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Briefing note June 2014

Sovereign pari passu clauses: NML Capital 2, Argentina 0 The US Supreme Court has declined to hear Argentina's appeal against a lower court's judgment on the effect of a pari passu clause in Argentina's bonds. This leaves in place the decision that if Argentina pays current interest on its restructured bonds, it must also pay its holdout creditors in full. This points the spotlight directly at Argentina. Argentina has so far flatly refused to pay the holdouts. Will it now default on the restructured bonds, try to negotiate a settlement with holdouts or does it have a plan to circumvent the US courts? The decision also has wider implications for other sovereign borrowers. The US court rulings make sovereign payment default even more unattractive than it would otherwise be, but careful drafting of sovereign bonds could mitigate the risk of a similar fate for other sovereign borrowers.

The US Supreme Court's refusal to However, subsequent statements, hear Argentina's appeal in NML such as those from Argentina's legal Key issues Capital Ltd v Argentina leaves counsel, may suggest that the Argentina seemingly with nowhere to position has softened, and the court  US courts order Argentina to go in the legal system. The decision has appointed a "special master" to pay its holdout creditors in full by the United States Court of Appeals facilitate settlement negotiations and when it pays interest on its for the Second Circuit in August 2013 instructed Argentina and the holdouts restructured bonds. is now final. Argentina really is to cooperate. How Argentina will  There are practical and legal prohibited under New York law from square this circle is not yet clear, obstacles to Argentina's paying paying current interest to the more though Argentina has had over 20 the holdouts. than 90% of its creditors who months since the lower court's  Argentina must find a way to accepted its restructuring terms decision to put in place contingency compromise with the holdouts or unless it also pays in full the holdouts, plans for this eventuality. Other adhere to the court order. It may who rejected those terms. As news of sovereign debtors will also be looking otherwise look to find a way to the Supreme Court's decision spread, on anxiously to see what transpires. pay on its restructured bonds the price of Argentina's bonds lurched outside the US, or default – lower, its stock market slumped, its Reprise again. currency crashed on the black market The background to the NML Capital  The decision gives holdout and its credit rating collapsed. case, as well as the Court of Appeals' creditors in general a powerful weapon, making restructuring decision, is set out in our briefing The next payment on Argentina's sovereign debt more difficult. entitled Sovereign pari passu clauses: restructured bonds is due on 30 June don't cry for Argentina - yet  The decision will focus the 2014, subject to a 30-day grace (December 2012). In summary, in attention of sovereigns and their period. Argentina's President creditors on the drafting of pari 2001 Argentina defaulted on well over Fernandez de Kirchner said that passu clauses, as well as on $80 billion of its bonds. Through Argentina will not submit to "extortion" how sovereign debts can be exchange offers in 2005 and 2010, from the holdouts but will honour its restructured more effectively. Argentina compromised with 93% of obligations to its other creditors.

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the bondholders, who exchanged Thomas Griesa at first instance, and could go back to Judge Griesa to their bonds for new, less favourable, then on appeal, the US Court of decide whether the holdouts can stop bonds. The 7% who refused to Appeals for the Second Circuit that payments being made on the compromise, including NML Capital pari passu means that if Argentina restructured bonds or can claim all or Ltd, have been pursuing Argentina makes any payment on its some part of the payment for through courts around the world ever restructured bonds, it must at the themselves. since but have had little success in same time pay all outstanding sums Alternatively, Argentina may have finding Argentine assets against on its defaulted bonds. devised a scheme to avoid payments which to enforce their rights. The beauty of this argument, as far as on the restructured bonds going The strategy that led to the Supreme NML is concerned, is not the direct through the institutions served with Court was NML's latching on to the effect on Argentina. Argentina has and bound by the US court orders pari passu clause lurking in the been ignoring its payment obligations (some press reports suggest an boilerplate of the defaulted bonds. for more than a decade; one more exchange for new bonds payable in The pari passu clause provides that court order to add to the pile is of no Argentina). It is, however, hard for Argentina's payment obligations on consequence. The significance of dollar payments to circumnavigate the the defaulted bonds rank equally with NML's success is the effect on third US entirely, nor does Argentina have its other external indebtedness. NML parties, such as payment agents, long to implement any plan before the persuaded US District Court Judge trustees and other banks, involved in next payment is due. Another default the payment flow on Argentina's will not help Argentina's cause. restructured bonds. They have been Argentina must decide whether to risk served with the court order and so normal payments through New York, A clearing house cannot do anything that might help to attempt a different means of Argentina evade the pari passu ruling. for information? payment, or to default on its Judge Griesa said that these parties restructured bonds. The alternative Although the Supreme Court did not are "in active concert or participation" would be to settle with the holdouts. accept Argentina's principal appeal, with Argentina within the meaning of But Argentina has persistently refused it did rule on another appeal in the applicable US law, and must make to do that - at least on terms same case - also against Argentina. sure that they do not violate the acceptable to the holdouts. In Republic of Argentina v NML rulings he laid down in his decision. Immediately after the judgment, Capital Ltd (16 June 2014), the He added after the Supreme Court's President Fernandez de Kirchner Supreme Court ruled (7-1) that there decision that "if anyone undertakes to offered to negotiate with the holdouts is nothing in the US Foreign make a payment to the exchanges, (causing bond prices to rebound), but Sovereign Immunities Act to prevent without making sure of a payment to a US court from ordering banks in the cabinet chief later ruled out a NML, they are in violation of this court the US to disclose details of mission to New York (causing prices order". Argentine payments, account to fall). balances and other assets that The immediate future might be recoverable outside the There are legal and practical US. This may offer NML an Having failed to attract the attention of difficulties in the way of settlement additional means to find and enforce the Supreme Court, NML Capital Ltd with the holdouts. For example, against Argentine assets, though v Argentina goes back down the court Argentina's own "lock law" prohibits any enforcement measures will have hierarchy. The immediate legal issue this (though laws can always be to be taken in the courts of the is what would happen if Argentina changed even if there is a political location of any assets. sought to pay on its restructured price to pay), and the restructured For more details, see our briefing bonds through New York in the usual bonds contain rights-upon-future- entitled U.S. Supreme Court Rules way. If the trustee received funds on offerings clauses ("RUFO") that, until that Sovereign States Are Not behalf of the restructured bondholders, the end of 2014, require Argentina to Immune from U.S. Court Discovery what would it be obliged to do? No offer the same terms to the holders of into their Worldwide Assets (June trustee would want to take the risk of the restructured bonds as are 2014). violating a court order, so the issue voluntarily offered to holdouts.

