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NML Capital v. Republic of Argentina

September 23, 2010

NML CAPITAL, PLAINTIFF-APPELLEE-CROSS-APPELLANT,
MONTREUX PARTNERS, CORDOBA CAPITAL, LOS ANGELES CAPITAL, FFI FUND & FYI, WILTON CAPITAL, PLAINTIFFS-APPELLEES,
v.
REPUBLIC OF ARGENTINA, DEFENDANT-APPELLANT-CROSS-APPELLEE.



SYLLABUS BY THE COURT

Cross-appeals from a judgment of the United States District Court for the Southern District of New York (Thomas P. Griesa, Judge) in favor of plaintiffs on certain Floating Rate Accrual Notes. Defendant contends that it was entitled to reformation of the notes because the interest rate provision at issue constitutes an unenforceable penalty, produces substantively unconscionable results, and violates public policy. Defendant further faults the district court's award of statutory interest in addition to contract interest for deficient post-maturity interest payments. Plaintiff NML Capital argues that the district court erred in not awarding it statutory interest for unpaid post-acceleration interest payments. Although we reject as without merit defendant's arguments in favor of reformation, we conclude that plaintiffs' entitlement to statutory interest on unpaid post-maturity and/or post-acceleration interest payments depends on significant and unsettled questions of New York law, which we hereby certify to the New York Court of Appeals.

AFFIRMED in part. Decision RESERVED in part pending the New York Court of Appeals' response to certified questions of state law.

The opinion of the court was delivered by: Reena Raggi, Circuit Judge

Argued: February 2, 2010

Before: CALABRESI, RAGGI, and CUDAHY,*fn1 Circuit Judges.

In this action to recover principal and interest owed by the Republic of Argentina on certain Floating Rate Accrual Notes, the parties cross-appeal from a judgment entered in the United States District Court for the Southern District of New York (Thomas P. Griesa, Judge) in favor of plaintiffs. Appellant Argentina contends that it was entitled to reformation of the notes because the relevant interest rate was unenforceable as a penalty, substantively unconscionable, or void on account of public policy. Argentina further faults the district court for awarding statutory interest in addition to contract interest on defaulted post-maturity (but not post-acceleration) interest payments. Meanwhile, cross-appellant NML Capital argues that the district court erred in denying it statutory interest for unpaid post-acceleration interest. We conclude that Argentina's appeal is without merit insofar as it challenges the district court's refusal to reform the notes, but that the parties' cross-appeals of the treatment of statutory interest turn on significant and unsettled questions of New York law, which we certify to the New York Court of Appeals as stated in Part II.C.of this opinion.

I. Background

A. Plaintiffs' Acquisition of Beneficial Interests in Argentina's Floating Rate Accrual Notes

In 1998, at a time when its economy was relatively stable, Argentina issued a series of securities known as Floating Rate Accrual Notes ("FRANs"). These securities, which -- as their name suggests -- bear interest at a floating rate, were issued pursuant to a Fiscal Agency Agreement ("FAA") dated October 19, 1994; a Prospectus dated March 27, 1998; a Prospectus Supplement also dated March 27, 1998; and a Floating Rate Accrual Notes Certificate (the "FRANs Certificate") dated April 13, 1998 (collectively, "the bond documents").*fn2

Plaintiffs are holders of beneficial interests in the FRANs. Some of plaintiffs' interests were purchased on the secondary market after Argentina's 2001 financial collapse and, in certain instances, after the FRANs' stated April 2005 maturity date. Other interests were purchased prior to the collapse, but at a time when Argentina's debt was trading at a steep discount given the prevailing view that financial collapse was imminent.

B. The FRANs Certificate and the FAA

According to the terms of the FRANs Certificate, Argentina promise[d] to pay Cede & Co. or registered assigns[] the principal sum of two hundred million U.S. dollars . . . on April 10, 2005 . . . , and to pay interest thereon . . . every six months in arrears on April 10 and October 10 in each year . . . at the rate set forth below, until the principal hereof is paid or made available for payment.

FRANs Certificate at A-1. The interest rates for each six-month payment period were to be calculated and published by a Determination Agent, which -- in this case -- was Morgan Stanley. The formula used to calculate those interest rates ("FRANs interest rate provision") was based on the yields to maturity of other Argentine-issued debt and thus accounted for any risk the market associated with the purchase of such debt.*fn3 Consequently, the interest rate on the FRANs would fluctuate in accordance with Argentina's creditworthiness at any particular time. This structure arguably provided an incentive for those who were familiar with Argentina's troubled financial history and, as result, concerned about a potential default nevertheless to invest in the FRANs.*fn4

Under the terms of the FAA, Argentina's "fail[ure] to pay any principal of any of the Securities of [any] Series when due and payable or [its] fail[ure] to pay any interest on any of the Securities of such Series when due and payable" constituted an event of default so long as the failure continued for a period of 30 days. FAA at 17. Argentina's declaration of "a moratorium on the payment of principal of, or interest on, [its] Public External Indebtedness" also constituted an event of default.*fn5 Id. at 18. In the event of any such defaults, holders of any of the securities were afforded the right to accelerate the securities and declare the principal "due and payable immediately." Id. The FRANs Certificate, which repeats these default provisions, makes clear that it "and all rights of the registered Holder [t]hereof are expressly subject to the [FAA]." FRANs Certificate at A-7. Indeed, it states that the "Security and the [FAA] together constitute a contract, all the terms and conditions of which the registered holder by acceptance [t]hereof assents to and is deemed to have notice of." Id.

