On 24 February 2015, the German Federal Court of Justice (“Bundesgerichtshof“) handed down two judgements which could have a significant impact on holders of government bonds. The Federal Court of Justice held that the Argentine Republic cannot refuse payment to private creditors under its government bonds (“Inhaberschuldverschreibung“) by invoking state necessity due to inability to pay.
In 2002, Argentina faced a fiscal crisis. This resulted in the passing of the Public Emergency and Exchange Regime Reform Act no. 25.561 of 6 January 2002 Argentina (the Act). The Act declared a “public emergency in social, economic, administrative, financial and monetary policy“. On the basis of decree no. 256/2002 of 6 February 2002 on the Restructuring of Obligations and Debt Payment of the Argentinian Government (the Decree), Argentina suspended the service of foreign debt in 2002 in order to restructure its foreign debt service. The Act has been repeatedly extended – most recently until 31 December 2015.
The claimants’ claims arose out of government bonds they held which had been issued by Argentina in 1996 and 1997, respectively. As a consequence of the Act and following Decree, Argentina defaulted on these bonds and the claimants initiated proceedings against Argentina before the Local Court in Frankfurt/Main (“Local Court”) in 2011.The first claimant sought refund of the notional amount of the co-ownership share acquired in the government bonds which had fallen due by the end of October 2009, together with interest payments. The second claimant claimed interest payments for the year 2005 arising out of the government bond which had fallen due in November 2005 and loss of profit which he purportedly suffered due to the non-payment of the interest.
The German instance courts’ decisions
The Local Court essentially granted both claims. Argentina’s appeal before the Frankfurt District Court was dismissed. Argentina argued that under international public law a state which was undergoing a financial crisis and had agreed with the majority of its debtors on a restructuring of its debt had a right to refuse performance. They further argued that this were even the case where the terms and conditions of the respective government bonds did not foresee a restructuring clause (so called “collective action clauses”). The District Court rejected this argument and found in favour of the claimants. With its appeal to the German Federal Court of Justice, Argentina sought to have the instance court decisions overruled and the claims dismissed.
The Federal Court of Justice’s decision
The Federal Court of Justice dismissed the appeal. It ruled that there is no general rule of international public law which would entitle a state to temporarily refuse the fulfilment of its private-law payment obligations to private debtors. It added that a state could neither invoke state necessity declared due to inability to pay nor an agreement reached with the majority of the debtors to restructure the debt.
The Federal Court of Justice drew on to the case law of the German Federal Constitutional Court (“Bundesverfassungsgericht”) which found in 2007 – with respect to a different type government bonds issued by Argentina – that international public law neither provides for a unified nor a codified insolvency law of states. The Federal Court of Justice found that this finding of the Constitution Court persists even in light of the worldwide financial market crisis in the years 2008 and 2009 and the bail-out measures taken by the European Union to help Greece and Cyprus. The Court rejected the position taken by Argentina, that it had to be inferred from those more recent developments that a general rule of international public law has developed which would oblige all private creditors of a state to participate in a debt restructuring in case of an economic and financial state crisis. In that context, the Court also rejected the contention that distressed states were entitled to withhold performance of private-law payment claims until a debt restructuring agreement has been reached.
Comment: the way forward
This most recent decision of the Federal Court of Justice has reinforced the position previously taken by the German courts. A state cannot escape its payment obligation under its government bonds in Germany simply by invoking state necessity due to inability to pay. The decision creates legal certainty for future actions in Germany and provides guidance to the lower courts. However, Argentina may well consider bringing the two judgements before the Federal Constitutional Court so that the Federal Constitutional Court revisits its decision from 2007.
Whilst the decision of the Federal Court of Justice can be regarded a victory for bondholders, it is merely the first step in a long process. It is highly unlikely that the Argentine government will submit to the decision of the German court. The bondholders will therefore have to enforce their judgements against Argentina; something that will require considerable time and patience. Fortunately for the bondholders, time is something they do have: under German law the judgements remain enforceable for the next thirty years.
For further information, please contact Mathias Wittinghofer, Partner, Tilmann Hertel, Associate, or your usual Herbert Smith Freehills contact.