Chadbourne lawyers working on projects in Latin America reported a number of effects from the turmoil in Argentina. However, the situation remained fluid as the NewsWire was going to press in late January.

Debt Freeze

The Duhalde government moved quickly to try to bring order to the economy, but many of the new rules were hastily drafted and leave unanswered questions. Argentine lawyers are reluctant to express firm views because of the frequency of new decrees from the government.

Argentina declared a formal moratorium on repayment of government debt on December 23.

However, payment of private debts denominated in foreign currencies has also been blocked by inability to get approval from the central bank for transfers of foreign currency out of the country.

The Argentine Congress passed a set of emergency measures — called the devaluation law — the first week in January to give the government broad powers to manage the crisis. The new law ended the one-to-one peg between the Argentine peso and the dollar.

A new currency exchange regime took effect on January 11. It established a two-tier exchange regime. There is a “regulated market” in which exporters are required to sell the foreign currency they collect from export sales at the rate of one dollar for 1.4 pesos, and importers of certain goods are permitted to buy dollars to pay for their imports at the same ratio.

The peso has been allowed to float for all other transactions. The peso dipped as low as 1:1.95 in late January, but had recovered by press time to 1:1.8. Some analysts are forecasting that it could drop to 1:2.70 by the end of this year.

The Argentine central bank announced a hierarchy of imports, tied to the tariff classifications of goods, in which purchasers of the most favored imports would be allowed to buy dollars within the next 90 days, the next most favored within 180 days and the next within 360 days. All requests for foreign currency must be made through commercial banks.

However, little if any currency is being dispensed in practice. US embassy officials in Buenos Aires reported on a conference call with American business representatives on January 25 that most exporters appear to be delaying collection of foreign currency receivables in the hope that by the time they receive payment, mandatory conversion into pesos at the 1:1.4 rate will have been dropped in favor of the floating rate. This puts a severe strain on the regulated market because the government is attempting to limit use of dollars for imports to the amount of foreign currency brought in by export sales.

The devaluation law had a number of other significant provisions.

It authorized the government to impose a 5-year tax on oil and gas exports. Tax rates of 20% to 30% are being discussed, but the government is under pressure from the oil and gas industry to look elsewhere for revenue.

It directed that all contracts denominated in foreign currency should be renegotiated within 180 days to apportion the effects of the peso devaluation between the parties. The central bank subsequently issued regulations directing that lenders of foreign currency loans of more than $100,000 would have to agree to extend payment terms and lower the interest rate. Loans with maturities of from one to five years must be extended by 20%. Longer-term loans must be extended by 10%. The regulations require a 33% reduction in interest rate.

The new law also declared unenforceable any sort of price indexing in contracts.

It also rescinded any provisions in contracts with the government that link payments to the value of foreign currency — for example, price escalation clauses intended to compensate the contractor if the peso loses value in relation to the dollar. It authorized the government to renegotiate such contracts, and said that suppliers could not use the new law as an excuse to suspend or vary performance. US power companies that bought Argentine utilities when they were privatized in the 1990’s found themselves squeezed potentially by a mismatch between dollar obligations and the declining value of peso revenues. At least one said it would cooperate with the government to prevent spikes in electricity prices, but would resist giving up any contract protections against loss in value of the peso.

Argentine lawyers advise that whether these new rules apply to contracts that, by their own terms, are governed by New York or other foreign law must be determined on a case-by-case basis.

Creditors’ Rights

In late January, the Argentine Congress commenced debate on a bill limiting creditors’ rights and overhauling the bankruptcy laws. The measure quickly passed the Senate and was expected also to pass the House. International banks complained. The US ambassador met the third week in January with the ministers of economy, foreign affairs and production to voice US objections.

In its initial form, the bill would have given insolvent debtors an “exclusivity period” of 180 days — rather than the 60 days allowed currently — to present a reorganization plan. If the debtor could not get approval for its plan within the new longer time period, then there would be mandatory “capitalization” of creditors’ claims in which creditors would be forced to accept nonvoting preferred shares in the debtor in place of their debts. The only preference the shares carried would be at liquidation.

This mandatory capitalization feature had been dropped from the bill by the time the NewsWire went to press.

However, the bill still proposed to overhaul existing bankruptcy laws in several other significant respects. All foreclosure proceedings against Argentine borrowers would be suspended for 180 days after the bill is enacted. The bill would eliminate any “cram-down proceedings” under which a debtor who cannot get approval for its plan of reorganization is essentially put up for sale to creditors and third parties under special bidding procedures. It would also allow a debtor to shed 100% of its debts in bankruptcy. Current law does not allow a debtor to seek release for more than 60% of each admitted claim.

Paul Weber, a project finance partner in London, said the bill is being watched closely by lenders because any material impairment in the collateral for a loan or in the ability of a lender to enforce its rights under the financing documents is a default under most loan agreements.

Effects

The most immediate effects of the Argentine government actions were on US power companies that bought Argentine assets and on banks.

Banks with commitments to lend into Argentina but whose loans are not yet fully disbursed looked for ways to avoid any further funding. Most loan agreements have “conditions precedent” that must be met before each draw on the loan. One common condition is that there must have been no “material adverse change” in the condition of the project or the borrower or in the validity or priority of the lien that the lenders have on the project assets. Another condition is that the loan cannot be in default.

Some loan agreements, particularly with multilateral lending agencies, make an “inconvertibility event”— defined as a change in the one-to-one peg of the peso with the dollar — automatically a default. In other loan agreements, it is a default if there is any “material adverse action” by a governmental authority or if the borrower goes more than a specified period of time without being able to gain access to dollars with which to make payments on the loan.

