The way hedge funds – often called “vulture funds” - work is by buying at a very heavy discounted price the debts that were not included in the rescheduling, and then suing for full payment of capital plus all the interest due. Interest comes free when debt is under an impaired value credit category. Elliott Associates – the major shareholder of NML Ltd - has made a reputation for cornering governments in times of need and getting away with it. Panama was the first one; Congo, Peru, Argentina are among those that have followed. Their argument is that these lawsuits discipline the debtors.

The international relevance of these activities is that it brings to the fore the nature and presence of US law and rulings in international finance. Most US dollar-denominated debt is issued under US law and subject to the Southern district courts of New York City - those near Wall Street. This means that if Botswana borrows from Uganda in US dollars, it is almost certain those contracts will be written under New York law and any legal action between those two countries will be subject to New York law. The implication is that NY law becomes world law and is applied globally, becoming a mechanism of coercion. The enforcement of payment in the ruling is executed through bank account or asset embargoes. For example, in 2012 the Argentine frigate Libertad was seized in a port in Ghana under orders from a New York judge. It was released after some months under a ruling from the UN International Tribunal for the Law of the Sea because she holds diplomatic immunity.

The latest ruling includes non-dollar denominated instruments signed under British and other laws with the argument that the payment due to one creditor is equally due to all. Ecuador, a debtor that defaulted and bought its debt at a 70% discount in 2008 decided in May 2014 to buy back 80% of the held out debt plus interest and got it over with. The huge return on investment for unpaid bondholders was less of a problem for Ecuador than the likelihood of having its accounts frozen after the new loans were disbursed, given it is a dollar denominated economy.

Collective Action Clauses and the experience of Peru

Debt papers before 2001 did not have collective action clauses (CAC) yet, which means that if most creditors agreed to a debt workout solution, this includes only those who joined voluntarily. With a CAC, if a large portion of the creditors are in favour of a workout, all instruments are included.

The lack of CAC was made evident when Elliot Associates sued Peru in the 1990s and won the case in 2000. Peru had undergone the longest sovereign default in history and came out with a debt restructuring that included a sharp haircut and new Brady bonds (dollar-denominated bonds). Four instruments were left at Swiss Bank Corp., which sold the instruments to Elliot after the Brady deal had been signed in what appeared to be a breach of contract on Swiss bank’s side. Elliot then sued Peru for 100% of capital. It had paid 5% of the face price of the papers. On top of that, it sued it for unpaid interest since 1984. The profit of the Peruvian operation was 1600 per cent. It apparently got a helping hand from a Peruvian lawyer who happened to be an official at the Ministry of Finance in 1994. A lot of information was passed in 1994 from the Ministry of Finance to the creditors leading to the trial of Finance Minister Jorge Camet Dickman, responsible for this operation. He died in 2013 serving a prison term at home for this and other cases.

Peru’s case was made using the Champerty Doctrine that says that no debt purchased with the sole purpose of harming a debtor should be taken into account by the US judiciary. Investors who become creditors through the purchase of debt instruments at a time when the debtor is undergoing hardship should not be taken into legal consideration. Nevertheless, the New York judge ruled against Peru. Amongst the group of investors was a former US ambassador to Peru. It remains unclear if the former ambassador was there in his own right or as a representative of the US State Department. The Peruvian Government lost the case and the appeal, and as a result all Society for Worldwide Interbank Financial Telecommunication (SWIFT) dollar transactions were blocked. After that, Elliot sued Peru in the Belgian courts that ruled in favour of Elliot and prevented the use of Brussels based Euroclear. It then proceeded to use Clearstream in Luxembourg knowing this would also be blocked. The argument of the Belgian Court was pari passu - all creditors should be treated equally.

The Argentine case

NML associates, a subsidiary used by Elliot to carry out the Argentine operation, invested 50 million dollars to purchase debt at depressed prices that had not entered the restructuring scheme in 2005, and sued for USD 1.5 billion. They then started the legal proceedings that have lasted six years until finally the judiciary ruled in favour of NML. The Argentine debt is held with creditors in many jurisdictions and, theoretically, not all are subject to US law. Equally there are dollar and non-dollar denominated instruments and agent banks operating outside the US. The ruling, however, starts from a peculiar reading of the principle of pari passu, that equal payments must be made to all creditors whether they restructured or not, regardless of the law applied in their contract. The Trustee in charge of making the payments is Bank of New York Mellon who must abide by this ruling and comply with the law.

This ruling essentially takes away the incentive to restructure sovereign debts normally done on the basis of debt reductions. Even worse, it places legal creditors who underwent the restructuring procedure on the same basis as highly speculative investors who operate on bad faith buying the debt after the swaps are finalised, in the spirit of Champerty. The gravest consequence is that a New York ruling is converted into a global ruling for any Argentine assets held by anyone anywhere. An explanation was given that the ruling is not meant to be a precedent which means the ruling was done as a specific punishment, reminiscent of the ruling of the Court of The Hague against Austria in 1931 when it decided it wanted to form a customs union with Germany. Then, as now, if it is not a precedent, it is a punishment. The question is why.

Ways forward

Argentina’s position is that it is the right of a sovereign debtor to restructure its debt. It believes in the principle of non-intervention in foreign states and does not admit legal actions executed outside the natural range of the justice of the United States. In so doing it believes it is defending the property rights of the holders of Argentine bonds, especially those whose right is not governed by justice of the United States. But also of those who entered the swap agreements in good faith in 2005 and 2010 which this ruling has declared, for all intents and purposes, invalid. Argentina opened the fight by depositing the money at the Bank of New York Mellon so bondholders could collect. As the money belongs to the bondholders, they should be able to do so. This is the sense of a communique published in the international press in July 2014, a week after the ruling was made public.

The vultures have a press campaign stating that Argentina does not want to pay any of its debt nor comply with US law. Argentina on its side has informed the clients it will pay through Euroclear which should protect them from the US international payment embargo as book entry accounts in Euroclear enjoy unconditional immunity from attachment.

The international support given to Argentina is an expression of what is globally perceived as being an unjust ruling from a court that should not have extraterritorial functions over currencies and assets that are not US assets. The capture of a payment for Cuban cigars traded between Germany and Denmark under US law is an expression of the extraterritorial use of US law, which is unacceptable. If the international system is going to evolve it must go in the direction of international law and international courts and not in the direction of local law with a local court with global ramifications. This implies a new financial architecture. It could mean the creation of a clearing house and more use of non-dollar means of payments in international transactions. The creation of an international financial law process at the United Nations similar to that being developed for international trade law (UNCITRAL) is vital. This should come together with the development of the concept of international tribunals for debt arbitration in order obtain reasonable debt workouts of sovereign defaults following the principles of fair and transparent arbitration that should begin with a debt audit, keeping the Champerty principle in mind.

The lesson from the NML Argentina case is that non-OECD countries in the future should not issue debt instruments in US dollars, nor be subject to New York law and courts, given the risk described above. International trade should equally not be settled in US dollars and a new non-OECD international clearing house should be started to prevent the problems that have arisen due to dubious US rulings.