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Did vulture funds accidentally create a sovereign bankruptcy court, or an Argentine default?

The clock is ticking for Argentina to decide whether it will pay back creditors it has held off for eleven years.

The country has been locked in litigation with the lenders who have refused to participate in two restructurings since the country’s 2001 default, demanding the full value of their bonds. In 2012, these hold-outs won a significant legal victory, entitling them to equal treatment with the lenders who agreed to take a 75% discount on their bonds.

The courts got the international payments system involved, holding Argentina’s bank, Bank of New York Mellon, responsible for processing the payments. The country could pay both the hold-outs and the lenders who took a haircut—$1.3 billion to the so-called “vulture funds” on top of a $3 billion payment—or it could pay neither, defaulting on its debt and further limiting its access to international markets.

Argentina earned an injunction while it appealed the ruling, but the appeal is over. The appeals court has given Argentina one last chance to come up with a plan to pay both by March 29, or it may have to face the music on its next payment date of March 31.

The only trouble is, there’s some dispute over what the appeals court’s request actually means.

Argentina has been fairly vehement about its willingness to default rather than pay the hold-outs. Its attorneys told judges that the country wouldn’t obey them. President Cristina Kirchner has offered a similar message, including at this rally welcoming back the Libertad, a naval vessel the bondholders had seized for several months in Ghana:

This is clearly an important political issue in Argentina and concessions won’t come easy. But the country can’t be locked out of the international financial system forever—its economy is in trouble, with 30% inflation, foreign exchange problems and citizens yelling at ministers.

The appeals court has a problem, too. Technically, it is trying to uphold the lower court’s ruling, which entitles the hold-outs to the full face value of their bonds— a decision many think was wrong. But if Argentina’s response to being told to pay full value is to default instead, then, as Felix Salmon puts it, that “could wind up being just as bad for the Southern District [the New York judicial district where the case is being heard], and for New York’s status as an international financial capital,” because it would mean that Argentina can simply ignore the courts’ judgments.

That’s why the appeals court has given Argentina a final chance to come up with a payment plan. And therein lies the ambiguity.

Some experts see the court’s request as a signal that it would force the hold-outs to accept less than face value on their bonds if Argentina offered a such a restructuring. If so, it would be the makings of a sovereign bankruptcy court in New York, which would be rather revolutionary. Right now when a government defaults, there’s no set process for reaching a compromise between the government and its creditors, the way there is if a company goes bankrupt. It becomes a geopolitical issue (see Greece) where the international community hashes out a deal with the state. That doesn’t always go smoothly and the results are inconsistent, leading to calls for a kind of bankruptcy court for nations administered by the IMF or the G-20.

“A regime where a court enforces involuntarily modified contracts looks like sovereign bankruptcy, achieved here using the court’s equitable powers against the background of the debtor’s immunity,” writes Anna Gelpern, an American University law professor.

However, attorneys at the firm of Shearman & Sterling have been following the case closely and believe the court’s offer to let Argentina come up with a payment does still require that Argentina make good on the face value of the bonds, not offer the hold-outs a haircut. In that case, the order will “commit Argentina in a public filing (not comments in the heat of oral argument) to the position that it will not pay plaintiffs.”

Which in turn means a default, at least temporarily, barring a sudden concession or a reprieve from the Supreme Court—raising the question of whether the Obama administration weighs in.

The Argentine plan and the court’s next decision have all kinds of messy implications for Argentina’s economy, Wall Street’s work underwriting bonds for foreign governments in dollars, and of course, whether anyone holding Argentine debt will ever get paid. Stay tuned.

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