C. Argentina's December 2001 Financial Collapse

Prior to October 2001, the FRANs interest rates published by Morgan Stanley ranged from 9% to 14.4% per annum. In late 2001, however, Argentina experienced a severe economic crisis. As a result of this crisis, on December 20, 2001, Argentina announced that it would no longer service its approximately $80 billion in external debt, including both the FRANs and the 2006 and 2027 Bonds whose yields to maturity were factors in the FRANs interest rate provision. As a consequence, the notional yields to maturity on these bonds increased, thereby raising the interest rates applicable to the FRANs. At the time Argentina announced its intention to cease service of its external debt, the semiannual interest rate on the FRANs as calculated by Morgan Stanley was 12.703%. Thereafter, it continued to climb, reaching 50.526% (or roughly 101% per annum) by the time of the FRANs' April 2005 maturity date.*fn6

In addition to increasing the prevailing interest rates, Argentina's decision to declare a moratorium on the service of external debt triggered plaintiffs' contractual right to accelerate the FRANs. While most plaintiffs declined to exercise this right, NML accelerated the maturity of $32 million of the $102 million in FRANs principal that it had purchased on the secondary market. In 2005, Argentina offered holders of certain of its defaulted debts the opportunity to exchange their beneficial interests in those debts for performing, but discounted, debt taking the form of guaranteed loans. According to plaintiffs, because the offer would have permitted them to recoup only 15-25% of what they were owed, they did not accept this offer.

D. Procedural History

In a series of lawsuits filed in the Southern District of New York, plaintiffs sued Argentina for its failure to pay principal and interest due under the FRANs. Following motions filed by plaintiffs from 2005 to 2008 in each of the cases underlying this appeal, the district court awarded plaintiffs summary judgment as to Argentina's liability under the FRANs and directed the parties to confer to determine the exact amounts in which final judgment should be entered. When no agreement was reached, plaintiffs jointly moved on April 10, 2008, for partial summary judgment as to the amount of interest Argentina owed on the FRANs. In particular, they sought application of the floating interest rates calculated and published by Morgan Stanley for the various six-month payment periods occurring through the 2005 maturity date. For purposes of calculating post-maturity interest, plaintiffs sought application of the 50.526% interest rate that governed the payment period ending on April 9, 2005. Finally, plaintiffs sought to collect further interest at the 9% statutory rate for all interest payments -- whether due and owing prior to or after acceleration or maturity -- that Argentina had failed to make.

In opposing plaintiffs' motion for partial summary judgment, Argentina argued that the FRANs interest rate provision was unenforceable and/or subject to reformation because it (1) constituted an unreasonable penalty; (2) effected a substantively unconscionable result; and (3) violated public policy, specifically New York usury law. Argentina further argued that plaintiffs were not entitled to 9% "interest on interest" for post-acceleration interest payments that it had allegedly missed.

On March 18, 2009, the district court granted in part and denied in part plaintiffs' motion for partial summary judgment. Finding that "the interest rate mechanism specified by the FRANs was employed to determine [Argentina]'s obligations under the contract[,] not its obligations resulting from a breach," the district court concluded that the FRANs interest rate provision was not a liquidated damages clause and, therefore, not subject to the rule that such clauses are unenforceable when they function as penalties. NML Capital, Ltd. v. Republic of Argentina, No. 05 Civ. 2434, 2009 WL 721736, at *3 (S.D.N.Y. Mar. 18, 2009). Turning to Argentina's unconscionability claim, the district court determined that there was no basis for finding either procedural or substantive unconscionability, as Argentina was a sophisticated party capable of understanding the contractual terms that it had itself proposed and the FRANs interest rate provision was reasonable at the time of contract. See id. at *3-4. In so holding, the court rejected Argentina's contention that events occurring after the time of contract were relevant to the substantive unconscionability inquiry and, therefore, warranted consideration. See id. at *4. Because the district court determined that New York's usury law did not apply to transactions as large as the one at issue, it further rejected Argentina's argument that the FRANs interest rate provision was unenforceable as a violation of the public policy expressed in such law. See id. at *4-5. Finally, relying on this Court's prior decision in Capital Ventures International v. Republic of Argentina, 552 F.3d 289 (2d Cir. 2009), the district court ruled that plaintiffs were not entitled to 9% statutory interest on any interest payments that had allegedly become due after acceleration of the bonds. See NML Capital, Ltd. v. Republic of Argentina, 2009 WL 721736, at *5-6. ...


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