(Updates with details of court hearing, judge's ruling; adds byline)
By Nate Raymond and Joseph Ax
NEW YORK, Sept 26 (Reuters) - A U.S. judge said Friday he would allow Citigroup Inc to process a disputed $5 million payment by Argentina on bonds issued under its local laws following its 2002 default.
U.S. District Judge Thomas Griesa in Manhattan agreed to an order proposed by bondholders suing Argentina over defaulted debt to allow Citigroup to process the interest payment, which is due Sept. 30.
The ruling gave temporary relief to Citigroup, which has said it faces regulatory and criminal sanctions by Argentina if it cannot process the interest payment on U.S. dollar-denominated bonds issued under Argentine law following the country's 2002 default.
The bondholders that consented to the stay include Elliott Management's NML Capital Ltd and Aurelius Capital Management, both of which did not participate in Argentina's past restructurings.
With the deadline looming, the holdout bondholders proposed allowing the payment to go through by issuing a stay that would allow litigation until the next payment is due on Dec. 31.
"The reason plaintiffs have proposed a stay is so that the parties and Your Honor will not have to deal with these important issues on an emergency basis," Edward Friedman, a lawyer for Aurelius, said.
Citigroup's lawyer, Karen Wagner, pushed Griesa to go even further and rule that the bank was not subject to an injunction at all, after the judge said his prior order favoring the creditors was focused on bonds "payable in New York and governed by New York law."
Griesa ultimately declined to rule Friday, instead giving the parties 30 days to exchange information in order to resolve the issue promptly.
"We do not want to be back here over and over when interest payments are due," he said.
The hearing was the latest in a series of proceedings following Argentina's most recent default in July, an event triggered by its refusal to honor court orders to pay $1.33 billion plus interest to the holdout bondholders.
The hedge funds had spurned the country's 2005 and 2010 debt restructurings, which resulted in exchanges for about 92 percent of the country's defaulted debt for a fraction of their face value.
The July default came after the U.S. Supreme Court declined to hear Argentina's appeal of a ruling by Griesa that it must pay the holdouts when it paid holders of the exchanged bonds.
Griesa subsequently blocked Bank of New York Mellon Corp from processing a $539 million interest payment, sending Argentina on a course to default after no settlement was reached.
Amid the litigation, Citigroup sought assurances it could process payments it received from Argentina on bonds issued under Argentine law.
Griesa initially ruled for Citigroup. But on July 28, he rescinded the order, only allowing the bank to make a one-time payment due July 30.
Another hearing is scheduled Monday, when Griesa will weigh holding Argentina in contempt and ordering sanctions of $50,000 per day for not complying with his orders. (Reporting by Nate Raymond in New York; Editing by Leslie Adler)