Lenders whose loans are already fully funded appear to have few good options other than to wait for the situation to stabilize.

Payments are continuing on many foreign currency loans on large infrastructure projects with the project sponsors using offshore accounts to make payments. Many of these loans were structured to take advantage of a special provision in Argentine law that waives withholding taxes on interest payments on foreign borrowing to finance projects that produce goods for the export market. Borrowers under such loans — called “negotiable obligations” — are allowed to keep the foreign currency earned from export sales in offshore accounts.

The International Finance Corporation said that 11% of its $10.9 billion in disbursed loan and equity portfolio is in Argentina. The director urged IFC staff to cut costs and concentrate on closing new financings so that the agency can add more good assets to its books. The IFC — an arm of the World Bank — provides financing for private projects in developing countries.

The freeze on repayment of government debt has led to claims against foreign banks on credit default swaps. Credit default swaps are financial instruments that holders of sovereign debt sometimes enter into with investment or commercial banks to protect against loss in value of the bonds in the event of a government default. The terms of the swaps vary and ability to collect depends on how such key terms as “restructuring,” “repudiation” and “moratorium” are defined in the particular agreement, according to Robin Lahiri, a consultant with Chadbourne in London. Press reports varied about the amount of government debt affected by the moratorium. The estimates ranged from $141 billion to $155 billion. Government bonds had already been trading in the market at one quarter of face value before the moratorium, so there had already been a substantial loss in value before any “credit event” that triggered payment on the swaps.

The equivalent protection for private debt is political risk insurance. The standard political risk policy protects against “inconvertibility,” or the inability at any exchange rate to convert local currency and transfer the converted proceeds overseas. A number of notices of potential claims have come in, according to Julie Martin, former head of the political risk program at the Overseas Private Investment Corporation and now with Marsh & McLennan, but these are not full-blown claims yet because the insurance policies have a waiting period before claims are paid. The purpose of the waiting period is not so much to verify the facts that justify a claim, Kenneth Hansen, a project finance partner in Washington explained, but rather “to limit the insurer’s risk with respect to momentary crises that are quickly resolved.” Hansen said there is always the potential for Argentine claims to “evaporate into uncovered devaluation prior to the expiration of required waiting periods,” but no one is making predictions.

Insurance coverage for losses caused by devaluation — as opposed to inconvertibility — became available for the first time last year, but no policies were written on Argentine pesos.

According to Julie Martin, most political risk insurers have significant exposure in Argentina. Some political risk providers have suspended all coverage for the country — not just for inconvertibility, but also other traditional coverages for expropriation and political violence. As yet the market is not seeing a spillover effect to Brazil, but probably because the market is already at capacity on Brazilian exposure and not in a position to write more.

Spillover

Ironically, the spillover effects of the Argentine situation may be less significant in Latin America than in Spain. As much as 12% of the Spanish gross domestic product, or GDP, is tied to Argentine investments.

US embassy officials in Buenos Aires said there have been few effects on neighboring countries in Latin America apart from tourism. The number of Argentine tourists flocking to beaches in Uruguay is down significantly. Governments in neighboring countries have been watching, perhaps with greater interest, the potential for political instability to spread. Argentina is an exporter of gas to power plants across the border in Brazil.

A Chadbourne lawyer, David Schumacher, reported from São Paulo that he found no evidence of Argentine contagion during a trip across Latin America in late January. “People knew the devaluation was coming and planned on it occurring, so it has not been a surprise perhaps like it was in Asia. There are potential balance of trade issues, but as far as the ability of projects in other countries to borrow, it does not seem to have had an effect.”

Some corporate debt issuers in other Latin countries have expressed concern about their ratings in cases where they have significant Argentine investments. There have been discussions, but no action taken, about whether currency exchange risk coverage should be obtained on transactions in places like Panama, where the dollar is legal tender.

Next Time?

Is there anything that developers or lenders should do differently after the experience in Argentina?

“Monday morning quarterbacking is hard,” said Noam Ayali, a project finance partner in Washington. “Maybe look harder at whether to buy political risk cover; maybe look harder at country stability and the government situation. There have been complaints about political corruption and mismanagement in Argentina for years.”

Multilateral lending agencies, like the IFC and Inter-American Development Bank, enjoy preferred creditor status, meaning that governments tend to ensure that scarce foreign currency is used to repay them first. Export credit agencies like the Overseas Private Investment Corporation and US Export-Import Bank do not enjoy the same protection. Ayali said that one of the lessons for lenders may be the cost of working with multilateral lending agencies is worth it, because lenders who lend alongside a multilateral as part of a “B loan” syndicate share in the preferred creditor status of the multilateral lender.

“It struck me that a lot that has happened here has happened before,” Paul Weber said from London. Many Argentine deals, even though structured at the height of euphoria over Latin America and unprotected against currency devaluation risk, were still carefully designed to match expenses with revenues in the same currency.

Law firms revisit their standard contract clauses after large events like Argentina to see what can be learned from the experience. Paul Weber suggested broadening “material adverse change” clauses to make clear that they refer to changes that affect the economic prospects of the entire country and not necessarily just the project. Aruna Chandra, in New York, pointed to clauses in project agreements that allow offtakers to pay in the local currency in situations where they cannot convert into dollars. Developers are always careful in such situations to put mirror provisions in their contracts with suppliers, but there is the potential for a mismatch due to different interpretations of the contracts by the project counterparties. Rather than try to match language, the developer might be better off allowing the offtaker to pay in pesos only to the extent that it can get the supplier to accept pesos.

by Keith Martin, in Washington