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SOVEREIGN DEBT RESTRUCTURING:EVALUATING THE IMPACT OF

THE ARGENTINA RULING

LAURA ALFAROHARVARD BUSINESS SCHOOL & NATIONAL BUREAU

OF ECONOMIC RESEARCH*

ABSTRACT

Recent rulings in the ongoing litigation over the pari passu clause inArgentinian sovereign debt instruments have generated considerable contro-versy. Some public sector participants and academic articles have suggestedthat the rulings will disrupt or impede future sovereign debt restructurings byencouraging holdout creditors to litigate for full payment instead of participat-ing in negotiated exchange offers. This paper critically examines this claim andargues that the incentives for holdout litigation are limited because of (1) signif-icant constraints on creditor litigation, (2) substantial economic and reputa-tional costs associated with such litigation, and (3) the availability ofcontractual provisions and negotiating strategies that mitigate the debtors col-lective action problems. It also argues that the fact-specific equitable remedy inthe current Argentina case was narrowly tailored to Argentinas unprecedenteddisregard for court opinions and for international norms of negotiating sover-eign debt restructurings and is therefore unlikely to be used in future debtrestructurings.

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 RI. SOVEREIGN DEBT: OVERVIEW OF THE LITERATURE . . . . . . . . . . 50 RII. NEGOTIATION PROCESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 R

A. Guidelines for Negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 RB. Argentinas Negotiations with International Creditors . . . 53 R

III. CREDITOR ENFORCEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 RIV. HOLDOUT INCENTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 R

A. Litigation Expense and Specialized Knowledge . . . . . . . . . 61 RB. Investor Constraints and Illiquidity . . . . . . . . . . . . . . . . . . . . 61 RC. Business Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 RD. Reputation and Regulatory Pressure . . . . . . . . . . . . . . . . . . . 62 RE. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 R

V. DEALING WITH HOLDOUT CREDITORS . . . . . . . . . . . . . . . . . . . . . . 64 RA. Ex Ante Contractual Provisions . . . . . . . . . . . . . . . . . . . . . . . 64 R

1. Collective Action Clauses . . . . . . . . . . . . . . . . . . . . . . . . . 64 R

* Laura Alfaro, Harvard Business School, Morgan 297, Boston, MA, 02163, U.S.A.(email: lalfaro@hbs.edu). I thank Gaurav Toshniwal whose independent study project and nu-merous discussions shaped this document. I also thank Katelyn Barry, John Elden, and HilaryWhite for excellent editorial and research assistance. Finally, I thank Della Fok and the editorsof the Harvard Business Law Review for their assistance in preparing this article forpublication.

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48 Harvard Business Law Review [Vol. 5

2. Pari Passu Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 R3. Sharing Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 R4. Choice of Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 R5. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 R

B. Ex Post Negotiating Strategies . . . . . . . . . . . . . . . . . . . . . . . . . 68 R1. Minimum Participation Thresholds . . . . . . . . . . . . . . . . . 68 R2. Exit Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 R3. Full Payout . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 R4. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 R

VI. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 R

INTRODUCTION

On August 23, 2013, the United States Court of Appeals for the SecondCircuit affirmed an award of equitable relief by the District Court for theSouthern District of New York that barred Argentina from paying certaincreditors after refusing to pay other plaintiff-creditors that had declined anexchange offer as part of a sovereign debt restructuring.1 In reaching thisruling, the court interpreted the bondholder-friendly pari passu clause thatArgentina offered in its now-defaulted debt documentation.2 Argentina im-mediately rejected the courts ruling and vowed to appeal to the UnitedStates Supreme Court.3 The Argentinian government also initiated a plan tocircumvent a possible adverse ruling.4 In fact, in the countrys most recenteffort to avoid such rulings, the president of Argentina stated that she wouldtry changing the payment mechanism on Argentinas international bonds toavoid the reach of U.S. courts.5

