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Known Unknowns in Pari Passu ... and More to Come

posted by Anna Gelpern

The Friday decision in NML et al. v. Argentina has clearly shaken the sovereign universe. While I am normally more prone to panic than Felix Salmon or Vladimir Werning, these wise folks reasonably point out that the decision may spell the End of the World for sovereign immunity, sovereign debt as we know it, etc. "May" is the operative word in my view. We need more information and analysis (stay tuned) before we dash for the bunker.

Yes, it looks like previously unenforceable sovereign debt has suddenly become more enforceable. Zero to something. But how much? It depends on too many things to know for sure. Will the Second Circuit rehear the case en banc? Will the U.S. Government and those who sat on the sidelines in this round -- the IMF, the Federal Reserve, more intermediary banks -- pipe in? Will SCOTUS take the case? Will Judge Griesa pare back the effect of the injunction if Elliott wins the appeals? Vladimir is right that this will not go away. But we really do not know enough about what "this" is to say much more than that. We have a Second Circuit opinion that seems to disdain its own implications, and some history of SCOTUS slapping down Argentina when the U.S. Government was on the other side. Go figure. Ask your favorite court maven (I will).

Yes, Argentina's CDS have gone through the roof, correctly reflecting immense uncertainty about the near future of its foreign bond stock. But I doubt that either the courts or the policy establishment would find this fact compelling. Argentina has been a headache for too many for too long to elicit sympathy. What I really want to know -- consistent with the thrust of the U.S. brief -- is whether other sovereign and sovereign CDS spreads are  going nuts, and if yes, which ones. The way Argentina wins here is by invoking the good of the system without overclaiming. No mean feat.

Yes, we seem to have a damagingly broad interpretation of pari passu out of the Second Circuit. Does it mean that a prospectus warning holdouts they might not get paid amounts to a subordination in violation of the pari passu clause, at least versions similar to Argentina's? Maybe. Will foreign courts adopt the Second Circuit's reading, exposing countries such as Italy to Argentina-scale uncertainty? Yikes. For what it's worth, this is where I feel most comfortable being worried. I will be looking for more data on just how many other countries have vulnerable formulations of the clause.

All this to say, there is a big difference between "mostly dead" and "all dead". And I suspect that Argentina -- and more so the broader universe of sovereign debt and sovereign immunity -- is "mostly dead" as far as pari passu goes. For now.

Comments

I don't understand the concern here. The court's decision focused on the "equal protection" clause in the pari passu covenant. Not all pari passu covenants have this provision, in fact few do. Without that specific covenant there is no issue. The court did not find legal subordination as far as I read the opinion which would have broader implications. Between an en banc request, remand before Griesa, further appeals and a cert petition, this fight has years to go.

This fight may indeed have years to go. The concern with the court's interpretation, however, is precisely that Argentina's pari passu clause is not that unique. The court focused on Argentina's representation that its "payment obligations" under the bonds would rank equally with its other external indebtedness. That language is quite common - not every issuer uses it, but many do. (There's evidence to this effect in the Scott & Gulati book linked in the main post, and also here on pp. 20-21: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1633439)

If the court held that the Lock Law was the problem, its decision wouldn't necessarily have a broad impact. In places, however, it suggests that the clause is violated whenever the issuer pays some bondholders but not others (e.g., "The second sentence ... prohibits Argentina, as bond payor, from paying on other bonds without paying on the FAA bonds.") That interpretation could have real implications for other issuers.

The appeals court did throw into question the one aspect of the district court's ruling that seemed most innovative, the part that would have made it difficult for Argentina simply to ignore the substance of the ruling and continue paying off only on the more recent restructured bonds. Now, it seems, it remains easy (or easy enough) for Argentina to do exactly that until further developments.

I'll defer to you Mark since you published on this topic but I have looked at numerous indentures and the FAA bonds at issue here seemed less common to me at first look. That bonds must rank equally with respect to external debt is common, that payment obligations must also be equal appeared rare. Christopher also raises an important point that the court was apprehensive in the broad scope of Griesa's injunction, something they questioned during oral argument and confirmed in their opinion. At the end of the day, what prevents Argentina from paying bondholders in Argentina by requiring hedge funds to open domestic accounts or through some other intermediary? Yes, Argentina would be in default and would possibly trigger a technical default on its CDS but Argentina is not affected. Nor is holding Argentina in contempt much comfort for holdout bondholders. A company or person held in contempt goes to jail or has to pay a fine but the FSIA would preclude such remedy here.

I completely agree that Argentina might find a way to work around the court's order (even assuming the order survives further appeals). Also that contempt isn't an available sanction. I guess the court is betting that Argentina will find it harder to ignore a direct order than to flout money judgments. We'll see, I suppose...

The puzzling thing about the "payment" language is just how common it is. It's essentially the same language that got Peru into trouble in 2000-2001, but it just won't go away.

Question...How likely do you see Griesa defining the ratable payment to make it equivalent to what the new Exchange Bonds are receiving (i.e., basically paying to the holdouts as if they had accepted the exchange). I believe this would be the only situation where Argentina might be willing to pay the holdouts. Anything that goes beyond what people who have accepted the exchange (canje) seems extremely unlikely.

Mark, I've read your article with Scott and Gulati on origin myths etc. Am I wrong to think that it may be of use to the lawyers for the hedge funds pressing this? After all, you present evidence that undermines the Buchheit and Pam picture, and Buchheit-Pam in turn has been widely invoked as support for precisely the case that Argentina wants to make -- that pari passu has an accepted narrow meaning NOT applicable here.

Your own bottom line in that article might be paraphrased: since the 1980s, the wording of the clauses, and so presumably their significance, has been moving AWAY from the narrow one envisaged by Buchheit and Pam.

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