was only the beginning. These factors paved the way for an extraordinarily difficult...