Argentina's (not so) unusual pari passu clause
Thanks very much to Credit Slips for inviting me to guest blog. I know that many readers of this blog have been following the pari passu saga unfolding in the Second Circuit. Posts by Anna Gelpern here, and by Felix Salmon and others elsewhere, have explored some of the implications. I want to add some context to show why the Second Circuit's recent decision strikes many as a very big deal. In this post, I'll focus on whether Argentina's pari passu clause was somehow unique, so that the court's decision has only minor implications for other countries. (The short answer: It wasn't unique.)
As contracts, sovereign bonds are fascinating. They are very long, it's not clear that anyone reads them, and it is tempting to assume (wrongly) that they all say the same thing. But in fact, bonds vary in lots of seemingly minor ways. The problem is that it can be hard to tell whether the variance is accidental or is a deliberate effort to modify the standard template. (I'll say more on this in a future post discussing another snippet of contract language that got Argentina into trouble: its sovereign immunity waiver.) Argentina's bonds, however, included a fairly significant addition to the standard pari passu clause.
The Securities ... shall at all times rank pari passu and without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness.
Throughout the lawsuit, the plaintiffs have taken pains to stress that their argument focuses on the meaning of the bold text. One reason for this may be to avoid giving the impression that the case has serious implications for other sovereigns and future restructurings. The suggestion, which I have heard echoed in other places, is that Argentina uses a unique version of the pari passu clause. But that's not true.
The Second Circuit interpreted the bolded language as a promise that Argentina would not pay on its exchange bonds without also paying holdouts ("The second sentence ... prohibits Argentina, as bond payor, from paying on other bonds without paying on the FAA bonds"). Whether or not you agree with that interpretation, it's fair to say that it took a lot of people by surprise. There is a lot of confusion about what the pari passu clause means and why it keeps appearing in sovereign bonds. When asked, lawyers have lots of explanations, most of which don't hold up very well against the data. In fact, one of the real mysteries is why lawyers keep making changes to the clause, including by adding language just like the boldface text used by Argentina. As the two sources linked immediately above demonstrate, this or functionally similar language has become more common over time.
The figure below divides pari passu clauses into three categories: (1) those that seem to promise only that the issuer will maintain the equal ranking of its bonds (green); (2) those that, like Argentina's clause, arguably imply an equal payment obligation (yellow); and (3) those that contain what amounts to an explicit promise of equal payment (red-e.g., the bonds "rank pari passu in right of payment and shall be paid as such"). You can see the increase over time, to the point where nearly half of the bonds issued in the 2000s fall into the yellow category, meaning they use language that is functionally identical to that used by Argentina. (Note: the figure draws from a sample of bonds governed by foreign law; it doesn't include bonds governed by the issuing country's own law.)
This doesn't mean the Second Circuit got it wrong, of course. But the court's decision has significant implications for other issuers. Read broadly, the court interpreted Argentina's pari passu clause as a promise never to restructure. That's because sovereign restructurings have to be voluntary, but few bondholders will agree to reduce their claims if they know that the issuer is obliged to pay holdouts in full. The Second Circuit dismissed this concern, because it thought collective action clauses would eliminate holdouts. But as Anna has pointed out, that's not necessarily true.
Of course, the court's decision is only as potent as its remedy. But this post has gone on long enough, so I'll take that up in a later post.