The Pari Passu Dilemma in the Sovereign Debt Context · The Pari Passu Dilemma in the Sovereign Debt Context 2 Time constraint, just to ignite the discussion. Only substantial aspects—no

The Pari Passu Dilemma in the Sovereign Debt Context

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The Pari PassuDilemma in the Sovereign Debt

Context

Prof. Rodrigo Olivares-Caminal

Nottingham, UK

September, 2013


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Time constraint, just to ignite the discussion.

Only substantial aspects—no UK/US procedural issues.

Opinions are personal.


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T H E P A R I P A S S U C L A U S E

S t r u c t u r e & I n t e r p r e t a t i o n

Clause Structure Clause Interpretation

1. INTERNAL LIMB: the bondsrank pari passu with each other

2. EXTERNAL LIMB: the bondsrank pari passu with otherunsecured indebtedness of theissuer

Two Limbs Two Interpretations

1. NARROW or RANKINGINTERPRETATION: obligationsrank and will rank pari passu withall other unsecured debt

2. BROAD or PAYMENTINTERPRETATION: when thedebtor is unable to pay all itsobligations, they will be paid ona pro-rata basis

PARI PASSU—STRUCTURE AND INTERPRETATION


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“The Securities [i.e., the bonds] will constitute . . .direct, unconditional, unsecured and unsubordinatedobligations of the Republic and shall at all times rankpari passu and without any preference amongthemselves. The payment obligations of the Republicunder the Securities shall at all times rank at leastequally with all its other present and futureunsecured and unsubordinated ExternalIndebtedness (as defined in this Agreement).

Internal Limb

With a payment element? What does this really mean?

Wood: “rank means ‘rank’. It does notmean ‘will pay’, nor does it mean thatwill give ‘equal treatment to creditors’.If the clause adopts a variant, such as‘rank pari passu in priority of payment’, the result is the same”.

THE PROSPECTUS (ARGENTINA’S 1994 FAA, CLAUSE 1(C))

External Limb

Mitu Gulati and Robert Scott: “legalprofessionals still do not agree on itsmeaning or purpose and even less onits origin ... a harmless relic ofhistorical evolution”


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ELLIOTT

ELLIOTT


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It is DECLARED, ADJUDGED, andDECREED that the Republic is required ... atall times to rank its payment obligationspursuant to NML’s Bonds at least equallywith all the Republic’s other present andfuture unsecured and unsubordinatedExternal Indebtedness.

It is DECLARED, ADJUDGED, andDECREED that the Republic violatesParagraph 1(c) of the FAA whenever itlowers the rank of its payment obligations… including (and without limitation) byrelegating NML’s bonds to a non-payingclass …

NML CAPITAL v. REPUBLIC OF ARGENTINA (08-cv-06978-TPG)


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Why the District Court said thatthere has been a breach of theclause?

Lock Law

It is DECLARED, ADJUDGED, and DECREEDthat the Republic lowered the rank of NML'sbonds in violation of Paragraph 1(c) of the FAAwhen it enacted Law 26,017 and Law 26,547.


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No CACs or exit consents Argentina run out of options to enhance creditor participation creatively use of the contractual terms of the bonds, i.e. most-favored creditor clause but therewas a drafting failure !

Argentina passed Law 26,017 (Lock law) to reassure participating creditors that the offer was theonly possible choice.

The Lock law provided a basis for considering an alteration in the legal ranking of the existingunsecured creditors resulting in the involuntary subordination of the holdout creditors.

Argentina opened the window to a breach of the pari passu clause on legal subordinationrather than on a broad or ratable payment interpretation.

The problem here is not the issuance of performing debt as result of the exchange offer formally subordinated the holdouts to non-performing status/ i.e. payments do not rank equallyanymore = 2 unsecured obligations ranking differently.

SEC Form 18K (Annual Report): holdouts are a category separate from its regular debt and thatsince 2005, it has “not [been] in a legal … position to pay” that category.

Buchheit: ‘you can do pretty much whatever you want in discriminating among creditors (in termsof who gets paid and who does not) but do not try to justify your behavior by taking steps thatpurport to establish a legal basis for discrimination’.

BREACH OF PP CLAUSE: SUBORDINATION


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Argentina “lowered the rank” of plaintiff bonds intwo ways: (1) “when it made paymentscurrently due under the Exchange Bonds, whilepersisting in its refusal to satisfy its paymentobligations currently due under [plaintiffs]Bonds”; and, (2) “when it enacted [the Lock Law”and [the Lock Law Suspension]”.

“… in pairing the two sentences of its Pari PassuClause, the FAA manifested an intention toprotect bondholders from more than justformal subordination” according to the CoA,the Pari Passu clause protects against: (1) “theissuance of other superior debt (first sentence)”;and, (2) “the giving of priority to otherpayment obligations (second sentence)”.

THE VIEW FROM THE BENCH


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“As we explicitly stated in our lastopinion, we have not held that asovereign debtor breaches itspari passu clause every time itpays one creditor and notanother, or even every time itenacts a law disparately affectinga creditor’s rights. We simplyaffirm the district court’sconclusion that Argentina’sextraordinary behavior was aviolation of the particular paripassu clause found in the FAA.”

Second Circuit Court of Appeals, NML Capital, Ltdv Republic of Argentina, 12-105(L), 23 August2013.


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Jan 2012 District Court issued a temporary restraining order enjoining Argentina from altering the payment process (including the use of different firms or other vehicles).

