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Sovereign Restructuring after NML v. Argentina: CACs Don't Make Pari Passu Go Away

posted by Anna Gelpern

A remarkable number of people are buying the creditors' argument that widespread introduction of collective action clauses (CACs) in sovereign bonds makes the debate about the pari passu clause in the Second Circuit irrelevant to the broader regime for sovereign debt restructuring. This is intuitively appealing, but totally wrong.

We are in this mess because Argentina defaulted on its debts, restructured most but not all on punitive terms, and is facing lawsuits from the remaining few creditors. The exasperated SDNY judge granted the creditors an injunction based on the pari passu clause in their bonds, requiring Argentina to pay pro rata those creditos that took a 70% haircut and those that took none.

The United States intervened somewhat grudgingly, arguing among other things that the SDNY interpretation of the pari passu clause threatens the broader regime for sovereign restructuring. The creditors and amici retort that, among other things, the introduction of CACs in sovereign bonds should make pari passu injunctions like this one rare-to-nonexistent.

Recall the most common version of a CAC allows a super-majority of bondholders to amend the entire issue against the wishes of a holdout minority. CAC adoption, already pervasive in the UK market, skyrocketed in the United States after a concerted effort by the U.S. Treasury and under threat of a treaty-based sovereign bankruptcy regime promoted by the IMF.

According to the creditors, if most sovereign bonds have both CACs and pari passu clauses that give rise to pro rata payment obligations, debtors will offer attractive restructuring terms to secure supermajority creditor support, and amend the contracts (pari passu and all) over the objections of the holdouts. No holdouts, no pari passu problems.

Even assuming that *all* foreign sovereign bonds soon come to have CACs (we are in the 80% range now according to the briefs), this argument fails for two reasons. First, not all sovereign debt is in the form of CACed or CACable bonds. Second, not all CACs contain an aggregation feature, which allows majority amendment across multiple bond series. As a result, and as was the case in Elliott v. Peru, a holdout can obtain an obscure little instrument that is not even syndicated let alone bonded, and sue to her heart's content. In the alternative, as is the case in Greece's foreign law bonds (which have had CACs but no aggregation going into the March debt exchange), she can buy a blocking position in a tiny bond issue trading at a deep discount, block the restructuring of that issue, and pari passu right ahead. Holdout strategies have never been about joining the masses--they are all about piggy-backing on the masses' concessions. From that perspective, and at least until aggregation becomes pervasive, CACs clear the field for the holdouts.

Based on this, some might say that a ruling against Argentina in the Second Circuit that lets loose the pro rata payment interpretation of pari passu would make a darn good argument for statutory sovereign bankruptcy. No ad-hoc, willy-nilly, heterogeneous contracts and wacky interpretations of obscure clauses that take on a life of their own because something got lost in translation between Latin, English and Belgian court-ish.

All that said, if the Second Circuit can see its way to affirming on the narrowest of grounds tied to Argentina's "Lock Law," without passing on a broad interpretation of pari passu, they might not need to reach the broader implications.

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