The pari passu clause is back on track in Argentina’s sovereign debt restructuring

July 2020 | EXPERT BRIEFING | FINANCE & INVESTMENT

financierworldwide.com

The ‘pari passu’ clause and its interpretation by the US courts are front and centre right now as Argentina is once again carrying out a sovereign debt restructuring. Previously, when the rulings of the US courts on how this clause and its equal treatment provision had to be applied were issued within the Argentina sovereign bonds litigation, the concern was that such rulings would have an impact on the viability of debt exchanges in the future.

The rulings of judge Thomas Griesa of the US District Court for the Southern District of New York and of the US Court of Appeals for the Second Circuit that were passed throughout the last decade, undoubtedly constitute case law that will be relevant when construing the ‘pari passu’ clause under New York law in other cases beyond the so-called ‘trial of the century’ involving Argentine debt.

The core argument of the plaintiffs in NML Capital, Ltd. et al v. The Republic of Argentina was that the ‘pari passu’ clause provided under the defaulted sovereign bonds they held required Argentina to make payments to the plaintiffs in the event a payment was made under the exchange bonds issued by Argentina in 2005 and 2010 as a result of its debt restructuring.

Judge Griesa agreed with the plaintiff’s claim, ruling that making payments under the exchange bonds while refusing to pay amounts that continue to be outstanding under the defaulted bonds constituted a breach of the ‘pari passu’ clause. The judge issued an injunction providing that whenever the Republic paid an amount under the exchange bonds, the Republic had to make a “ratable payment” to plaintiffs. The Court of Appeals confirmed this decision, but its enforcement was stayed until June 2014, when the US Supreme Court denied the petition for a writ of certiorari filed by Argentina to review the ruling, and consequently the obligation to implement the ratable payment became enforceable thereof. That ruling irradiated its effects on the payments under the exchange bonds and ultimately led Argentina to settle the litigation with the holdouts and pay.

The concern at that time was, in view of upcoming sovereign defaults, that such an interpretation could go against the goal of having orderly and predictable sovereign debt restructurings. The question was: what incentives would creditors have to enter into a debt exchange, accepting haircuts and deferral of payments if, based on the ‘pari passu’ clause of the defaulted bonds, no payments could be made to them by the debtor without a prior or concurrent payment of 100 percent of the principal, interest and other amounts owed to the holdouts?

Those forecasts and concerns materialised into reality. Argentina put forward its exchange offer and creditors are now analysing the two main alternatives facing them: to accept the exchange, or to be a holdout and litigate instead. Creditors are not only analysing the economics of the exchange proposal rationally, but also taking into account the legal consequences of their decision. That is why the ‘pari passu’ clause provided under the specific sovereign bonds they currently hold, and its case law, has become the centre of their analysis.

There is also an intense debate revolving round the collective action clauses (CACs) and other aspects of the restructuring terms proposed by Argentina. But the focus of this article is to give some initial insights on the evolution and relevance of the ‘pari passu’ clause over the years in Argentine sovereign bonds.

Is it possible to draw an analogy between defaulted bonds held by the then plaintiffs in the NML case, and the bonds that are now eligible for the current exchange? The bottom line is that the only effective and successful remedy in practice from a holdout’s perspective to force the sovereign to pay them the full amount of the defaulted debt, was to obtain an injunction with the power to affect the normal performance of the restructured bonds. This put the sovereign at risk of defaulting on the exchange bonds – all based on the ‘pari passu’ clause provided under the defaulted bonds they held. That is why this clause is particularly relevant for those bondholders that are now at the crossroads of accepting the exchange or litigating against the sovereign.

An initial approach to tackle this issue would be to analyse the way in which the clause is written in the bonds of the NML case and compare them with the clause of the bonds that are currently subject to the exchange. This analysis shows how the NML case helped shift the shape of the ‘pari passu’ clause in Argentine bonds throughout the years.