Feb 2012 District Court issued an injunctive relief each time that a payment is done to exchanged bonds the same fraction of the amount due to them shall be paid to holdouts justification is equitable relief since Argentina made clear (even by a formal act) its intention not to pay any money judgment

Since Argy might refuse to comply with the injunction order (under Rule 65(d)(2)) the parties, their officers, agents, servants employees, attorneys as well as other persons who are in active concert or participation with them are bound by the injunctions.

Plus the injunctions expressly prohibit Argentina’s agents from aiding and abetting any further violation of the order by the court.

o NB: Art. 4-A of the UCC pure intermediaries cannot be affected.

SOME PROCEDURAL NOTES


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In the context of a broad or “payment” interpretation a creditor can obtain a courtorder directing:

(1) DEBTOR: not to pay other debts of equal rank without making a ratablepayment under the debt benefiting from the clause.

(2) OTHER CREDITOR:a) not to accept a payment from the debtor unless the pari passu-protected

lender receives a ratable paymentb) if has knowingly received and accepted a non-ratable payment

answerable to the pari passu-protected creditor for a ratable share ofthe funds.

(3) A FINANCIAL INTERMEDIARY (e.g. a fiscal agent or a bond clearingsystem): to freeze any non-ratable payment received from the debtor and toturn over to the pari passu-protected creditor its ratable share of the funds.

Buchheit & Pam


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RESTRUCTURING?

US citizen bondholders to claim the payment of their credit (whichlimited the chances of achieving debt restructuring under the IMF'sumbrella) vs. not allowing the claim because it would prejudice NY as afinancial world centre (Pravin case, Court of Appeals)

Operational ramifications that impact on the functioning of thepayment systems vs. enforcement of creditors’ rights least of twoevils = NY will lose !

Sovereign Immunity

RATABLE PAYMENT? Temporary Restraining Order (payment method) +Permanent Injunctions (aiding and abetting)?


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THE CLAUSE VARIES WITH THE DRAFTER

Italy’s 2015 US dollar bond, issued in 2010 and governed by NY law:

Pari Passu Clause (although NO reference to the terms “pari passu”)

“The debt securities will be the direct, unconditional,unsecured and general obligations of Italy. They will rankequally with all of our present and future unsecured andunsubordinated general borrowing. The full faith and creditof Italy will be pledged for the due and punctual payment ofthe debt securities and for the due and timely performanceof all of our obligations under the debt securities. We willpay principal and interest on the debt securities out of theMinistry of Economy and Finance of Italy. We will payamounts due on the debt securities equally and ratablywith all general loan obligations of Italy.”


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Elliott’sDecision in Brussels

SDRM(Pub. Sector) NGO Activism

Vulture Repudiation(Bills/Acts)

Rogue Debtors

Arg. 2001-05Ecuador 2008Greece 2012?

CACs+

Exit Consent(Priv. Sector)

Increased Vulture Activity

(mistaken) Re-emergenceof Odiousness

+Illegit. Mut

Rogue Creditors?


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The EFSF has the samestanding as any othersovereign claim on the country(pari passu)

ESM will enjoy preferredcreditor status in a similarfashion to the IMF, whileaccepting preferred creditorstatus of IMF over ESM.

PRIORITY?

IMF

ESM

Other Creditors


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“As we have observed, this case presentsno claim that payments to the IMF wouldviolate the FAA. A court addressing such aclaim in the future will have to decidewhether to entertain it or whether to agreewith the appellees that subordination of“obligations to commercial unsecuredcreditors beneath obligations to multilateralinstitutions like the IMF would not violatethe Equal Treatment Provision for thesimple reason that commercial creditorsnever were nor could be on equal footingwith the multilateral organizations.”

Second Circuit Court of Appeals, NML Capital, Ltd v Republic ofArgentina, 12-105(L), 23 August 2013.

IMF

ESM

Other Creditors


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THE PARI PASSU CLAUSE IN HISTORICAL PERSPECTIVE

No. Historical Purpose of the Pari Passu Clause Market / Judicial Reaction-Solution

1 To prevent the earmarking of revenues of the government towards a single creditor Expanded negative pledge clause

2Against legal measures which have the effect of preferring one set of creditors against the

others (e.g. enacting a specific norm)

Libra Bank Limited v. Banco Nacional de Costa Rica S.A. and Allied Bank

International v. Banco Credito Agrícola de Cartago

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Against legal measures which discriminate between creditors creating an involuntary

subordination (e.g. the Philippines and Spain)

Exhaustive due diligence of the issuer


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keep itsimple.

1. Pre-Argentina’s litigation = incorrect interpretation of the pp clause (Belgium court)

2. Post-Argentina’s litigation = could have been based on a correct interpretation and an actual breach of the pp clause in its ranking or narrow form A GREAT MISSED OPPORTUNITY a new wake of litigation.

3. Olivares-Caminal (2009) and Gulati and Scott (2011) the clause has little or no meaning in the sovereign context boilerplates are sticky, even more after the CoA decision.


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Any Questions ?

谢谢. Cam rá. Efharisto. Obrigado. Gracias. Grazie. Thank You.

Merci. Danke. شكرا. etc.

[email protected]

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The Pari Passu Dilemma in the Sovereign Debt Context · The Pari Passu Dilemma in the Sovereign Debt Context 2 Time constraint, just to ignite the discussion. Only substantial aspects—no