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No Food, No Phone, All Heat, Some Light: Dispatches from the Pari Passu Hearing (Updated to Reflect Rehearing Decision)

posted by Anna Gelpern

I am just back from joining 250+ other obsessed (and some paid) persons at the second Second Circuit hearing on the pari passu clause in NML v. Argentina. My first reaction on leaving the courtroom was that Argentina was done for, as was Bank of New York-Mellon, and by implication, the Exchange Bondholders. My second reaction (with the benefit of a glazed donut) was that some odd moments in the argument might point to a surprise outcome. My third reaction (with the benefit of coffee) was that my first reaction was right. More than you want to know below.

First, the atmospherics. The hearing took place 2-4:30 pm on Wednesday in the newly renovated courthouse (they just moved back in January), which may explain the confusion surrounding room size, access, overflow, press passes, communications, etc etc. By 10 am, quite a few folks were milling around the elevator bank adjoining the courtroom -- notably Argentine press. Word came down that Argentina's Vice President and Economy Minister would attend the hearing (true). Since all but a few journalists covering the courts had to check their phones at the front door, rumors spread the old-fashioned way, up and down the line, with people plotting to get in, get close, get the best sound, or get some fresh air. An hour before the doors opened, it became clear that not even all the lawyers for the bazillion parties who submitted briefs in the case would get into the 60-seat courtroom, and the two overflow rooms were overflowing.

Inside, the compressed argument schedule became something of a running joke. The judges seemed to encourage lawyers to go on for multiples of their time allotments. What started as a subdued and measured exchange (talking about the formula) got hot-hot-hot by rebuttal-time, with judges shaking their heads, rolling their eyes, and raising their voices, while the masses in the overflow rooms hooted and hollered at their favorite zingers.

Second, the substance. The panel was reviewing Judge Griesa's decision on remand from their October 26 ruling. They wanted to know (a) what ratable payment formula should apply in the injunction based on the pari passu clause in Argentina's defaulted bonds, and (b) how the injunction should apply to third parties.

General consensus going into the hearing was that Judge Griesa's formula would not be reopened, if only because it came straight from the contracts: everything owed NML (full principal+past due interest) should be paid alongside everything owed Exchange Bondholders (coupon). Any alternatives would have to be made up. That same consensus held that BNY stood some chance of escaping contempt sanctions for receiving funds from Argentina and distributing them to the bondholders. Wednesday's argument seemed to buck both parts of the consensus--to a point.

FormulaThe judges spent a surprisingly long time probing counsel (mostly Jonathan Blackman for Argentina, but also David Boies for the Exchange Bondholders) for plausible alternatives to the District Court formula. These seemed few. Argentina proposed giving everyone the same proportion of their old unrestructured principal on any given payment date, on the theory that it would approximate bankruptcy treatment.  On the other hand, the court was bothered (and one judge was immensely bothered) by the fact that Argentina's offer came so late in the game, and would not make up for missed paymends over the eleven years of default. When asked, Boies floated a few other formulas that took the eleven-year gap into account. The key point for Argentina, implicitly endorsed by the Second Circuit in remanding the question earlier, is that there must be a difference between "payment obligaitons" (everything due, uncontested) and "ratable payment obligations" (some proportion of everything due, very contested). Even so, I did not get the sense that any of the new formulas was a keeper. The fact that the court took up so much of its time with the question made me think that maybe the judges had come looking for more decision options, but did not get them. Or maybe not.

Third Parties. BNY's argument that it was a passive vessel receiving funds from Argentina for the bondholders, and that notice alone was not enough to support a contempt sanction, seemed to fall flat. The judges said at one point that it would have been "reckless" for lawyers to advise BNY to go forward with a payment even if it were not named in Judge Griesa's order. Weirdly, the judges just do not seem to buy the idea that Trustees represent bondholders, not issuers. At one point, a judge seemed thrilled to find out that Argentina was paying BNY's fees. In her view, this fact alone made BNY into Argentina's (constructive?) agent despite indenture language to the contrary, and hence "in active concert and participation." On the other hand, BNY's lawyers cited oodles of case law saying that the proposed sanction would be inappropriate, while counsel for NML did not counter any of it directly. They again, NML also relied on amici to make this counter-argument in their briefs.

