Sovereign pari passu clauses: lost rights or last rites? 1

Briefing note February 2017

Sovereign pari passu clauses: lost rights or last rites? In late 2012, the New York courts decided that a pari passu clause in a sovereign bond prevented the sovereign from paying other creditors without paying the bondholders at the same time. This caused concern in some quarters, not least because of the power it offered holdout creditors in sovereign debt restructurings. Four years later, the position may have changed. A New York court has now held that the same sovereign's payments to other creditors do not breach the same pari passu clause. Instead, more egregious behaviour - in substance, subordinating the bonds - is, it seems, required.

"The second sentence "[t]he payment The payment interpretation went a obligations... shall at all times rank at step further. Not only must there be least equally with all its other present equal ranking, but the sovereign must Key issues and future unsecured and unsub- also pay its creditors equally. This ordinated External Indebtedness" was most graphically expressed by  Payment of other creditors prohibits Argentina, as bond payor, Professor Andreas Lowenfeld: "A may no longer on its own from paying on other bonds without borrower from Tom, Dick and Harry breach a pari passu clause paying on the FAA Bonds." Thus can't say "I will pay Tom and Dick in  Action by the sovereign spoke, with apparent clarity, the full, and if there is anything left over relegating bondholders' rights United States Court of Appeals for the I'll pay Harry." If there is not enough may be required Second Circuit in NML Capital Ltd v money to go round, the borrower  This more restrictive The Republic of Argentina on 26 faced with a pari passu provision interpretation of a pari passu October 2012 (see our briefing must pay all three of them on the clause may reduce the entitled Sovereign pari passu clauses: same basis." In other words, a influence of holdout creditors don't cry for Argentina - yet for more sovereign bound by such a pari passu  The increasing use of CACs in background and details). clause is obliged not only to ensure sovereign bonds similarly that its bonds rank equally but it is There had long been a debate about facilitates sovereign debt also obliged to pay its creditors whether pari passu clauses of this restructuring equally (even if it means that none is sort should be given a ranking paid in full). provision potentially offered new interpretation or a payment remedies, in particular injunctions to interpretation (though, of course, the In NML Capital, it appeared that the obstruct the sovereign's payments to proper interpretation turns upon the New York courts had come down other creditors through the US or US drafting of each individual clause). resoundingly on Professor institutions. This would enable holdout The ranking interpretation only Lowenfeld's side of the argument. creditors to bring greater pressure on required sovereign debt to rank Holdout creditors had always been the sovereign by challenging equally with other relevant debt. The able to obtain judgments for their payments to creditors who had sovereign could not do anything that debts and then to try to enforce those accepted a restructuring deal, as well might subordinate the debt below judgments - never easy against as payments to other creditors. other debts, such as allocating foreign sovereigns. The payment Restructuring potentially became currency reserves to another debt. interpretation of the pari passu

