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Pesky holdouts, old-timey edition. (Or, more on why Argentina matters.)

posted by Mark Weidemaier

"[T]he principal beneficiaries of the litigation were an unscrupulous body of commercial pirates, who had purchased ... bonds at a mere nominal price..."

When would you guess the litigation referenced in this quote took place? The sentiment sounds like something an Argentine finance official might have expressed in the last week or so. But the quote (p. 449) refers to buyers of distressed Bolivian bonds in the 1870s. Like modern holdouts, these old-timey "commercial pirates" recovered an amount disproportionate to their investment, and it didn't win them any friends.

In this post, I want to discuss the historic treatment  of holdouts in sovereign debt restructurings. In a (just posted) paper, Mitu Gulati and I review terms used in both sovereign bonds and sovereign debt restructuring proposals over the course of the 20th century. We're primarily interested in collective action clauses-which, as many readers know, are clauses that allow a majority of bondholders to approve a restructuring in a way that will bind dissenters. Indirectly, however, these historic practices also shed light on the pari passu clause at the center of the NML vs. Argentina litigation.

I'm focusing here on restructurings in the first half of the 20th century. There was probably no "typical" restructuring. But as we discuss in our paper, there were some patterns:

First, unlike modern restructurings, no effort was made to bind holdouts. Each bondholder could accept or reject a country's restructuring proposal, and (in most cases) assenting bondholders were bound even if they were the only one to approve the deal. Countries paid so little attention to holdouts that, in one case, the restructuring country followed these typical procedures even though its bonds actually included CACs. (These were Czech bonds issued in 1922.)

Second (and, in this case, just like modern restructurings), holdouts didn't get paid. Often-though, surprisingly, not always-the restructuring country also promised that it would never strike a better deal with holdouts without also giving the new deal to restructuring participants.

Bondholders were typically represented in these restructuring negotiations by a standing committee, such as the Corporation of Foreign Bondholders in Britain or the Foreign Bondholders Protective Council in the US. One way to think of these institutions is as repositories of knowledge about bondholder rights. Put differently, if we want to know what contract language means, we might do better to look to the meaning assigned by these institutions rather than to the meaning assigned by individual bondholders, who are likely to interpret contracts opportunistically in ways that suit their present needs. Plus, because countries were immune from suit in most courts until the latter half of the century, judges didn't have much opportunity to interpret sovereign bond terms.

What does any of this have to do with pari passu? The Second Circuit interpreted Argentina's pari passu clause to prohibit the country from paying restructuring participants the reduced amount they had agreed to take unless it also paid holdouts the higher amounts they insisted on receiving. We don't have any direct evidence of how, or even whether, the CFB and FBPC interpreted the pari passu clause. But we do know that the clause was occasionally included in sovereign bonds in the first half of the 20th century. During that time, the CFB and FBPC routinely negotiated restructuring deals in which participants got paid, and holdouts didn't, without any indication that this practice might violate the terms of some bonds.

To be clear, I don't know whether the CFB and FBPC negotiated a restructuring of bonds that included the pari passu clause. Furthermore, the few pari passu clauses used in the early 20th century did not include the magic "payment" language found in bonds issued by Argentina and other countries. So I'm not suggesting that the court's interpretation is contrary to some settled historical understanding. But I do want to emphasize the significance of the court's holding. In essence, it interpreted the clause as a promise by Argentina to forego a century's worth of restructuring practices. That's a pretty big deal.

Comments

I have recently encountered the following idea, pitched as if my correspondent were addressing policy makers in Argentina. The country could presumably offer unsecured bondholders the option of exchanging their bonds for new and SECURED bonds, perhaps tied to export receivables. This newly issued bond would have (but for that tie) the same terms as the existing paper, but it would now rank senior to the existing unsecured paper.

the secureds nature of the bonds they would receive for the exchange would presumably attract most investors, and the pari passu language of the old issuance would no longer be a burden.

My correspondent concluded thus: "You [Argentinian policy makers] do not have to pay holdouts, change jurisdictions, or reopen the exchange. problem solved."

Is it that simple?

Alas, is anything ever that simple? The example assumes that Argentina is willing to violate Judge Griesa's order (as I read it anyway) and can find financial institutions and other intermediaries to help it do so (all possibly while violating other bond covenants...)

Mark,

Great topic of investigation. So much effort has already been put into looking at what variation of the meaning of ranking was attributed to pari passu at different points in history. It is refreshing to now read how holdouts themselves were "ranked" vs other creditors in the eyes of judges (rather than how their claims can be mechanically ranked vs similar contracts held by other creditors). After having looked at the tree in front of us for so long its nice to take in the view of the forest.

Christopher,

I have recently heard this idea being bounced around. But in the context of the recent Appeals Court ruling it would not offer Argentina an elegant (legal) exit. Note that when interpreting pari passu the Court distinguishes two sentences in the clause.

The first, refers to the protection provided to creditors from subordination by a sovereign acting as an "issuer" (issuing new bonds with guarantees or collateral not offered to similarly ranked creditor... As is being suggested to you).

The second sentence (always according to the Court), refers to protection from the sovereign when it acts as a "payer" (this form of subordination is the one Argentina is being accused). Unlike the first, most observers consider the interpretation of the second sentence to be controversial... And one that does more damage than good to sovereign credit markets in an era of mass securitization).

So the pari pass interpretation has not shifted to mean one thing today vs something else in the past. Rather, it has been interpreted to mean two things simultaneously.

The idea you mention would get Argentina off the hook for the actions that it takes as a payer in violation of the second part of the clause. But the Court would place Argentina right back on the hook for subordinating creditors through actions taken as an issuer, in violation of the first sentence in the clause.

Vladimir

Vladimir: Great point about how the pari passu clause, as the Second Circuit interpreted it, protects against multiple kinds of sovereign behavior. If the issuer formally subordinated one group of unsecured bondholders to another, the court would presumably say that it had violated the first sentence of the clause.

The concept of "secured" debt is slippery in the sovereign context, so it's conceivable the court might invoke the PP clause if an issuer granted a security interest to previously-unsecured bondholders. But that sounds like a more likely violation of the negative pledge clause (assuming the bonds have one), which is an explicit promise not to create secured debt without granting equal security to existing bondholders.

the imperialist creditor nations -- which placed themselves permanently in charge of the IMF and World Bank when they created them after WWII

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