Taking the bite out of the collective action clause of the superbond.

A unanimous three-judge panel of the U.S. Court of Appeals for the Second Circuit has ruled that the government of Argentina must not discriminate among its creditors. Let's hope that principle also applies in America the next time the government decides to bail out the auto industry.

In a unanimous October 26 decision, the court affirmed a district court ruling in favor of a group of Argentina's bondholders. Ever since Argentina's 2001 default on roughly $100 billion of its sovereign debt, these bondholders have held the reasonable position that Argentina ought to pay its bills. Holding more than $4 billion of Argentina's debt, these creditors declined restructuring deals in 2005 and 2010 that offered bondholders as little as 25 cents on the dollar.

Argentina has refused to pay a nickel of the more than $1.3 billion in principal and interest due so far to the holdouts. At the same time, Buenos Aires has been making regular payments to bondholders who accepted a restructuring and took big write-downs. This practice of treating some bondholders better than others is specifically prohibited by the contracts with investors that Argentina's government freely accepted.

Not that Argentina's current government has a particular affinity for the rule of law. Watching the behavior of Buenos Aires might make any investor want to swear off sovereign debt. But both creditors and borrowers in the sovereign markets will be well served by the appellate court's ruling. Having U.S. courts maintain a consistent position that a contract is a contract will both encourage investors and discourage those issuers tempted to skip out on their obligations.

In their decision the federal judges obliterated a number of arguments advanced by Argentina. Among them was the claim that making additional payments could trigger a financial crisis in Buenos Aires. But the court noted that the government holds more than $40 billion in foreign currency reserves.

The Argentine government also tried to claim sovereign immunity under U.S. law, which in many cases prevents U.S. citizens from seizing the assets of a foreign government. But the appellate judges noted that Argentina had voluntarily waived its immunity from the jurisdiction of the district court, and they pointed out that no property is being seized. The judges aren't ordering Argentina to make any specific payments to anyone. They are simply ordering that if the government is making payments to bondholders, it must treat them equally.

Argentine bond prices fell after the ruling, perhaps because creditors who accepted a restructuring didn't anticipate that the country would also have to pay the holdouts. At the margin, the country may now appear to have a weaker credit profile. But Argentina pays sky-high rates to borrow because it is a recidivist deadbeat. The country's bonds rallied a bit on Monday and if U.S. courts can persuade the government to honor its debts over the long term, spreads will come down much further.

That won't happen until Argentine politicians stop talking about the "vulture funds" that own some of the country's bonds and start talking about honoring its debts.

A version of this article appeared November 7, 2012, on page A24 in the U.S. edition of The Wall Street Journal, with the headline: Rule of Law 3, Argentina 0.