2 Sovereign pari passu clauses: lost rights or last rites?

more difficult. This in turn generated a payment to other creditors, holdouts were entitled to be paid the number of policy initiatives to try to constituted the breach of the pari sums due to them under their bonds, reduce the impact that holdout passu clause in NML Capital. but they did not suffer any loss over creditors might otherwise have (see Argentina's "extraordinary conduct" at and above that non-payment. Their our briefing entitled New ICMA that time made it a "uniquely financial remedy was confined to sovereign collective action and pari recalcitrant debtor". The key to NML enforcing payment of the sums passu clauses). Capital was the overall pattern of outstanding on their bonds. Argentina's behaviour at that time - its More significantly, the judge also All change "entire and continuing course of pointed out that the holdouts had no But the outlook may now be different. conduct" - not just the payments to right in law to an injunction to prevent In White Hawthorne LLC v The other creditors. breach of the pari passu clause. An Republic of Argentina (22 December Then came Argentina's election in injunction "is an extraordinary remedy 2016), Judge Thomas P Griesa, November 2015, which "changed that is not normally available for whose first instance judgment was everything". The judge recognised breach of contract". The court had upheld in NML Capital, has that Argentina's new government had already lifted the injunction granted in reinterpreted the position. The displayed "courage and flexibility in NML Capital in the light of the sovereign was the same, the pari stepping up to and dealing with this changed circumstances, and passu clause was the same, and the long festering problem which was not reimposing it would, the judge argument was simple: "[i]n short, of their making", that it desired to considered, be unwarranted. plaintiffs allege breach due to the resolve the disputes, and that it had Republic's decision to pay other The court also held that the normal repealed the lock law. Settlement had creditors while plaintiffs hold out for a six year limitation period under New been reached with the plaintiffs in better deal", ie payment to any York law applied to both principal and NML Capital and the injunction creditors but not, at the same time, to interest outstanding on the sovereign granted in that case lifted. the holdout creditors was a breach of bonds in question. The limitation period started on the day each "Argentina was rewarded for coming in from the cold interest instalment fell due, with the result that a plaintiff could recover and its engagement, on the urging of the court, with only those interest payments that fell its creditors. The remaining holdouts now felt the due within the six years prior to commencing the action. So far as chill." principal was concerned, the limitation period ran from the date the bond the holdout creditors' rights under the In the light of this, the previous matured or, if earlier, the date it pari passu provision. The decision in Argentine government's conduct was became due and payable following NML Capital might have offered the "ancient history and... no longer acceleration. plaintiffs hope of success. However, occurring". All that was left was Judge Griesa held that the plaintiffs' Argentina's payment to other creditors Conclusion allegations were not, on their own, while not at the same time paying its The long history of Argentina's enough to demonstrate breach by holdout bondholders. That was not, in engagement in the New York courts Argentina of the pari passu clause. the judge's view, enough on its own to forms important background to White breach the pari passu clause. Hawthorne. For many years after its The judge looked at the earlier 2001 default, Argentina defied decisions and other cases in the Rights and remedies numerous judgments and other court Second Circuit, and decided that it In his opinion in White Hawthorne, the orders made against it. But that was Argentina's "lock law" (which judge went further and decided that, changed on President Macri's election. prohibited payments on Argentina's even if he had found Argentina to be Argentina has settled with most, but defaulted bonds) and the "incendiary in breach of the pari passu clause, evidently not all, of its holdout statements by the former that breach did not give the holdout creditors. Argentina has successfully administration" that, coupled with creditors a claim in damages. The re-entered the international capital

Sovereign pari passu clauses: lost rights or last rites? 3

markets. When some of the much- and obtain judgment for the debts due diminished number of holdouts sought to them. But enforcing judgments Contacts to deploy again the pari passu clause against sovereigns is difficult, even to bring pressure on Argentina to with the benefit of a waiver of Deborah Zandstra meet the holdouts' demands, the New sovereign immunity. The extra tool - Partner York district court was no longer in the pari passu provision leading to an T: +44 20 7006 8234 such a creditor-friendly mood. Instead, injunction - that NML Capital offered E: deborah.zandstra Argentina was rewarded for coming in may now prove more difficult to utilise @cliffordchance.com from the cold and its engagement, on unless also coupled with a blatant Simon James the urging of the court, with its display of defiance by the sovereign Partner creditors. The remaining holdouts towards its holdout creditors' rights. T: +44 20 7006 8405 now felt the chill. Sovereign debtors involved in E: simon.james @cliffordchance.com This apparent change in legal restructuring can, it seems, now direction will be welcomed by many in choose to pay one creditor rather than Robert Houck the sovereign debt restructuring arena another, but they will need to be more Partner because it potentially reduces the cautious over what else they say and T: +1 212 878 3224 ability of holdout creditors to frustrate do. Anything that might be argued to E: robert.houck deals agreed by the majority of affect the ranking of a payment @cliffordchance.com creditors. Collective action clauses obligation, whether de facto or at law, Steve Nickelsburg can achieve the same by allowing a could still infringe a pari passu Partner majority of bondholders to bind the provision even on the White T: +1 202 912 5108 minority, and these clauses have Hawthorne interpretation of the clause. E: steve.nickelsburg been included in a significant number Silently paying some creditors but not @cliffordchance.com of recently issued sovereign bonds others looks to be fine - as long as the Andrew Yianni (see the IMF's Second Progress New York courts don't slide back Consultant Report on inclusion of enhanced towards the NML Capital T: +44 20 7006 2436 contractual provisions in international interpretation - but more overt E: andrew.yianni sovereign bond contracts, January rejection of the holdouts' rights may @cliffordchance.com 2017). still cause problems. Jonathan Zonis Absent that constraint, NML Capital Partner had opened up the possibility of T: +1 212 878 3250 holdout creditors stepping in to E: jonathan.zonis prevent payment to those who had @cliffordchance.com accepted a restructuring, thereby rendering restructuring much more difficult to achieve - at least, so far as New York law governed bonds were concerned (the position for English law bonds was not necessarily the same: see the Financial Markets Law Committee's papers on the interpretation of sovereign pari passu clauses governed by English law, March 2005 and April 2015). White Hawthorne restricts, but does not remove, the power of holdout creditors. Holdout creditors can still refuse to participate in a restructuring

4 Sovereign pari passu clauses: lost rights or last rites?

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