UNLIKE the obligations of firms or individuals, government bonds are backed merely by the issuer's word. In theory, when states act commercially in foreign jurisdictions, they have no more rights than any other borrower. In practice, the assets they hold abroad - embassies, military equipment, central-bank reserves and the like - are protected by treaties. Ever since wars to collect unpaid debts went out of fashion, governments have been kept in check only by their need to borrow again in future. Such impunity is now under threat. For seven years the Argentine government, which reneged on $81 billion of liabilities in 2001, has been sparring with a group of hedge funds that holds its non-performing bonds. The country staged two restructurings in 2005 and 2010, in which the owners of 93% of the defaulted debt exchanged their holdings for new securities, at a 65% loss. The remaining creditors have tried their luck in the courts. Over the years these "hold-outs" have won a series of judgments in New York ordering Argentina to pay their full claims, including 11 years of past-due interest. But the government in Buenos Aires has ignored these rulings, vowing never to give a cent to "vulture funds." The creditors have seized a handful of bank accounts, and last month got a court in Ghana to detain an Argentine naval frigate. Even so, they have received far less than have their peers who participated in the exchange. But the hold-outs" patience seems to have been vindicated. On October 26th an appeals court in New York ruled that Argentina had violated the pari passu clause in its bond contracts, which requires that the government treat all its creditors" claims equally, by paying out on the restructured securities but not on the hold-outs" assets. The judges prohibited Argentina from paying interest on its performing paper unless it also pays the hold-outs as well. And they declared that any financial firm that enables Argentina to violate the ruling would become liable as well. Argentina will appeal against the ruling, and can stay current on its other obligations in the meantime. The court did not specify how much the government will have to pay, and asked the judge who first heard the case to set the amounts. He might say that the hold-outs have to get the same coupon payments as everyone else, which Argentina might grudgingly accept. But if he requires Argentina to pay all of the $1.3 billion demanded by the hold-outs (comprising past-due interest and the face value of the bonds), that would be politically unthinkable. It would open the door to further litigation, too. Holders of the rest of its $6.6 billion of unexchanged debt would rush to file claims; if the government were to pay off the hold-outs at par, lenders who participated in the exchange would probably sue to get the same terms. Argentina could just try to pay its current bondholders outside America. It could easily find a foreign bank to process the payments. But most creditors would not like having to open accounts abroad, and would be reluctant to sacrifice the protection of American law. Changing the payment location might also trigger credit-default swaps, although that threat may have only a modest effect on Argentina. Because of the steep rates demanded by investors, it has not launched a new bond issue even under its own law since 2007. Indeed, the hold-outs" victory may well wind up causing more problems for other countries that do still borrow abroad and want to restructure. Although most sovereign debt sold since 2002 includes "collective-action clauses" (CACs), which make the terms of an exchange binding on all creditors if they are accepted by a big majority, few older securities contain them. Moreover, CACs are usually valid only for one specific issue, rather than for a state's total debt portfolio, so investors can still buy a small subset of securities and block a country's CACs. Today's struggling sovereigns are in Europe, not developing countries selling debt in New York. But the next generation of hold-outs will surely try to cite the Argentina pari passu case as a precedent. "It's a watershed moment," says Vladimir Werning of J.P. Morgan. It shifts the balance of power.