Vulture funds: US court ruling on Argentina enrages debt justice campaigners

3 September 2013 by Bodo Ellmers

Photo: James Robertson/Jubilee Debt Campaign

The long litigation odyssey between the government of Argentina and holdout creditors continues. Debt justice campaigners in Argentina and the USA are enraged about a new ruling by the New York appeals court in favour of the vulture funds NML Capital Ltd and Aurelius Capital, which sued for full payment of US$1.3 billion of holdout debt.

The New York court upheld the previous ruling that Argentina must repay the vulture funds Vulture funds
Vulture fund
Investment funds who buy, on the secondary markets and at a significant discount, bonds once emitted by countries that are having repayment difficulties, from investors who prefer to cut their losses and take what price they can get in order to unload the risk from their books. The Vulture Funds then pursue the issuing country for the full amount of the debt they have purchased, not hesitating to seek decisions before, usually, British or US courts where the law is favourable to creditors.
every time it repays the creditors that participated in the debt swap of 2005. Enforcement is still on hold until the US Supreme Court has made a decision to take the case. If it is upheld in this last instance, Argentina would face the choice between paying vulture funds that speculated on the country’s bankruptcy after the financial crisis of 2002, which is forbidden by Argentine law, or defaulting on the restructured debt too.

Flawed interpretation of equal treatment

The US court rule is mainly based on the pari passu (parity) clause in bankruptcy proceedings, which says creditors should be treated equally and without preference. On this basis, the US court decided that, when Argentina pays the creditors that participated in the debt restructuring, it has to pay the vulture funds that expect full payment too. But, as Jubilee USA put it, “their interpretation of the parity clause is deeply flawed”.

This view is shared by the international community, as the relevant international organisations find that vulture funds undermine inter-creditor equity Equity The capital put into an enterprise by the shareholders. Not to be confused with ’hard capital’ or ’unsecured debt’. . The United Nations’ responsible lending and borrowing principles are that “lenders should be willing to engage in good faith discussions with the debtor and other creditors to find a mutually satisfactory solution”. That has certainly not happened in this case. Argentina has recently offered an alternate payment plan to holdout creditors that was essentially the same deal taken by the 92 percent of creditors that participated in the debt restructuring after Argentina’s debt crisis in the early 2000s. But the holdout creditors rejected the plan. Offering them full payment would put Argentina in a difficult position, as the UN principles do not approve of arbitrary discrimination among creditors.

Devastating implications for debt crisis management

The US court ruling might have severe consequences for the functionality of the international financial architecture. A recent paper on sovereign debt Sovereign debt Government debts or debts guaranteed by the government. restructuring by International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
(IMF) experts said that the impacts are already being felt. The IMF finds that “litigation against Argentina could have pervasive implications for future sovereign debt restructurings by increasing leverage Leverage This is the ratio between funds borrowed for investment and the personal funds or equity that backs them up. A company may have borrowed much more than its capitalized value, in which case it is said to be ’highly leveraged’. The more highly a company is leveraged, the higher the risk associated with lending to the company; but higher also are the possible profits that it may realise as compared with its own value. of holdout creditors … the ongoing Argentina litigation has exacerbated the collective action problem”. The US court decision would undermine future debt restructuring as it gives new leverage to holdout creditors suing for full payment. In consequence, “holdouts will multiply and creditors who are otherwise inclined to agree to a restructuring may be less likely to do so due to inter-creditor equity concerns”.

Jubilee USA reports that the IMF’s Managing Director Christine Lagarde planned to file an amicus brief to the US Supreme Court in support of Argentina, but she was stopped from doing so by intervention from the US Treasury. The USA is the IMF’s largest shareholder and is endowed with a de facto veto right over its decisions. European governments such as France supported Argentina in this case. German courts had previously declined to accept vulture fund claims.

New dangers for financing development and poverty eradication

The US judges said that the ruling would not have implications elsewhere because “Argentina has been a uniquely recalcitrant debtor”. However, Eurodad research has shown that vulture funds are a permanent annoyance for debt restructuring that is made in good faith, including for the world’s poorest countries. The African Development Bank (AfDB) statesthat 11 heavily indebted poor countries Heavily Indebted Poor Countries
In 1996 the IMF and the World Bank launched an initiative aimed at reducing the debt burden for some 41 heavily indebted poor countries (HIPC), whose total debts amount to about 10% of the Third World Debt. The list includes 33 countries in Sub-Saharan Africa.

The idea at the back of the initiative is as follows: a country on the HIPC list can start an SAP programme of twice three years. At the end of the first stage (first three years) IMF experts assess the ’sustainability’ of the country’s debt (from medium term projections of the country’s balance of payments and of the net present value (NPV) of debt to exports ratio.
If the country’s debt is considered “unsustainable”, it is eligible for a second stage of reforms at the end of which its debt is made ’sustainable’ (that it it is given the financial means necessary to pay back the amounts due). Three years after the beginning of the initiative, only four countries had been deemed eligible for a very slight debt relief (Uganda, Bolivia, Burkina Faso, and Mozambique). Confronted with such poor results and with the Jubilee 2000 campaign (which brought in a petition with over 17 million signatures to the G7 meeting in Cologne in June 1999), the G7 (group of 7 most industrialised countries) and international financial institutions launched an enhanced initiative: “sustainability” criteria have been revised (for instance the value of the debt must only amount to 150% of export revenues instead of 200-250% as was the case before), the second stage in the reforms is not fixed any more: an assiduous pupil can anticipate and be granted debt relief earlier, and thirdly some interim relief can be granted after the first three years of reform.

