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Argentine debt defiance may strengthen holdouts' legal position

By Daniel Bases

NEW YORK (Reuters) - Argentina has fought in court for a dozen years against the claims of holdout investors in its defaulted debt, and Argentina has lost. The holdouts, led by Paul Singer's Elliott Capital Management and Mark Brodsky's Aurelius Capital Management, are still waiting to collect a single penny or peso.

Argentina defied court-ordered demands to pay all its bondholders by a June 30 deadline, and a 30-day grace period runs out this week. Argentina says a payment to its trustee bank insulates it against charges it doesn't pay its bills on time. It has described the holdouts as vultures and the judge who made the orders as unjust. The country has enough foreign currency to cover about five months' worth of imports, and billions of dollars of debt coming due next year. Until it pays the holdouts, it will remain locked out of international capital markets.

Having talked itself into a corner, Argentina now has to either swallow its pride and pay the holdouts, or keep its pride, accept another default and face isolation and penury. Making things worse for President Cristina Kirchner and Economy Minister Axel Kicillof, continued refusal will likely end up strengthening Elliott and Aurelius, two distressed-debt specialists who haven't amassed billions of dollars in assets by backing down from a fight.

"My sense is that the holdouts might get a stronger hand in a much worse situation because default is a Pandora's box," said Hans Humes, chief executive officer of Greylock Capital Management in New York who served as co-chair of the Global Committee of Argentine Bondholders (GCAB) and on the private creditor-investor committee for Greece's restructuring in 2011.

"Right now they are pari passu with the other payments. If there is a default they become likely senior to those bonds as the documentation on the exchanged bonds of 2005 and 2010 is weaker than what the holdouts sued on," Humes said, referring to the legal doctrine of treating all creditors equally.

In the realm of distressed debt investing, Elliott and Aurelius are among the big guns, buying up the bonds of troubled lenders for pennies on the dollar and then pushing to negotiate for profitable payments, sometimes through the courts. Elliott has about $24.8 billion in assets under management and Aurelius has about $4.5 billion. Argentina has about $30 billion in foreign currency reserves. Singer and Brodsky are both lawyers.

BATTLE WITH PERU

Elliott is using similar tactics with Argentina as it employed in its successful pursuit of Peru's sovereign debt. It bought up defaulted Peruvian commercial bank loans starting in the mid-1990s and used the pari passu argument to collect on the debt.

In the dispute with Peru, Elliott was first rejected in both U.S. District Court in New York and a Belgian commercial court, but later won on appeal.

In Belgium it succeeded in getting an injunction blocking payment, similar to the way U.S. District Judge Thomas Griesa blocked Bank of New York Mellon from distributing payments to exchanged bondholders.

These victories over Peru forced a face-off with President Alberto Fujimori, who was then facing corruption and human rights violation charges. Blocked by the courts and with just days to go before a default could be declared, Peru caved and did not fight Elliott any further.

"At the same time Elliott was trying to negotiate. But also remember that Fujimori was caught up in a corruption scandal investigation. I think he just didn’t have the focus and settled," said Humes.

Elliott spent just over $11 million on the loans and walked away with about $60 million just weeks before Fujimori fled the country, the Peruvian government said in its official report.

Elliott has used its financial muscle in the corporate world as well. In the case of energy group Hess Corp., the firm pushed for a corporate restructuring that resulted in its nominees joining the company's board. It pressed for BMC Software to sell itself to private equity firms after fighting a proxy battle in 2012 to get two directors on its board in 2012.

Argentina has been a more intractable situation, with the current dispute stretching into its second decade without a final resolution. Moody's Investors Service says Argentina is the only sovereign default out of 34 studied in the modern era to have resulted in persistent litigation.

TRADING POSITION

Neither Elliott nor Aurelius have ever revealed their trading position, making it impossible to know what profit they stand to make after millions in legal fees and lost opportunities from the tied up cash. But sources say they have owned Argentine debt prior to the default in January 2002.

Multiple requests for comment from Elliott and Aurelius for this story were unsuccessful.

Argentina's government says Elliott stands to make a 1,680 percent profit in just six years if it gets the full payment on its portion of an award of $1.33 billion plus interest handed down by Griesa in New York. He based it upon the equal treatment clause.

Argentina was ordered to pay Elliott concurrently with the exchange bondholders.

Buenos Aires deposited $539 million sitting in a BNY Mellon account at the Central bank of Argentina in June, ahead of a regular interest payment. BNY Mellon, the trustee for the bondholders, hasn't moved the money because of Griesa's order.

That leaves Latin America's No. 3 economy closer to a new default on July 30.

Holdouts, with a court victory to back them up, have said for years that they're ready to negotiate, while the government has refused to meet with them face-to-face. The holdouts have also said they would accept bonds as part of any settlement rather than simply cash.

The court-appointed mediator has failed to get the two sides in the same room, even after weeks of coaxing the government. Argentina is sending a delegation to New York on Tuesday, mediator Daniel Pollack said in a statement on Monday.

"I again urged direct, face-to-face conversations with the bondholders, but that will not happen tomorrow," Pollack said.

Argentina and its lawyers at Cleary Gottlieb Steen & Hamilton have argued that if it pays holdouts it opens itself up to an even bigger liability in the tens or even hundreds of billions of dollars.

That liability is not just from other holdouts who never participated in 2005 and 2010 but from those who did exchange their bonds and thought they were protected by the so-called rights upon future offers clause, or RUFO, that bars Argentina from voluntarily offering better terms to exchange bondholders.

Even if they default, Griesa's injunction remains in force and legal observers believe banks will be reluctant to do business in Argentina for fear of violating the ruling.

"If they default, I think the holdouts lose some of their leverage because the judge gave Argentina a choice. They opted for paying no one and Elliott and Aurelius don't have any money yet," said one senior lawyer who specializes in sovereign debt restructurings.

The lawyer's firm works for one of the parties to the case and therefore spoke on the promise of anonymity.

"One way around RUFO is to have a sum equal to what has been paid to the exchange bondholders paid into an escrow account, therefore not violating the clause and wait until it expires," the lawyer said, referring the RUFO expiration on Dec. 31, 2014.

(Reporting By Daniel Bases. Editing by John Pickering)

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