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Some Confusion About Argentina’s Power to Reverse an Acceleration

posted by Mark Weidemaier

Mark Weidemaier and Mitu Gulati

As negotiations between the Argentine government and its creditors have gotten increasingly acrimonious, some have begun talking about litigation. Because Argentina’s bonds have collective action clauses, it can impose restructuring terms on dissenting creditors as long as it has the support of a supermajority. Even if it doesn’t have supermajority support to do the cram down, it still has weapons.

One important weapon that often gets overlooked in discussions of the cram down power is the power to rescind or reverse a decision by creditors to accelerate the debt. In effect, this is a power to create a standstill. Argentina’s bonds have some relatively unusual provisions in this regard. One possible interpretation of these provisions is that Argentina is about to lose the ability to reverse an acceleration. We think this interpretation is wrong, but we have heard it raised with some frequency and want to address it here.

The issue comes up in the context of the cross-default provisions in Argentina’s bonds. For simplicity, assume two series of bonds, A and B. The country fails to make a payment of more than $50 million when due on bond A. That’s a default on bond A, of course. It’s also a default on bond B by virtue of that bond’s cross-default provisions. Here’s the relevant provision as described in the prospectus to Argentina’s 2016 exchange offer:

Each of the following is an event of default under each series of the Bonds:

3.  Cross Default. Any event or condition occurs that results in the acceleration of the maturity … of any of the Republic’s performing public external indebtedness having an aggregate principal amount of U.S.$50,000,000 …, or the Republic fails to pay performing public external indebtedness having an aggregate principal amount of U.S.$50,000,000 … when and as the same shall become due and payable and that failure continues past the applicable grace period, if any;

Because of this provision, holders of 25% or more in principal amount of bond B can accelerate the bond and demand full payment. This is all pretty standard for a sovereign bond issuance. It is why a payment default on one bond can start a cascade, as holders of bonds B, C, etc. start to accelerate.

Also standard is the provision allowing for reversal of acceleration, on two conditions. First, the government must cure the underlying event of default (which means only paying amounts due on bond A, plus interest and some expenses, not paying the accelerated principal on bond B). Second, a simple majority of creditors must support reversal. Again, here’s the relevant part of Argentina’s bonds as described in the 2016 prospectus:

Holders of a series of the Bonds representing in the aggregate more than 50% of the principal amount of the then-outstanding Bonds of such series may waive any existing defaults, and their consequences, on behalf of the holders of all of the Bonds of such series, if:

following the declaration that the principal of such Bonds has become due and payable immediately, the Republic deposits with the trustee a sum sufficient to pay all outstanding amounts then due on those Bonds (other than principal due by virtue of the acceleration upon the event of default) together with interest on such amounts through the date of the deposit as well as the reasonable fees and expenses of the trustee; and

all events of default (other than non-payment of principal that became due by virtue of the acceleration upon the event of default) have been remedied or waived.

This is a pretty typical provision for reversing acceleration. A majority of series B holders can reverse if Argentina pays past due amounts on bond A. We’ll call this the “cure plus majority” mechanism.

But then there’s this provision, which follows shortly after the provisions quoted above:

In the event of a declaration of acceleration because of an event of default described in (3) above [i.e., the cross-default provision] …, the declaration of acceleration will be automatically rescinded and annulled if Argentina has remedied or cured the event of default or if the holders of the relevant indebtedness rescind the declaration of acceleration within 60 days after the event.

This strikes us as unusual. We don’t see this latter provision in most other sovereign bonds (although we haven’t yet done a representative survey). It allows for reversal of acceleration within 60 days of “the event” if either Argentina cures the underlying event of default or holders elect to reverse (presumably this requires a majority, though the provision doesn’t say). We’ll call this “cure or majority” mechanism. Keep in mind that it applies only when the decision to accelerate was based on the triggering of the bond’s cross-default provisions.

What is the relationship between these two provisions (cure plus majority; cure or majority)? One possibility—quite unfavorable to Argentina—is that Argentina is about to lose any power to reverse an acceleration. Whether that interpretation is correct—we think it is not—depends on how two ambiguities are resolved.

Ambiguity 1: Is the 60 day period triggered by the Event of Default or by Acceleration?*

The cure or majority provision creates a 60-day window for reversing an acceleration. The window is triggered by “the event.” What event? One possibility is the event of default (i.e., the non-payment of bond A). So interpreted, the power to reverse disappears in 60 days whether or not there has been an acceleration. Argentina went into default in May. So if interpreted this way, Argentina is about to lose the right to reverse an acceleration (at least under this provision), even though there haven’t been any accelerations to this point.

