If you're a certain kind of dork you will enjoy the hell out of the Argentinian pari passu clause decision out of the Second Circuit today; the opinion is here and here are good things to read from Anna Gelpern and Joseph Cotterrill. In 1994 Argentina issued bonds under New York law that said "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." Then it exchanged those bonds into new unsecured and unsubordinated external bonds, at 25-29 cents on the dollar, in 2005 and 2010, promising holders that if they did not take the new haircut bonds then they'd never see a penny on the old bonds. Then Argentina went merrily on its way, making regular payments on the new bonds and not the old ones. A bunch of hedge funds, including mainly piratical Elliott Associates, bought the old bonds and sued to get them paid back.
If you're a human and can read you would predict the result:
- Argentina was paying the new bonds,
- it wasn't paying the old bonds,
- so it's definitely treating the old bonds worse than the new bonds, payments-wise,
- so doesn't that mean that "the payment obligations [on the old bonds don't] rank at least equally with" the new bonds?
And the answer is some sort of indeterminate quantum state. You can take the regular-human reading - bonds that you don't pay, and explicitly say you'll never pay, do seem to be getting screwed vis-à-vis bonds that you do pay - or you can take the legalistic reading, which is that never paying interest on a bond is not the same a ranking its interest payments lower. The old bonds and new bonds rank equally as to payment, it's just that one of them is being paid and the other one isn't. Simple!
Weirdly that latter theory has lots of support. From the opinion:
Argentina argues that the Pari Passu Clause is a boilerplate provision that, in the sovereign context, “has been universally understood for over 50 years ... to provide protection from legal subordination or other discriminatory legal ranking by preventing the creation of legal priorities by the sovereign in favor of creditors holding particular classes of debt.”
The court disagrees, citing a lot of scholars saying things like "No one seems quite sure what the clause really means" and "there is at least disagreement about the meaning of the clause" and "the meaning of the clause is uncertain." And then it takes the regular-human reading of "come on, if you stop paying the old bonds and keep paying the new ones, that's kind of subordinating them, is it not?" So Elliott won, Argentina lost, and now you can apparently be guilty of subordinating bonds just by promising repeatedly that you'll never make any payments on them ever again.
This regular reading spirals into strange places. Like: if you borrow from the IMF, which demands seniority, does that breach the pari passu clause? The court says the following unclear things:
We are not called upon to decide whether policies favoring preferential payments to multilateral organizations like the IMF would breach pari passu clauses like the one at issue here. Indeed, plaintiffs have never used Argentina’s preferential payments to the IMF as grounds for seeking ratable payments. Far from it; they contend that “a sovereign’s de jure or de facto policy [of subordinating] obligations to commercial unsecured creditors beneath obligations to multilateral institutions like the IMF would not violate the Equal Treatment Provision for the simple reason that commercial creditors never were nor could be on equal footing with the multilateral organizations.”
That last sentence says approximately nothing except "Elliott had a good case here"; the first sentence says "we don't want to think about this now." One thing that has been of academic and perhaps real interest has been debating whether a European sovereign's borrowing from a senior or quasi-senior or perhaps-de-facto-senior creditor like the IMF would constitute subordination and thus trigger CDS payments. ISDA said no a while back when Ireland borrowed from the IMF, but this opinion might provide ammunition to someone trying to take another run at that question - at least for bonds under New York law.1
Creepier, though, is the result for Bank of New York, the trustee of these bonds. As Felix Salmon said after the argument in this case:
[Elliott's lawyer] made it very clear that if the order was upheld, and Argentina kept on trying to pay its new bondholders while stiff-arming its holdouts, then Elliott would go after Bank of New York for “aiding and abetting” Argentina in flouting the order.
That would put Bank of New York in a very invidious position. On the one hand, it acts as a trustee for the new bondholders, and if it is given a coupon payment by Argentina, then that coupon payment belongs to the bondholders. BoNY has to pass the coupon payment on to them. On the other hand, if it does so, it might well be found in contempt of court.
That is rather unsolvable; the court had "concerns about the Injunctions' application to third parties" like BoNY and remanded for further dithering. The Clearing House Association argued for Argentina here, and you could see how people in the clearing business would prefer, um, clarity! One thing to notice is that BoNY was making payments on the new bonds before Elliott sued - that is, as a trustee bank, the most conservative species on earth, it seems to have believed that the pari passu clause did not stand in the way of it being the trustee on the new bonds and making payments. That alone is strong evidence of settled market expectations. As Anna Gelpern says, "If I were Argentina, an agent bank, or much of the sovereign establishment, I would be shocked and dismayed."
That's an oddity of this case. In general, an anti-debtor decision by a court should have some consoling benefit for debtors: giving creditors stronger rights should in theory reduce their risks and thus make them more willing to buy more bonds at lower rates, so generically and in the long term it should make it easier for sovereigns to borrow. But giving creditors stronger rights at the expense of making intermediaries' - bankers and trustees' - lives more difficult and risky, and at the expense of confusing market expectations, counteracts that benefit. That's perhaps not great for other sovereign borrowers, but it's pretty impressive for Elliott.
1.Another one is just how do you do a sovereign restructuring now? You can't get a bankruptcy court to force everyone to take a haircut, so how do you get anyone to take a haircut when they could instead just hold out and sue like this? Well the court answers:
In any event, it is highly unlikely that in the future sovereigns will find themselves in Argentina’s predicament. Collective action clauses – which effectively eliminate the possibility of “holdout” litigation – have been included in 99% of the aggregate value of New York-law bonds issued since January 2005, including Argentina’s 2005 and 2010 Exchange Bonds. Only 5 of 211 issuances under New York law during that period did not include collective action clauses, and all of those issuances came from a single nation, Jamaica. Moreover, none of the bonds issued by Greece, Portugal, or Spain – nations identified by Argentina as the next in line for restructuring – are governed by New York law.
That's not very nice Portugal and Spain! Also Jamaica I guess.