The ruling was not only unacceptable to the Argentinian government,but also controversial among commentators. Public sector participants wereworried that it could set bad precedent for future sovereign debt restructur-ings by creating a free rider problem: creditors would now have an incentiveto litigate for a better bargain instead of accepting a haircut as part of aconsensual restructuring process. For instance, the International MonetaryFund (IMF) suggested that the ruling could have pervasive implications forfuture sovereign debt restructurings by increasing leverage of holdout credi-tors.6 Similarly, France filed an amicus brief supporting Argentinas peti-tion for certiorari on the grounds that the ruling created a powerful

1 NML Capital, Ltd. v. Republic of Argentina, 727 F.3d 230, 248 (2d Cir. 2013).2 Id. at 24748.3 Camila Russo, Argentina Plans New York-Buenos Aires Bond Swap, BLOOMBERG NEWS,

Aug. 27, 2013, available at http://www.bloomberg.com/news/2013-08-27/argentina-plans-new-york-buenos-aires-bond-swap-on-singer.html.

4 Id.5 Id.6 IMF, Sovereign Debt RestructuringRecent Developments and Implications for the

Funds Legal and Policy Framework, 1 (Apr. 26, 2013) [hereinafter IMF, Recent Developments2013], https://www.imf.org/external/np/pp/eng/2013/042613.pdf.

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2015] Sovereign Debt Restructuring 49

incentive . . . for private creditors to forgo participation in voluntary restruc-turing in order to enforce full payment of debt against an already distresseddebtor.7

This Article critically examines the claim that the Second Circuit rulingwill impede future sovereign debt restructurings by encouraging dissentingcreditors to litigate. It argues that such incentives are, in fact, limited be-cause there are (1) significant constraints on creditor litigation, (2) strongincentives against holding out because creditor litigation is uncertain, expen-sive, and risky, and (3) extensive contractual provisions and negotiatingstrategies available to sovereign debtors to avoid collective action problems.Furthermore, the fact-specific, narrowly tailored equitable relief in the Ar-gentina case was predicated on Argentinas unprecedented and widely docu-mented bad-faith negotiations with creditors; this remedy is unlikely to beavailable in future sovereign debt restructurings.

This Article proceeds as follows. The first part presents an overview ofthe scholarship on sovereign debt, with emphasis on the economic literature.The second part outlines the guidelines suggested by international organiza-tions for negotiations between sovereign debtors and creditors. It contrastsArgentinas uniquely recalcitrant negotiating strategy8 with the consen-sual, good faith negotiating process that most sovereign debtors use torestructure their debt. The third part looks at the critical role of effectivecreditor enforcement in sustaining the sovereign debt market, but concludesthat recent cases of sovereign debt litigation, including the Argentinian expe-rience, show that creditor enforcement is, at best, a weak remedy for credi-tors. The fourth part looks at the incentives for holdout creditors.Conventional wisdom holds that creditors have an incentive to free ride insovereign debt restructurings. However, this view ignores the substantialcostsfinancial, managerial, and reputationalof litigating. The fifth partexplores the various ex ante contractual provisions and ex post negotiatingstrategies available to sovereign debtors to avoid collective action problems.Argentina did not bargain to secure any ex ante contractual provisions thatwould have diluted the litigation rights of its creditors. Moreover, it deliber-ately chose to avoid using any ex post negotiating strategies, such as mini-mum participation thresholds, that would have resulted in meaningfulnegotiations with creditors and significantly reduced collective actionproblems. Finally, a short conclusion emphasizes the equitable nature of theSecond Circuit ruling and the fact that it was narrowly tailored to the uniquecircumstances of the Argentina case. Other courts are unlikely to grant simi-lar relief in future sovereign debt restructurings.

7 See Brief for the Republic of France as Amicus Curiae in Support of the Republic ofArgentinas Petition for a Writ of Certiorari at 5, Republic of Argentina v. NML Capital, Ltd.,727 F.3d 230 (2d Cir. 2013), 2014 WL 1246725.

8 See, e.g., NML Capital, Ltd. v. Republic of Argentina, 727 F.3d 230, 248 (2d Cir. 2013).

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50 Harvard Business Law Review [Vol. 5

I. SOVEREIGN DEBT: O