The contrary interpretation treats “the event” as the declaration of acceleration, if one is made. Under this interpretation, Argentina has nothing to worry about until an acceleration occurs.

Ambiguity 2: Does the “cure or majority” mechanism displace or supplement “cure plus majority?”

We have heard rumors that some market participants assert that Argentina is about to lose the right to reverse an acceleration. As noted just above, that’s wrong unless the 60-day window is triggered by the underlying event of default. It’s also wrong if the cure or majority mechanism supplements, rather than displaces, the bond’s usual cure plus majority mechanism.

Put differently, when an acceleration is based on a cross-default, there are two possible interpretations:

  • Either the government (by cure) or bondholders (by decision) may unilaterally reverse an acceleration within the 60-day window. In addition, and even outside that window, a majority of bondholders can reverse if the government has cured.
  • Either the government (by cure) or investors (by decision) may unilaterally reverse an acceleration within the 60-day window. Otherwise, the acceleration may not be reversed.

The second interpretation is nonsense, especially if the 60-day window is triggered (as we think it should be) by the event of default rather than by acceleration. We think—we hope, anyway—that experienced market participants will share this view. Sovereign bonds allow a bondholder minority to accelerate the debt. The reason for allowing a majority to reverse that decision is to prevent a minority of litigious investors from forcing a litigation that is contrary to the group’s collective best interest. It would be bizarre to limit the majority’s exercise of that power to a 60-day window. And it would be especially bizarre to give a litigious minority an option—exercisable simply by delaying acceleration for 60 days—to negate the majority’s reversal power altogether.

The upshot:

We confess to some uncertainty here (especially about what triggers the 60-day window), but the best interpretation is as follows: The unilateral right to reverse an acceleration (by cure for the government, by decision for investors) terminates 60 days after the underlying event of default. But as long as the government cures the underlying default, a bondholder majority can exercise its usual right to reverse an acceleration even outside the 60-day window.  

As noted, we aren’t positive about what triggers the 60-day window. But on balance, we think the intent is to have the underlying default act as the trigger, rather than the acceleration itself. The reason is that cross-default provisions are early warning signals. A payment default on bond A doesn’t directly harm holders of bond B, but it gives them cause to worry. So they are allowed to declare a default and accelerate too.

On the other hand, at times a default on bond A won’t really spell trouble for holders of bond B. A good proxy for these scenarios is when the government quickly cures the default. Fast cure demonstrates both ability and willingness to pay and should ease the concerns of holders of bond B. That’s the reason why cure is itself enough to reverse the acceleration, without requiring a bondholder majority to rouse itself to act. But the longer the default goes uncured, the more reasonable it is to worry. If enough time goes by, and bondholders have accelerated, the government’s belated payment gives little room for optimism. At best, it demonstrates willingness to pay, but ability to pay remains in serious doubt. Sensibly understood, then, the 60-day window functions as a proxy for situations in which reversal should not be conditioned on majority approval.** It can’t serve this function well if the 60-day window is triggered by acceleration, because the date of acceleration is not correlated (or is less correlated) with the risk that cross-default provisions are designed to address.

Anyway, our best guess is that Argentina is about to lose the ability to reverse an acceleration by cure alone, but it will retain the ability to reverse an acceleration by cure + majority support. Not the end of the world, by any means. But it would be nice if the text provided a bit more clarity on these questions.

*There is a third ambiguity, which is whether the 60-day limiting period applies to both scenarios (i.e., cure by Argentina, waiver by bondholders) or only to the latter scenario. We’re overlooking it. (But it applies to both…)

** Technically, it also determines when cure is required, but the point is the same. A bondholder minority of bond B has less reason to complain about the lack of cure on bond A if the bondholder majority acts quickly. Nothing prevents the minority from accelerating the debt again outside the 60-day window, in which case cure will become a condition of reversal.

Comments

Very interesting discussion indeed. For what is worth (perhaps not much, I concede) my view as a non-NYC/US practitioner, coming from non-common law training, is that the ambiguity pertaining what "event" triggers the 60-day cure period, may be a bit blown out of proportion by some. Reading the Events of Default / Cross-Default on the Argy 2016s, to me it just seems quite straightforward to conclude that the provision refers to the "60 days after the [Event of Deafult]" (i.e. the underlying default on Argy's Series A bonds). Any other interpretation on this specific point, while certainly plausible, just reads as a bit of a stretch.
Thanks for sharing

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