The Exchange Bondholders' argument was essentially all about BNY, with a smattering of the Constitution. David Boies did try to frame the constitutional takings point for Supreme Court review (the court took our contracts for the sake of other people's contracts). There was a related exchange between Boies and the court on whether the old and the new contracts were effectively linked through the pari passu clause, or totally independent (Boies), and whether paying the Exchange Bondholders without also paying NML et al. would amont to granting new debt priority over old debt. 

However, the main objective of David Boies' argument seemed to be to free up the payment chain so the money could flow to his clients, which brought it back to BNY. When Ted Olson for NML conceded that merely receiving money from Argentina would not put the bondholders themselves in contempt, Boies seized on the concession to hammer home the fact that "THEY [BNY] are US." His repeated plea was to spare "us and our trustee". The whole thing was a bit surreal, since everyone seemed to agree that there was no way for Argentina's money to reach the beneficial holders without either BNY or another intermediary, and/or rerouting the payments in violation of the injunction. But if anyone wants to get paid, the eye of the needle is all yours.

From the entire discussion about third parties, it seemed that the Court was in no mood to slice and dice the payment and clearing chain (a worthy subject for a separate post). The thought must be that if BNY is covered, the payment either will not take place, or will take place through others who would be at risk of contempt on the same theory as BNY. The only exempt link in the chain is the beneficial holders of the bonds -- but of course in today's world, there is no way of getting them the money without involving various market intermediaries (trustees, registrars, paying agents, etc.). The technical UCC concept of "intermediary bank" in the payments sense does not seem to map helpfully onto the clearing chain. More another day.

Big Bonus Feature: Sovereign Prerogative. One of the bigger bombshells of the day came from Argentina in the form of the statement that it would default on everyone unless the Court adopted something like its payment formula. The fact that the statement was made with the Vice President and the Economy Minister sitting in the room made it feel like an even bigger deal. Jonathan Blackman's contention was that sovereigns do not and cannot -- and Argentina will not --  "voluntarily obey" foreign judgments against their own domestic law and public policy. Argentina's submission to U.S. jurisdiction was made subject to the understanding that under FSIA, some judgments could go unenforced, and them's the ropes. Since NML was effectively (though not technically) trying to enforce a judgment, it was out of luck. Blackman's hypothetical of an Iranian court order against the U.S. government seemed like a high-risk move under the circumstances. The threat of default prompted Ted Olson for NML to say that Argentina promised this extreme course "to force this Court to back down ... The Court cannot give into that!" True, but methinks the goal was to make it easier for BNY and the Exchange Bondholders to say that the injunction was effectively directed at them (also true). Argentina made the Court very very mad, but it also made Olson sound a little hollow when he argued for upholding the injunction on the assumption that Argentina would comply -- it said it would not. The Court is then stuck with the choice between issuing a feckless injunction, and letting Argentina persist in its "contumacious" ways.

Little Bonus Features. Of all things, the rumor of Elliott's CDS holdings and their seat on the ISDA Determinations Committee came up (did NML stand to benefit from Argentina's default?), as did the idea of the escrow account (wouldn't it be good faith?), and the story about the Exchange Bondholders driving the passage of the Lock Law (innocent bystanders?!). Collective Action Clauses did NOT come up. Yay!

Third, the process. The hearing started with the Court announcing that Argentina's petition for rehearing was denied. This prompted some confusion, since Argentina asked for two rehearings -- panel and en banc -- and some people thought that only the panel rehearing was denied. No one has seen the denial order so far, so who knows. It sounded to me like the whole thing was denied, since Argentina seemed to suggest its only recourse now was the U.S. Supreme Court. UPDATED: Only the panel rehearing has been denied; the en banc petition is still apparently pending, though chances remain slimmest.

While there will be at least that one more round of appeals, and no doubt more submissions from the parties clarifying some of the points from the argument, there is some chance that the decision will be issued and the stay lifted before near-term payments on the exchange bonds are due. At least so it seems from the fact that one judge asked when those due dates might be (soonest in March). Of course if the Court decides to re-remand for more thinking about the formula, that would take more time -- but it seems awfully unlikely.

Fourth, the atmospherics, again. Boy was the Court mad at Argentina. The judges said clearly that they would not be driven by market reactions, the fate of other defaulted bondholders who would have to line up behind NML for their slice of the pari passu pie, the speculative incentive effects on restructurings, or wishy-washy policy imperatives they did not buy anyway. As they see it, they have a truly atrocious party before them, and they will do whatever it takes to get at it -- Argentina should be treated as the pariah it is. From this perspective, collateral damage does not seem terribly damaging.


