Argentine Supreme Court rules in favor of the “pesification” of public debt securities subject to Argentine law and the deferral of such debt

This Argentine Supreme Court finding, dated April 5, 2005, rejected a request for the declaration of the unconstitutionality of Decree No 471/2002, which established the forced conversion of each U.S. Dollar to Argentine Pesos at a Peso 1.40/US Dollar 1 parity for obligations in non-Argentine currency of the Argentine Government (National, Provincial and Municipal) in effect on February 3, 2002, governed exclusively by Argentine law.In addition, such decree established that the “pesified” securities would be adjusted according to the Coeficiente de Estabilización de Referencia (“CER”), a consumer based inflation index.Through this finding, the Argentine Supreme Court accepted the constitutionality of the “pesification” of public debt securities subject to Argentine Law.

The ruling includes four opinions. Even though all the justices voted in favour of the constitutional validity of “pesification” and the deferral of payment, the different opinions do not agree on the status of the bonds that did not accept the debt exchange set forth through Decree No 1735/2004.The opinion of Justices Belluscio and Boggiano adheres to the legal opinion of the General Attorney of the Republic of Argentina, which meticulously traces the Argentine economic emergency prior to Decree No 471/2002, and does not take up a clear position vis-à-vis the securities that did not enter into the exchange.

The opinion of Justices Highton and Maqueda does not define the situation of these securities: “the situation of those bondholders who, as is the case of the plaintiffs, having had the opportunity to participate in the debt exchange, decided not to participate therein, has not yet been regulated”.

On the other hand, in her vote, Justice Argibay finds that the bonds that did not accept the exchange are “pesified”, and that, pursuant to Law No 26,017, they are permanently excluded from such proceeding.

Lastly, even though Justices Zaffaroni and Lorenzetti do not define the status of the bonds that did not enter into the exchange, their vote could open the door to claims for damages caused to investors by the Argentine Government’s default against financial institutions, based on their advice prior to the purchase of debt securities.

As regards the unilateral deferral of the debt, this Supreme Court finding is based on Argentine Supreme Court precedent “Brunicardi, Adriano c/ Banco Central” (1996).This ruling discusses the constitutional validity of Decree No 772/1986, insofar as it unilaterally modified the conditions of bonds in U.S. Dollars (the “BONODs”), also subject to Argentine law.The BONODs had been issued by the Argentine Government in 1982 as a consequence of the exchange insurance (“seguros de cambio”) in effect in previous years.In view of the significant devaluation of the Argentine currency during this period, Argentina transformed private debt into public debt and modified the terms for payments of the BONODs’ amortization of principal.The Argentine Supreme Court found that this modification was reasonable and therefore constitutional. Its decision was grounded on many factors: first, the gravity of the general economic situation and the need to avoid default of the public sector; second, the “sovereign” nature of the act (“acto soberano”) of issuing the BONODs (since the creditors did not play a relevant role in the issuance of such public debt; they simply received one paper for another); and third, the reasonability of the modification, which, in the Court’s understanding, did not entail a confiscatory act nor did it violate the constitutional right to property, since it only deferred its compliance which would be carried out in terms and conditions deemed compatible with collective interest.

In the “Galli” finding, the Supreme Court considered that the economic situation immediately prior to Decree No 471/2002 was even more serious than the one that justified the solution in the “Brunicardi” case, and that, for this reason, the more dramatic measures this time round are justified.In addition, the Court followed the doctrine set down in the “Brunicardi” case by concluding that “international law (ius gentium) exists that would free a State from international liability for wholly or partly suspending or modifying payment of external debt, in cases in which it is forced to do so for reasons of financial necessity that cannot be postponed”.

Another of the arguments in the ruling under analysis refers to the inclusion of CER as adjustment of the value of the “pesified” securities.The Court considered the CER a mechanism for compensation in order to lessen the loss of value arising from “pesification” and therefore a fundamental element when analysing whether the “pesification” set forth by Decree No 471/2002 was confiscatory in nature.

In addition, the Court stated that Decree No 905/2002 established that “pesified” debt securities were to be considered in their original conditions for the purposes of being calculated for future public debt exchanges.In other words, within the framework of the exchange established by Decree No 1735/2004, holders of “pesified” debt securities participated for the amount of their original holdings in foreign currency.This measure provided bondholders with an option to reduce the effects of the “pesification”.

Lastly, the Court concluded that the true nature of the sacrifice of the bondholders was not certain, since the financial situation could readjust in several ways, and end up compensating their losses.

As regards the unequal treatment of creditors (since only the debt subject to Argentine law was pesified), the Court found that such discrimination was not unreasonable insofar as it was based on an intrinsic element of the debt securities, and not on the creditor.In other words, the holders of debt subject to Argentine law are both Argentine and foreign; therefore, “pesification” affects them both.

Even though the involved securities are subject to Argentine jurisdiction, it is worth noting that in 1992, in the “Republic of Argentina vs. Weltover Inc.” case, the U.S. Supreme Court found that the issuance of debt securities by Argentina (this case also referred to BONODs), is susceptible of falling within U.S. jurisdiction, since Argentina did not have a right to sovereign immunity within this context.Its decision was based on that fact that, pursuant to the Foreign Sovereign Immunities Act of 1976, sovereign immunity is not recognized in cases in which the action is based on a commercial act which has a direct effect on the United States (or, inter alia, there exists an express waiver of such immunity, which did not occur in this case).The U.S. Supreme Court found that the issuance of the BONODs was: (a) a commercial act since (i) the holders were private parties, (ii) the bonds were negotiable in the international market, and (iii) they promised an income; and (b) they had an effect in the U.S. since payment of the BONODs was to be carried out in U.S. Dollars in such country.

In conclusion, in the “Galli” case, the Argentine Supreme Court found that first, the pesification of public debt securities subject to Argentine law was constitutionally valid, and second, the deferral of the terms of payment of the public debt were also constitutional, in this last case, on the basis of precedent set down in the “Brunicardi” case.