Sovereign pari passu clauses: NML Capital 2, Argentina 0 1 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. 2 Sovereign pari passu clauses: NML Capital 2, Argentina 0 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. Sovereign pari passu clauses: NML Capital 2, Argentina 0 3 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.