I keep trying to apply Reinhardt and Rogoff's "This Time is Different" formulation to the hearing yesterday. On one hand, I want to say, "Here's an outlier! This time *is* different." The entire sovereign restructuring scheme is built on de-fanging the holdouts/vultures/etc (see, for example, CACs and exit consents). But here, the holdouts seem to have the moral high ground.

On the other hand, if the whole idea of TTID is that financiers have a complicated model that means one way or another they'll get paid, then there's no functional difference between gunboat diplomacy, a US-led bailout (Tequila Crisis), and a ruling on pari passu in NML's favor. So, maybe, Reinhardt and Rogoff are right after all.

Dear K. Drake: Thank you for this thoughtful post. I suspect the answer depends on the difference you are looking for. If the project is to come up with a decision guide for bailouts vs. restructuring, it seems indeterminate without knowing your audience (eg, bankers, technocrats, consumers, governments, etc.). I am afraid if the moral high ground is a factor, the picture gets muddier still. One of the most interesting questions for me in TTID is who bears the losses when all is said and done. And here it is far from a foregone conclusion that NML will get paid, whatever the legal outcome.

Mr. Drake:

Yesterday's hearing also brought Reinhardt and Rogoff's work to my mind. Sovereign default is an historically common occurrence and, each time, we believe the situation is unique. While I expect a lively debate on whether NML's search for a credible enforcement mechanism does in fact distinguish this default from historical ones, history suggests that a belief in the singularity of the current situation is misplaced.

Creditors have always been able to turn to gunboat diplomacy or diplomatic responses. Does the Court's concrete interpretation of the pari passu interpretation distinguish this default from all historical defaults, or is it merely a natural step in the evolution of our response to sovereign default? A similar question could be asked with respect to the far reaching orders. Isn't this just another default, albeit with a clever new way to get paid? Why should we think that this time really is different?

The more I read these interesting posts, the more I wonder how useful TTID is (at least in its most basic form) as an analytical frame. Surely most events are neither "always" nor "unique". Are we getting litigation infection, with its insistence on stark contrasts and moral certainties?

The last comment is certainly an interesting one. Other fields of study might posit that there is always a degree of similarity and difference (e.g. linguistics) and that these similarities/and differences allow us to make meaning of a given phrase/ or a given situation. Here the the meaning given to pari passu and the scope of the injunction certainly give us ample room to point to difference. Similarities across defaults then help us place these differences in a broader context. The impact then may relate to how long this interpretation will truly be different and the degree to which markets work around it making it similar again.
An interesting update comes in the ongoing interpretation of ratable which may bring the different interpretation of pari passu closer to previous interpretations. For an update on that see:
A historical perspective might tell us that this is all the same. A legal perspective might make us think each new precedent is different. The interesting legal battles in the aftermath of NML may lie somewhere in between to determine whether or where this may evolve to. After all a line can point east at the same time it can point west without those positions being inconsistent.

@robertsp Great point. I guess I would only add that the legal perspective comes across as positively Hamlet-esque because, hey, we're lawyers, it's what we do!

Prof. Gelpern, I think it's the litigation bug if only because, as legal observers, we tend to dwell on those aspects. So it takes some doing to put on the i-banker or economist hat and see it from that perspective. (This is challenging for me, at least.) I read a Bloomberg piece on Wednesday's hearing's effect on Argentinian spreads and CDSs. I brought up TTID because, by coincidence a few days earlier, I was re-reading Michael Lewis's VF piece on Michael Burry. There's a telling moment when all of the banks are calling Burry, asking for him to sell his CDSs back, the reason being prices were spiking. TTID, of course, describing the American mortgage crisis which Burry profited from. Which got me to thinking: at core, what's actually different between this rise in derivative prices and those rises in derivative prices? I still don't have a great answer here.

All of which is to say, I think you're right. We love the legal twists and turns (how could you not?!), but in the grand sweep of defaults and financial crises, there's little new under the sun. But the conversation about the events is just as important as the events themselves, and this is a thoughtful conversation. Thanks, all, for helping me learn along the way...

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