Simultaneously the IMF and the World Bank change their vocabulary : their loans, which so far had been called, “enhanced structural adjustment facilities” (ESAF), are now called “Growth and Poverty Reduction Facilities” (GPRF) while “Structural Adjustment Policies” are now called “Poverty Reduction Strategy Paper”. This paper is drafted by the country requesting assistance with the help of the IMF and the World Bank and the participation of representatives from the civil society.
This enhanced initiative has been largely publicised: the international media announced a 90%, even a 100% cancellation after the Euro-African summit in Cairo (April 2000). Yet on closer examination the HIPC initiative turns out to be yet another delusive manoeuvre which suggests but in no way implements a cancellation of the debt.

List of the 42 Heavily Indebted Poor Countries: Angola, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoro Islands, Congo, Ivory Coast, Democratic Republic of Congo, Ethiopia, Gambia, Ghana, Guinea, Guinea-Bissau, Guyana, Honduras, Kenya, Laos, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Myanmar, Nicaragua, Niger, Rwanda, Sao Tome and Principe, Senegal, Sierra Leone, Somalia, Sudan, Tanzania, Togo, Uganda, Vietnam, Zambia.
have been targeted in 46 law suits. The costs could amount to 13 per cent of each affected countries’ Gross Domestic Product GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
(GDP). It finds that “vulture funds grind down poor countries in cycles of litigation, a practice referred to as ‘champerty’ and largely unknown in African legal systems”. The problem became so severe that the bank had to set up the African Legal Support Facility to help poor countries defend themselves before foreign courts. The facility diverts scarce resources from the AfDB’s core businesses in financing development and poverty eradication.

Vulture fund law suits are obviously good business for the law firm industry in financial centres such as New York and London. However, in order to make sure that aid can be used for more important purposes, Eurodad calls on governments to enact legislative changes at the national level to prevent vulture funds from using national courts to pursue their claims in the first place. Such legislation should make profiteering in defaulted sovereign debt illegal.

First steps in this direction have been made through vulture fund legislation in Belgiumand the United Kingdom. However, their scope could be enhanced further.

Vulture funds have also caused troubles for Greek debt restructuring. While 100 per cent of sovereign bonds covered by Greek law could be restructured, the holdout ratio was 44 per cent in the case of Greek government bonds issued under English law. Such holdouts have created tremendous extra costs for Greece, and for all the European taxpayers who are ultimately backing the EU’s bail-out instruments currently applied in Greece. Jubilee Debt Campaign UK has called on the British government to enhance the law, but this has not yet happened.

What next?

The US court ruling has once again unveiled both the ineffectiveness and unfairness of the current debt governance regime. The US court rejected the view that it would give too much leverage to creditors and suggested that governments should use collective action clauses (CACs) that would bind bondholders to majority decisions. Indeed, given the Greek experience, the EU recently introduced the rule that all new Eurozone bonds contain such clauses. But the IMF finds that such clauses are of limited use: “the court’s confidence in the salutary benefit of CACs appears somewhat optimistic given the ability of holdout creditors to take blocking positions in individual bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. issuances”.

The IMF suggested a new statutory debt workout mechanism as a more effective alternative. However, according to information obtained by Eurodad, the US representative vetoed the proposal in the IMF’s Executive Board, condemning the IMF to pursue piecemeal second-best reforms. Meanwhile, the UN took over the development of new debt workout mechanisms.

In a comment on the US court ruling, Jubilee South Argentina stressed that attention needs to be paid to the origins of Argentina’s debt. Even if rolled over in later times, much of the debt built up originally took place during the time of the military dictatorship and the ‘dirty war’ in which more than 30,000 people were killed. It would therefore qualify as ‘odious debt Odious Debt According to the doctrine, for a debt to be odious it must meet two conditions:
1) It must have been contracted against the interests of the Nation, or against the interests of the People, or against the interests of the State.
2) Creditors cannot prove they they were unaware of how the borrowed money would be used.

We must underline that according to the doctrine of odious debt, the nature of the borrowing regime or government does not signify, since what matters is what the debt is used for. If a democratic government gets into debt against the interests of its population, the contracted debt can be called odious if it also meets the second condition. Consequently, contrary to a misleading version of the doctrine, odious debt is not only about dictatorial regimes.

(See Éric Toussaint, The Doctrine of Odious Debt : from Alexander Sack to the CADTM).

The father of the odious debt doctrine, Alexander Nahum Sack, clearly says that odious debts can be contracted by any regular government. Sack considers that a debt that is regularly incurred by a regular government can be branded as odious if the two above-mentioned conditions are met.
He adds, “once these two points are established, the burden of proof that the funds were used for the general or special needs of the State and were not of an odious character, would be upon the creditors.”

Sack defines a regular government as follows: “By a regular government is to be understood the supreme power that effectively exists within the limits of a given territory. Whether that government be monarchical (absolute or limited) or republican; whether it functions by “the grace of God” or “the will of the people”; whether it express “the will of the people” or not, of all the people or only of some; whether it be legally established or not, etc., none of that is relevant to the problem we are concerned with.”

So clearly for Sack, all regular governments, whether despotic or democratic, in one guise or another, can incur odious debts.
’. Moreover, Jubilee South questioned whether New York courts are a competent jurisdiction to rule over Argentine debt and accused the Argentine government of acting unconstitutionally. They demand that a thorough debt audit should be conducted and claim it is necessary that “both the international community and the government of Argentina recognize that the country has every right and all the required evidence to denounce and nullify both the illegitimate debt contracts that have been imposed against the will and rights of the Argentine people, as well as the renunciation of sovereignty and jurisdiction”.

According to Jubilee South, a new strategy on sovereign debt restructuring must put “the defence and promotion of human rights over the claims of capital, as relevant domestic and international law demands”.



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