Derivatives: Important Decision by the Supreme Court

The Supreme Court decided in “Johnson & Johnson de Argentina S.A. CEI vs Deustche Bank S.A.” (“Johnson & Johnson”) that the conversion to Pesos of obligations in US Dollars under forward contracts provided by Decree No. 992/2002 (“Decree 992”) is unconstitutional. With this judgment the Supreme Court set the guidelines to be followed by a new judgment to be issued by Tribunal II of the Federal Civil and Commercial Court of Appeals in this case, in a matter on which the lower courts issued conflicting decisions.

In effect, the Supreme Court has not dictated a final judgment, but ordered the Court of Appeals to issue a new decision according to such guidelines, which means that the judges in charge of issuing such judgment will have to decide on the appeal filed by the plaintiff and other matters raised by the defendant.

A brief history of this ruling: On February 4, 2002, as a result of the abandonment of the convertibility of the Peso which fixed the rate of exchange at one Peso per US Dollar by law, the Government issued Decree No. 214/2002 (“Decree 214”) which converted to Pesos most obligations in foreign currency applying an exchange rate of Pesos 1.40 per US Dollar. A month later, on March 8, 2002, the Government, by Decree No. 410/2002 (“Decree 410”), amended the rules on conversion to Pesos of obligations in foreign currency to exclude obligations under certain transactions which, because of their nature, the Government considered should not be converted to Pesos. Futures and options were among those transactions excluded from the conversion to Pesos. However, three months later, the Government by Decree 992 excluded from Decree 410 certain transactions, thus subjecting them to the conversion to Pesos. Among those transactions excluded from Decree 410 and thus, subject to the conversion to Pesos rules were futures and option agreements outstanding as of January 5, 2002 in which at least one of the parties was a financial institution and that were governed under Argentine law.

The constitutionality of Decree 992 was challenged before the courts and there were opposing decisions. While most decisions of the Commercial Court of Appeals of the City of Buenos Aires considered that Decree 992 was unconstitutional, most decisions from the Federal Civil and Commercial Court of Appeals of the City of Buenos Aires held that Decree 992 was constitutional. In fact, Tribunal I of the Federal Civil and Commercial Court decided to reject the claim filed by Johnson & Johnson and accept the bank’s arguments, based on their opinion that Decree 992/02 was applicable and that that the conduct of the bank in the liquidation of the contracts was appropriate to the facts proved in the case.

On appeal by the plaintiff, the Supreme Court held that Decree 992 was unconstitutional as claimed by Johnson & Johnson. The Supreme Court based its decision on the following main arguments: (i) the protection of some financial institutions, which was the stated purpose of Decree 992, bear no proportionality to the burden imposed on the property rights of their counterparties, (ii) the conversion to Pesos of the US Dollar obligations under a forward contract altered the nature of the agreement, which was to transfer the devaluation risk from the buyer to the seller of the foreign currency, and (iii) forward contracts are aleatory contracts to which rules aimed to re-establish the economic balance in commutative contracts may not be appropriate.

As result of the decision in “Johnson & Johnson”, the obligations in US Dollars under non-deliverable forward contracts outstanding as of January 5, 2002 should be settled at market prices. As we mentioned before, this issue and others raised by the defendants shall be decided by a new judgment by another Tribunal II of the Federal Civil and Commercial Court of Appeals.