Distressed debt investors don't have much credence as victims. These are, after all, hedge funds that buy up bonds in or near default, typically at a steep discount, in the hope they'll be able to boost the value of the debt through the bankruptcy process or litigation in U.S. courts. Right now, for instance, distressed bond funds are preparing for battle over billions of dollars worth of Greek sovereign debt that they snatched up in anticipation of that country's default in March. Distressed debt funds quite literally feed off the flesh of moribund companies and foreign economies, which is why they're frequently called vulture funds. Vultures flanked by crafty lawyers aren't entitled to a whole lot of sympathy.

But they earned some from me when I read the Justice Department's new amicus brief, filed last week at the 2nd Circuit Court of Appeals in the long-running battle between The Republic of Argentina and NML Capital, Aurelius, and other holders of defaulted Argentine bonds. The brief suggests that the Justice Department believes the foreign policy objectives of the executive branch trump the obligations of a foreign sovereign to comply with U.S. court directives. That's an argument the government clearly feels conflicted about, based on the brief. And its support of Argentina, at the expense of the power of the U.S. court system, could roil the vulture-dominated secondary market for distressed sovereign debt in the midst of the Eurozone crisis.

Usually, the United States wouldn't get involved in a dispute over contract interpretation, which is at the heart of the cases at the 2nd Circuit. But the Justice Department believes Argentina's appeal implicates a "cornerstone" foreign economic policy. Last December, U.S. District Judge Thomas Griesa of federal court in Manhattan issued a series of orders in various bondholder cases against Argentina concluding that under the standard contract provision known as pari passu (or "equal footing"), Argentina must pay the vulture funds in full before making payments to investors who agreed to participate in two rounds of restructurings that followed Argentina's 2002 bond default. In February, Griesa issued injunctions based on those orders, which meant that Argentina could not make any payment to investors who were issued new debt in the 2005 and 2010 restructurings until it paid the holdouts everything it owes them.

Those injunctions, according to the Justice Department, are based on a misreading of pari passu precedent that endows holdout investors with too much power and interferes with the ability of sovereign nations to restructure their debt. The amicus brief, as well as Argentina's appellate brief, argued that Griesa's ruling offers investors little reason to participate in a foreign sovereign's efforts to resolve its debt crisis -- and every incentive to disrupt restructuring for their own selfish purposes. The briefs claimed that the judge disregarded the bond market's understanding of boilerplate language on the relative footing of debt holders and gave too much weight to the handful of cases cited by the vulture funds. (Argentina went so far as to assert that the trial-court judge -- who has been overseeing the Argentina bond litigation for almost a decade -- entered the injunctions merely to force Argentina to pay off the vulture funds and end the litigation.)

"The district court's interpretation of the pari passu provision could enable a single creditor to thwart the implementation of an internationally supported restructuring plan, and thereby undermine the decades of effort the United States has expended to encourage a system of cooperative resolution of sovereign debt crises," the U.S. amicus brief said.

As you might expect, the vulture funds don't think the market's understanding of pari passu clauses is as straightforward as the United States and Argentina contend. Nor is legal precedent, according to them. The bondholders haven't yet submitted their response briefs at the 2nd Circuit, but before Griesa, they pointed to a 2000 Belgian court ruling in a case involving Peruvian bonds as well as a California federal-court injunction against the Republic of Congo in a situation analogous to their case against Argentina. (Among the firms representing bondholders are Dechert and Gibson, Dunn & Crutcher for NML; MoloLamken; Simpson Thacher & Bartlett; and Friedman Kaplan Seiler & Adelman for Aurelius; and Milberg for individual investors.)

More fundamentally, the holdout bondholders say that Argentina is engaged in unprecedented disregard for U.S. court judgments. There hasn't been a final judgment entered on the $1.2 billion at issue in the cases now at the 2nd Circuit, although the bondholders have won summary rulings on Argentina's liability. They also have between $6 and $8 billion in final judgments against Argentina in related cases. Argentina has nevertheless not only refused to honor those judgments but has strenuously fought every bondholder attempt to get hold of Argentine assets in this country. For the most part, the 2nd Circuit has sided with Argentina on Foreign Sovereign Immunity Act grounds, turning back rulings that would have granted the vulture funds rights to money Argentina held at the Federal Reserve and money held in U.S. banks on behalf of Argentina's social security system. (The appeals court has affirmed two other attachments, but they add up to less than $100 million.)

Argentina has been so recalcitrant about owning up to its obligations that last month Griesa explicitly chided the foreign sovereign, even though he denied another creative attachment motion by the vulture funds. "This is yet another situation growing out of the Republic's continued intransigence in failing to honor its lawful judgment debts," the judge wrote. "The plaintiffs in these cases, in seeking to vindicate their legal rights, are not able to do so by any regular and clear-cut devices."

That's the source of the tension evident in the U.S. amicus brief: How can the U.S. government support a foreign sovereign that flouts the judgments of our courts? The brief insisted that's not what the Justice Department is doing. "The United States does not condone or excuse a foreign state's failure to comply with the judgment of a U.S. court imposing liability on the state," Justice lawyers wrote. "The United States consistently has maintained, and continues strongly to maintain, that Argentina immediately should normalize relations with all of its creditors, both public and private." The amicus filing also laid out the reasons why, as a matter of policy, the U.S. government is disturbed by Argentina's failure to satisfy its obligati ons.

But it also asserted that the public policy implications of Griesa's misreading of the pari passu provision outweigh the particulars of the Argentina litigation. The Justice Department doesn't say this, but it must believe that it's more important to make a policy statement about sovereign debt restructuring than about enforcing the power of U.S. courts. Otherwise it wouldn't have filed the brief, despite acknowledging Argentina's refusal to pay what it owes the vultures.

The U.S. government previously supported Argentina in the 2nd Circuit's consideration of whether bondholders could attach funds Argentina held at the Federal Reserve. That, however, involved an interpretation of the Foreign Sovereign Immunity Act, and the Justice Department only weighed in after the appeals court requested a brief. When Argentina first raised the question of the pari passu provision in a declaratory judgment suit back in 2004 -- asking for a U.S. judicial determination that the Belgian court's interpretation in the Peru case was incorrect -- the Justice Department did back Argentina. That case wasn't decided, since the issue wasn't then ripe. But Argentina continued to keep the U.S. government apprised once bondholders raised the equal footing argument.

Bondholders met with the U.S. Solicitor General's office after the Justice Department showed up at the 2nd Circuit in March in an attempt to change the government's mind, now that it holds billions of dollars in judgments against Argentina. That effort obviously failed.

When the vulture funds file their substantive appellate briefs next week, look for them to make their own policy arguments, asserting that investors ought to be able to rely on a U.S. court's endorsement of their legal rights. When the Justice Department takes a position that weakens the authority of this country's judiciary, they're sure to say, it's treading on dangerous ground.

(Reporting by Alison Frankel)

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