Pari Passu's Caribbean Detour

I wonder if this is how late night comedians feel about Anthony Weiner. He is, surely, the biggest gift that keeps on giving to their profession. On the other hand, it is summer, a time to relax and tell some knock-knock jokes ... but some people just cannot help themselves.

And so it is with pari passu. On the one hand, I will never have to look for content again. On the other hand, I do wish we could use the hiatus before the Second Circuit rules against Argentina to learn macrame or the Volcker Rule. But no. Another federal district judge in New York refused to dissmiss another pari passu case yesterday, and sent it full steam ahead to media frenzy.

FTAlphaville nicely sets out the basic background of Taiwan's suit against Grenada. In a nutshell, Grenada got hit by two hurricanes and restructured its debt--minus the four loans owed to Taiwan's Ex-Im Bank--circa 2005. At about the same time, it picked Beijing over Taipei, which probably ensured that the ensuing debtor-creditor spat would be about more than money. Grenada defaulted, Taiwan sued and got a judgment in New York, but has not gotten paid.

Fast forward to March 2013, when Taiwan filed a copycat lawsuit against Grenada, piggybacking on NML's victories against Argentina. Grenada asked the court to dismiss the case on the grounds that any contract covenant violation must be subsumed and extinguished in the money judgment on the same contract, which Taiwan got some years ago. This is known as the merger doctrine.

Judge Baer rejected Grenada's merger argument yesterday, partly on the grounds that the alleged pari passu violation--payment on restructured bonds while in default to Taiwan--happened mostly after the first case was filed. So Taiwan could not have brought the pari passu claim when it first sued on the contract, even though it mentioned the theory in its briefs. Of course if pari passu were just another covenant, it would not matter, because the remedy for breach would be acceleration, and the same old money judgment. But pari passu is no longer just another covenant; it is the one nuclear remedy that just might make sovereign debt collectable.

The ruling to let the suit against Grenada go forward is important because it expands the universe of potential pari passu plaintiffs in sovereign debt litigation. The NML bunch deliberately avoided getting judgments in the case pending before the Second Circuit, just in case merger might get in the way. The same folks have been working hard to change New York law to do away with merger. And fellow creditors holding judgments against Argentina have  hinted at bringing their own pari passu lawsuits, arguing that merger does not apply.  So yesterday's decision simplifies matters for creditors contemplating a lawsuit against a sovereign--you no longer have to pick between two uncertain roads, judgment and pari passu. You can take both.

Adding to the drama, the holders of Grenada's restructured bonds, whose payments would be blocked if Taiwan were to procure an NML-style injunction, were allowed to join the lawsuit as defendants. Like Grenada, they wanted the case dismissed--but not on simple merger grounds, but because Grenada has more favorable contracts and has acted nicer than Argentina. The judge gave them what they asked for--a full factfinding on whether and how Grenada might be different from Argentina.

Presumably, these folks want more leverage for creditors in general from doing away with the merger argument, and view this case as an opportunity to preserve and finesse the pari passu remedy. If a narrower version of the remedy emerges from a case involving a smaller, poorer, and more sympathetic sovereign, it could pave way for a compromise of sorts between more mainstream creditors and the policy world, freaked out about the implications of  NML v. Argentina.

Three things can happen from here on.

First, Grenada might settle with Taiwan--especially since it is out of money again, needs to restructure all its debt again, and would not want any glitches along the way. Given the political dimension, Taiwan might not wish to settle for less than what it is owed (roughly $30 million plus past due interest). Regardless, if the case settles, the take-away would be that the merger doctrine does not apply to pari passu violations that happen after the lawsuit is filed. The incentive will be to file the contract claim early. The scope of the pari passu remedy will continue to be broad, defined by Argentina.

Second, assuming the case goes forward, the judge could distinguish Grenada's contracts and behavior from Argentina's, and deny Taiwan the injunction. This would be a narrowing of NML v. Argentina. The effect on merger is the same as in the first scenario. This paves the way for more suits against Argentina, but perhaps not many others.

Third, the judge could grant the injunction. This would be a broadening of NML v. Argentina, because Grenada has a less vulnerable ranking formulation of the pari passu clause, and has been much more circumspect than Argentina about freezing out holdout creditors in its official enactments and public statements.

I am not going to begin to speculate on the broader fallout. Whatever happens, we will be here. Damn You, Pari Passu!