Capital Markets Law Journal, 2017 1 Solving the pari passu puzzle: the market still knows best Sergio J. Galvis* Key Points As a result of the Argentine sovereign debt crisis and ensuing holdout litigation saga, the pari passu (or ranking) clause became a source of great consternation in the international sovereign bond market. Specifically, Judge Griesa’s holding that Argentina had violated the pari passu clause by refusing to pay creditors who had not participated in the nation’s earlier debt exchanges, and accompanying requirement that Argentina had to pay those holdout bondholders, led to uncertainty in the market regarding the leverage holdouts could exercise in sovereign debt restructurings going forward. Concern was expressed over the ability of sovereigns to succeed with voluntary exchange offers premised on the threat that the restructuring sovereign would default on payments due to non- participating bondholders. This article evaluates the impact of the court’s decision in the Argentine litigation to date and discusses the adoption of improved ranking clauses and collective action voting clauses in recent issuances of sovereign debt in the effort to bring greater certainty to market participants and facilitate efficient restructurings in the future without the need for extra-contractual restructuring mechanisms and remedies. Concerns about mechanisms for orderly sovereign debt restructurings have long been the subject of debate among the International Monetary Fund (IMF), the US Treasury and the finance ministries of other G-10 countries, as well as the private sector.1 When the protracted and contentious legal battle between the Republic of Argentina (‘Argentina’ or the ‘Republic’) and the holdout creditors, led by NML Capital Ltd, surrounding the sovereign debt instruments’ pari passu (ie ranking) clause reached its pinnacle in June 2014 with the US Supreme Court’s refusal to hear Argentina’s appeal, the outcome was seen by some as a harbinger of catastrophe in the international capital markets. Judge Griesa’s holding that Argentina had violated the pari passu clause by refusing to pay creditors who had not participated in its debt exchanges, and thus had to make ‘ratable payments’ of the amounts due to such holdout creditors at the same time as any payments were made to the exchange-participating bondholders,2 gave rise to uncertainty * Sergio J Galvis is a partner in the firm of Sullivan & Cromwell LLP, where he leads the Latin American practice. The author is grateful for the assistance of Megan R O’Flynn in the preparation of this article. The views and opinions expressed in this article are those of the author and do not necessarily represent those of Sullivan & Cromwell LLP or its clients. 1 For a historical overview of the debate over sovereign debt restructuring leading up to recent developments at the policy level, see Kenneth Rogoff and Jeromin Zettelmeyer, ‘Bankruptcy Procedures for Sovereigns: A History of Ideas 1976–2001’ Int’l Monetary Fund, Working Paper No 02/133, 2002 5http://www.imf.org/external/pubs/ft/wp/2002/wp02133.pdf4 accessed 26 May 2017. 2 See NML Capital Ltd v Republic of Argentina, Nos 08-cv-6978 (TPG), 09-cv-1707 (TPG), 09-cv-1708 (TPG) (SDNY 21 November 2012), aff’d by NML Capital, Ltd v Republic of Argentina, 699 F.3d 246, 251 (2d Cir 2012). ß The Author(s) (2017). Published by Oxford University Press. This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs licence (http://creativecommons. org/licenses/by-nc-nd/4.0/), which permits non-commercial reproduction and distribution of the work, in any medium, provided the original work is not altered or transformed in any way, and that the work properly cited. For commercial re-use, please contact [email protected] doi:10.1093/cmlj/kmx019 Accepted 13 February 2017 2 Capital Markets Law Journal, 2017 as to how it would be applied in practice in the Argentine situation.3 More broadly, the ruling generated doubts around the effect of these pari passu clauses, which are found in virtually all external bond borrowings by sovereigns under New York law, in other potential sovereign debt restructurings, since one ‘stick’ that may be used by sovereign issuers in trying to achieve restructurings through voluntary exchange offers is threatening to default on payments that are due to non-participating bondholders. On the one hand, developments in the courts (to some extent reflecting changes in Argentine politics and policies4) and the markets since Judge Griesa’s initial pari passu ruling suggest that the risk of catastrophic outcomes for sovereign borrowers may have been overstated. On the other hand, the new Argentine administration’s decision to settle with the non-participating bondholders may