After the Argentine debt restructuring: a test for collective action clauses

November 2020 | EXPERT BRIEFING | FINANCE & INVESTMENT

financierworldwide.com

In the aftermath of the recently closed Argentine debt exchange, it is time to look back on this workout and determine how the architecture of sovereign debt contracts can be improved.

There are two main legal innovations that Argentina has implemented to tackle the creditor coordination problem, which is often the main hurdle a sovereign party may face in a complex restructuring scenario. These two innovations are ‘re-designation’ and the so-called ‘Pac-Man’ strategies, and their creation is a result of the collective action clauses (CACs) being tested in Argentina.

The new mechanisms are aimed at addressing how creditor aggregation works. This implies a step further in the evolution of CACs, which is a contractual or market-based tool to address the intercreditor coordination problem that may arise in sovereign debt crises. Given that there is no bankruptcy code or international treaty providing for sovereign debt insolvency workouts, the only tool available for the sovereign to avoid or minimise the holdout risk and move the process forward is the CAC.

The end of the story is that Argentina restructured 99.01 percent of its $65bn foreign law governed debt, as announced on 31 August 2020. The country received acceptance from 93.55 percent of bondholders to its exchange proposal, thereby obtaining the majorities required under the CACs in the series which were restructured. The explanation behind 99.01 percent of the debt being restructured is that the CACs’ forcing mechanism was triggered in those affected series of eligible bonds. These old eligible bonds were then replaced by new bonds providing for deferral, coupon adjustments and principal haircut.

But how was this undoubtfully successful result achieved? Behind the cold numbers hides a heated debate revolving around the economic and legal terms of the restructuring proposal launched by Argentina, which took many rounds of negotiations with groups of bondholders over the past few months and eventually resulted in the agreement – all in the midst of the coronavirus (COVID-19) pandemic. This article offers some initial thoughts on the two main controversial legal aspects surrounding the CACs and how they were shaped to close the deal.

The CAC, also known as a majority action clause, is a decision-making mechanism at a collective level which allows for amendment of the main terms of the bonds, by means of obtaining certain majority thresholds of creditors. This collective decision-making element enables a supermajority (the specific one provided in the relevant bond subject to amendment) to force all creditors, even the dissenting ones, to accept a restructuring. This is the only means available at present to mitigate the collective action coordination problem faced by the sovereign and how it gets rid of holdouts and triggers a full restructuring, in a context in which individual interest may not be aligned with the interest of the group.

Prior to the widespread use of the CAC since 2003 after being included in a Mexico bonds issuance governed by New York law, sovereign bonds provided unanimous consent clauses which required the consent of 100 percent of bondholders to amend the main terms of the loan. Old unanimous consent requirements gave rise to the holdout problem: a single bondholder could prevent the restructuring from happening.

Before addressing the two new specific aggregation features, a more general takeaway of the recent Argentine restructuring process has to do with the fact that contracts are incomplete. CACs were provisions included in the indentures of the eligible bonds, drafted at the time of their issuance, outlining the conditions for conducting a future hypothetical restructuring scenario. But now, years later, that potential scenario materialised into reality and the clause had to be implemented.

From Argentina’s standpoint as sovereign, it seems that such clauses as originally drafted evidenced certain gaps which had to be filled prior to putting them into practice in this exchange, so as to preserve the ultimate goal of achieving an orderly restructuring by avoiding holdouts that could put the whole restructuring at risk.

This was the context in which these two aggregation tools were designed to minimise the holdout power: the ‘re-designation’ provision sets out how the sovereign may move on with the restructuring if certain CACs thresholds are not obtained, and the ‘Pac-Man’ provision aims to regulate what the sovereign may do in the future with those bondholders that were left out of the restructuring. Finally, sitting at the negotiation table resulted in a more detailed regulation of the CACs. That is how the deal got through, and the level of contract completeness in this respect is now higher than before.

One of the central complexities of the latest Argentine debt restructuring was that the universe of bonds subject to exchange was comprised of bonds issued under two different contracts which, in turn, provided for different CACs requiring different majorities to amend the terms and conditions of the original bonds. A first group of bonds was issued within the prior restructuring carried out by the exchanges of 2005 and 2010, governed by the Trust Indenture of 2005. And a second group of bonds was issued later, governed by the Trust Indenture of 2016. The latter is an International Capital Market Association (ICMA) CAC-based agreement which adopts a stance that is more favourable to the sovereign, given that its acceptance thresholds are lower than the 2005 Indenture.

When initially launching its exchange offer, Argentina included among the restructuring proposal terms the ‘re-designation’ mechanism. This would allow Argentina, at the closing or after the acceptance period, to exclude some series of bonds in which the required majorities provided by the relevant CACs had not been met. By means of this mechanism, Argentina would determine the series of bonds to be included in the restructuring and exclude some of those that would not be affected by the restructuring proposal. This way, Argentina could redefine the pool of bondholders to reach the majorities required under the CACs in the series that would remain as the affected series.

This ‘re-designation’ strategy raised major concern for the groups of bondholders that actively negotiated with Argentina, who publicly alleged that the clause as initially written was abusive. From the sovereign debtor’s position, this was allowed, as it was not expressly forbidden in the terms of the eligible bonds. The parties finally agreed to further regulate the ‘re-designation’ mechanism, which resulted in amendment of the offering terms. If Argentina was to ‘re-designate’ the series of bonds, it had to give a five-day period for the bondholders to revoke their consent to participate in the exchange, unless a majority of 66 and two-thirds percent of the aggregate eligible bonds was reached. This should suffice for the sovereign to move on with the process, as well as giving bondholders an opportunity to get out.

The other aggregation feature, which also raised concern for the bondholders’ groups when originally drafted by Argentina, was the provision that would allow those bonds which were excluded in the current restructuring to join a future one by means of the sequential use of the aggregation method for “uniformly applicable” or single tier/limb modifications in successive future exchanges. It is what the market calls the ‘Pac-Man’ strategy. The bondholders’ groups request on this was to include restrictions on Argentina’s use of the method to conduct uniformly applicable modifications (this method was only provided in the 2016 Indenture, not in the 2005 Indenture), alleging that the dissenting creditors’ power originally protected by the CAC would otherwise be weakened. The parties agreed to regulate more specifically in the restructuring terms the way in which Argentina could make use of the single tier method in future exchange offers. This was how, after offers and counteroffers, these two legal provisions were finally written in a mutually agreed fashion on both the creditor and debtor sides.

What ended up happening in practice with these two features in this restructuring? When announcing the results, Argentina said that it had excluded the series of bonds in which it did not obtain the minimum threshold for the CAC to be triggered to drag along all the bonds comprised in those series. This implied the use of the re-designation tool in relation to almost 1 percent of eligible bonds which were left out. As to the ‘Pac-Man’, we will not see it in action for this restructuring, since Argentina successfully restructured all the bonds issued under the 2016 Indenture, the only one which would enable the ‘Pac-Man’ method.

These tweaks in the CAC proved to be successful for solving a debt crisis. At the time of writing, the debt workout closed without litigation and interest due on the few series of bonds which remained out of the exchange was paid by Argentina. It is likely that these strategies will be used and tested in future sovereign debt restructurings by other countries for them to run smoothly. For the moment, the path is paved for a future restructuring of Argentina’s recently issued new bonds. It remains to be seen whether this new approach is used in other cases around the world.

Agustina Ranieri is a lawyer at Marval O’Farrell Mairal. She can be contacted on +54 (11) 4310 0100 or by email: amr@marval.com.

Agustina Ranieri

Marval O’Farrell Mairal