The evolution of the ‘pari passu’ clause in Argentina sovereign bonds comprise in principle three chronological stages, which are reflected in three different contracts under which many series of bonds have subsequently been issued by the Republic. Those three contracts are: (i) the Fiscal Agency Agreement (FAA) dated 1994, which provided the terms of the bonds issued prior to Argentina’s 2001 default, then litigated by the holdouts in the NML case that gave birth to the case law; (ii) the Trust Indenture dated 2005, which provides the terms of the exchange bonds issued by Argentina in 2005 and 2010 as a result of its debt restructuring, and that are currently subject to the new restructuring proposal; and (iii) the Trust Indenture dated 2016, which provides the terms of the bonds issued by Argentina in 2016 mainly to settle the holdouts’ claims after the unfavourable outcome for the country in the NML case, and also of other bonds issued as from 2016, all of which are currently subject to the new restructuring proposal outlined in the second stage.

But these three chronological-based categories could be reduced to just two if the focus is on the shape of the ‘pari passu’ clause and the New York courts case law.

On the one hand, there is a “creditor’s-side” clause (the ‘before NML’ clause) which is provided in the 1994 FAA Bonds and the 2005 Indenture Bonds in substantially the same terms, as follows: “The Securities will constitute (…) direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu and without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness” (1994 FAA Bonds’ clause). The second sentence was referred to as the “Equal Treatment Provision” in the US courts’ rulings; and: “The Securities will constitute the direct, unconditional, unsecured and unsubordinated obligations of the Republic. Each Series will rank pari passu with each other Series, without any preference one over the other by reason of priority of date of issue or currency of payment or otherwise, and at least equally with all other present and future unsecured and unsubordinated External Indebtedness” (2005 Indenture Bonds’ clause).

On the other hand, there is a “sovereign debtor’s-side” clause (the ‘after NML’ clause) provided in the 2016 Indenture Bonds in the following terms: “The Bonds rank and will rank without any preference among themselves and equally with all other unsubordinated Public External Indebtedness of the Republic. It is understood that this provision shall not be construed so as to require the Republic to make payments under the Bonds ratably with payments being made under any other Public External Indebtedness.”

Analysis of the two categories shows that the creditor’s-side clause is present in the bonds issued by Argentina prior to the rulings in the NML case, in which the sovereign debtor at the time did not focus particularly on this clause as it was not possible to foresee the effects it would have in practice years later.

In contrast, the sovereign debtor’s-side clause is provided under the bonds issued as from 2016 onwards, after the rulings in the NML case changed the scenario drastically. Even the Latinism ‘pari passu’ was removed. The more contemporary clause addressed the lessons learned by Argentina, explicitly excluding the ratable payment interpretation provided by the New York case law. The new bonds offered in the current exchange will be subject to the 2016 Indenture, which of course adopts a stance favourable to the sovereign.

Though it is still too early to predict what the cornerstone arguments of the plaintiffs on potential claims resulting from this new restructuring would be, certain bondholders of the 2005 Indenture already publicly alleged that their creditor’s-side ‘pari passu’ clause provides them with stronger protection, putting the risk of holdout on the negotiation table.

It seems that the viability of the debt exchanges as a result of the ‘pari passu’ case law will only be answered once this issue is tested again in the US courts, which at some point depends on the outcome of the debt exchange that Argentina is currently carrying out. New rulings on this matter require that the restructuring does not achieve the acceptance thresholds needed under the CACs to force the dissenting bondholders. And, in turn, that such bondholders file their claims against Argentina with the New York courts to obtain the full amount owed under their original bonds.

At the time of writing, the result of Argentina’s current debt restructuring it is still unclear. The exchange offer procedure is still ongoing, and the challenge is even more acute given the coronavirus (COVID-19) pandemic. Argentina may obtain the majorities required under the relevant CACs, but at the same time there is a probability that at least a small portion of holdouts will remain, even in a scenario in which the country obtains a high level of participation but not enough to trigger the CAC majority-forcing mechanism. That is why analysis of the ‘pari passu’ clause is relevant. The question remains open.

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