exacerbate the holdout issue in future defaults because it signalled to investors that, with enough stamina and resources, they can stymie a restructuring process. On balance, notwithstanding the continuing relevance of these issues with respect to the outstanding international debt stock of sovereign debtors, subsequent legal outcomes and market responses to ‘correct’ for the concerns surrounding pari passu and the related collective action clauses have substantially reduced the uncertainties in this area. This article reviews certain aspects of Argentina’s sovereign debt litigation relating to the interpretation of the pari passu clause, as well as subsequent legal developments, ultimately concluding that the holdings in the Argentina litigation are unlikely to be applied more broadly. It then examines recent developments in contractual bond documentation that have further addressed the holdout creditor problem, and argues that these contractual revisions to future documentation, as well as liability management exercises to deal with outstanding debt stock, go a long way to reducing concerns about minority holder holdout litigation in sovereign debt restructurings. 1. The Argentina problem: NML v Argentina and judicial interpretation of the pari passu clause In 2001, Argentina defaulted on over $80 billion of its bonds issued pursuant to its Fiscal Agency Agreement (FAA) and offered new exchange bonds (‘Exchange Bonds’) to the bondholders in both 2005 and 2010,5 with considerably less attractive economics.6 Predictably, less than 100 per cent of the bonds were tendered for 3 See eg Citibank, NA’s Motion for Clarification of 21 November 2012 by Citibank, NA, NML Capital Ltd v Republic of Argentina, Nos 08-cv-6978(TPG), 09-cv-1707 (TPG), 09-cv-1708 (TPG) (SDNY 23 February 2012), Dkt 276; Clearstream Banking SA’s motion to Amend/Correct, NML Capital Ltd v Republic of Argentina, Nos 08-cv-6978 (TPG), 09-cv-1707 (TPG), 09-cv-1708 (TPG) (SDNY 23 February 2012), Dkt 352; and Bank of New York Mellon’s Motion of Non-Party for Clarification of the Amended 23 February 2012 Orders, NML Capital Ltd v Republic of Argentina, Nos 08-cv-6978 (TPG), 09-cv-1707 (TPG), 09-cv-1708 (TPG) (SDNY 23 February 2012), Dkt 361. 4 See Benedict Mander, ‘How Argentina Pulled off a Deal in Creditor Impasse’ Financial Times (5 December 2016)5https://www. ft.com/content/88a56580-a2c5-11e6-aa83-bcb58d1d21934 accessed 26 May 2017; ‘At Last—A Deal with Holdout Bondholders is Expensive, but Worth it’ The Economist (5 March 2016)5http://www.economist.com/news/americas/21693786-agreement-victory- countrys-new-president-argentina-reaches-deal-its4 accessed 26 May 2017. 5 NML Capital Ltd v Republic of Argentina, 699 F.3d 246, 251 (2012). 6 See Federico Sturzenegger and Jeromin Zettelmeyer, ‘Haircuts: Estimating Investor Losses in Sovereign Debt Restructurings, 1998-2005’, IMF Working Paper, 5https://www.imf.org/external/pubs/ft/wp/2005/wp05137.pdf4 accessed 26 May 2017, at 58 Sergio J Galvis Solving the pari passu puzzle 3 exchange.7 At the end of the day, Argentina ‘succeeded’ in restructuring approximately 93 per cent of its external debt through the 2005 and 2010 exchange offers.8 Following each exchange offer, Argentina made payments to holders of Exchange Bonds while continuing to withhold payments to the holdout creditors who did not tender bonds in default.9 In addition, to encourage participation in the exchange offer (or, as characterized by a plaintiff in the ensuing litigation, to ‘coerce creditors to accept the offer’10) before its closing date in June 2005, on 10 February 2005, Argentina enacted the ‘Lock Law’, prohibiting the government from reopening the exchange process or making any kind of settlement with respect to the bonds that were subject to the exchange offer.11 Six years later the Lock Law would loom large in Judge Griesa’s and the Second Circuit’s views on the application of Argentina’s pari passu clause. In 2011, a group of holdout creditors who did not participate in the exchanges, led by NML Capital Ltd, filed an amended complaint in the US District Court for the Southern District of New York against Argentina for their principal and past-due interest claims,12 alleging that the Republic had violated the ranking clause in its 1994 FAA and debt securities and seeking specific performance (ie payment on their never-exchanged 1994 FAA-governed bonds).13 In December 2011, US District Judge Griesa held that Argentina had violated the ranking clause in the Argentina FAA by failing to make payments due to holdout creditors when it made payments to holders of the Exchange Bonds and by enacting the Lock Law,14 and had effectively ‘relegat[ed] NML’s bonds to a non-paying class’.15 In a subsequent