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Argentina's wallet also may not hold always depend heavily on its drafting avoid pari passu clauses like sufficient to make it prudent to pay the (such as whether it includes a Argentina's but, even if that is not holdouts, especially since NML and rateable payment element) as well as possible, collective action clauses the other plaintiffs in the current the governing law – the ruling in NML (CACs) can reduce the risk of litigation represent only a portion of Capital Ltd will have made holdouts impeding a restructuring. the defaulted bonds still outstanding. restructuring those bonds more CACs allow a majority of the Estimates put the total defaulted difficult. Those who choose not to go bondholders to bind the dissident bonds outstanding as high as $15 along with the restructuring have a minority to a restructuring. CACs are billion. potentially powerful weapon to ensure currently much under discussion at that they are paid in full. This could the IMF, the ICMA and elsewhere, but, In the meantime, Judge Griesa discourage those otherwise inclined even if they were to be universally appointed a special master to to agree to a restructuring from doing accepted, it would take a long time "conduct and preside over settlement so. before all extant bonds contained negotiations." It is not clear from the them. court record whether one or more of A simple route round this may be to the parties requested this ensure that any restructured bonds There are many issues surrounding appointment or if Judge Griesa made have no contact with the US; but the broader adoption of CACs - for the appointment on his own initiative where US dollar payments are example, should they apply across after hearing overtures of settlement involved there is likely to be at least a several or all issues (aggregation), from Argentina's lawyers. Argentina correspondent bank in the US, what should the aggregation has also asked Judge Griesa to stay making this a difficult proposition. mechanism be, should an overall his injunction to allow settlement Payment within the sovereign issuer's majority of bondholders in all discussions to proceed without the own territory may be unattractive to aggregated bonds be sufficient or pressure of the upcoming payment bondholders. Payment elsewhere, should there also be majority date under the restructured bonds coupled with a non-New York requirements for each series being and while the RUFO provisions are in governing law, begs the questions of aggregated, and what should the effect. A ruling on that request is whether other courts will follow the majorities be. However, CACs may pending at the time of this publication. US courts' view of the meaning of the ultimately offer a more satisfactory clause and, if they do, whether they solution for distressed sovereigns It seems unlikely that we have seen can or will grant the same remedies than a bankruptcy regime, all the last of Argentina in the US courts. affecting third parties as the US discussions on which have so far The US is not the only venue of legal courts appear inclined to do. It is the foundered. proceedings involving Argentina's remedy for failing to honour a pari Interestingly in this regard, the euro defaulted debt. Less on the public passu clause that is the key: it is area has already implemented its own radar, but still significant, are the final generally only if a court can grant a model CAC to facilitate sovereign hearings in an arbitration brought remedy that impedes payment to a restructurings. Some want to go against Argentina by Italian retail third party that pari passu clauses further, however, and eliminate the investors holding nearly £1.4 billion in matter to sovereign debtors. current requirement in the euro area defaulted bonds. The arbitration is Others involved in any restructuring CAC to obtain a majority in each taking place at the World Bank's process must ensure that they are not series of instruments to be International Centre for Settlement of acting in contempt of a court to which restructured in order to reduce even Investor Disputes (ICSID) and is they are subject (if, as in NML Capital further the risk to a restructuring scheduled to end by 27 June 2014, Ltd, there are already court orders in posed by holdouts. with a final award some time after that. place) or committing a tort, delict or The wider future other wrong by helping a sovereign Conclusion evade its obligations under a pari The Supreme Court's rejection of the If other sovereign debtors have passu clause. appeal in NML Capital Ltd may in issued bonds that include pari passu itself not be a huge surprise, but it clauses to the same effect - and the Then there are future bond issues. came rather sooner than most had effect of a pari passu clause will Sovereigns will naturally be keen to expected. The prevalent view was

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that the Supreme Court would seek the US Solicitor-General's opinion Contacts before reaching its decision. As it turned out, the Supreme Court did not Deborah Zandstra find that necessary. This has turned Partner, London the immediate spotlight on Argentina: T: +44 20 7006 8234 E: [email protected] what will it do regarding payments on its restructured bonds, which it has Steve Nickelsburg pledged to honour? In the longer Partner, New York T: +1 209 912 5108 term, the case will cause those E: [email protected] involved in sovereign bond issuances to consider the boilerplate more Jon Zonis Partner, New York carefully, and will cause those T: +1 212 878.3250 involved in trying to make sovereign E: [email protected] bond restructurings work more Rick Antonoff effectively to accelerate their Partner, New York deliberations. T: +1 212 878 8513 E: [email protected]

Simon James Partner, London T: +44 20 7006 8405 E: [email protected]

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