On October 26, sovereign debt markets felt the shock of the Second Circuit’s ruling in the ongoing case of NML Capital v. Argentina. The court rejected a narrow interpretation of the pari passu clause advanced by Argentina. Under the narrow interpretation, a sovereign violates the pari passu clause if it formally or legally subordinates debt; instead, the court adopted a broader interpretation of the clause, holding that the clause prevents making payments to creditors of restructured notes and holding out creditors. In addition to interpreting the pari passu clause broadly, the court also upheld a novel injunction issued by the district court requiring ratable payments for holdout bondholders of the 2005 and 2010 Argentinian debt swaps.
This article will first describe the events leading up to the Second Circuit’s ruling in NML Capital v. Argentina. The next section will focus on the legal conclusions of the Southern District of New York (“S.D.N.Y”) and the Second Circuit. Finally, this article will provide high-level analysis of the fallout of the Second Circuit’s ruling.
The 2005 and 2010 Haircut:
The Argentinian bond saga begins in 1994, when Argentina began originating debt securities under the Fiscal Agency Agreement (the agreement will hereafter be referred to as “FAA” and debt instruments created by the FAA as the “Bonds”). The Bonds had a coupon rate ranging from 9.75 percent to 15.5 percent and maturity ranging from April 2005 to September 2031. The FAA contained a pari passu clause, standard in international sovereign bond agreements. Simply stated, a pari passu clause places all bondholders on equal footing–that is, protects bond payment obligations from subordination.
In December of 2001, Argentinian President Adolfo Rodriguez Saa halted payment on Argentina’s roughly $81 billion in sovereign debt. Following a four-year period of no payments to bondholders, Argentina offered bondholders a debt swap of 25 to 29 cents on the dollar. In 2010, Argentina offered another debt swap to the remaining holdout bondholders (hereinafter, the financial instruments created under the debt swap will be referred to as the “Exchange Bonds”). The two debt swaps resulted in a windfall for Argentina, with 92.4 percent of creditors participating in the debt swaps and Argentina paying 25 cents for every dollar on the 2001-defaulted debt. With the conclusion of the 2010 debt swap, the then-Minister of Economy, Amado Boudou, declared no further payouts to the holdout creditors. Soon after, Argentina passed a moratorium prohibiting payments on the remaining 2001-defaulted debt. A group of holdout creditors led by Elliot Management sued Argentina in New York, seeking to recover an estimated $1.33 billion in unpaid principal and interest on the Bonds.
NML Capital v. Argentina: A Take on Pari Passu
The legal background of the fight between the group of holdout bondholders and Argentina can fill a small law library. This article, however, is limited in scope to the Southern District of New York and Second Circuit’s analysis of the pari passu clause.
Summary of S.D.N.Y.’s Holding:
The legal story begins at the Southern District of New York, where plaintiffs asked the district court to rule on the meaning of the pari passu clause under New York law. Judge Thomas Griesa concluded that lowering the rank of payment obligations to holdout bondholders below the rank of other unsecured and unsubordinated external indebtedness violates the pari passu clause in the FAA. The district court found that Argentina lowered the rank of the payment obligations to plaintiffs when it made payments to those creditors who exchanged the Bonds under the two debt swap agreements but refused to satisfy payment obligations to the plaintiffs and when it enacted a moratorium prohibiting payment to holdout bondholders.
Two months later, in February 2012, the district court entered an injunction against Argentina. The injunction ordered that “the Republic [of Argentina] pays any amount due under the terms of the bonds [given under the debt swap],” Argentina must pay plaintiffs the “Ratable Payment.” Calculating the Ratable Payment under the injunction requires first dividing the amount Argentina paid or intends to pay to holders of Exchange Bonds by the total amount then due to holders of Exchange Bonds. This number is then multiplied by the total amount due to the plaintiffs to determine the Ratable Payment.
Summary of Second Circuit’s Holding:
Argentina appealed the district court’s order. Argentina alleged the district court erred for several reasons, one of which was that the district court misinterpreted the meaning of the pari passu clause. In particular, Argentina alleges that participants in sovereign debt markets–including creditors and sovereign issuers–have understood the pari passu clause to protect creditors from legal subordination and other discriminatory legal rankings by estopping “the creation of legal priorities by the sovereign in favor of creditors holding particular classes of debt.” Building on its interpretation of a “universally” understood definition of the pari passu clause, Argentina argued that no subordination has occurred because “any claims that may arise from the Republic’s restructured debt have no priority in any court of law over claims arising out of the Republic’s unrestructured debt.” In other words, because there is no enforceable legal framework governing a sovereign’s legal obligations, legal subordination cannot occur.
The Second Circuit disagreed with Argentina’s “clear” definition of pari passu clause; on the contrary, the court noted the uncertainty surrounding the interpretation of the pari passu clause. Instead of focusing on the customary usage of the pari passu clause, the court analyzed what would constitute a violation of the FAA’s pari passu clause.
Argentina’s pari passu clause provides: “Securities . . . shall at all times rank pari passu without any preference among themselves. 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. . .”
The court interpreted the first sentence of Argentina’s pari passu clause narrowly to mean Argentina will not formally subordinate bonds by issuing debt with a higher priority. This narrow interpretation conforms to Argentina’s and many observers’ interpretation of the clause. The court, however, interprets the second sentence of FAA’s pari passu clause more broadly to mean that Argentina, as bond payor, is prohibited “from paying on other bonds without paying on the FAA Bonds.” In other words, the two sentences making up Argentina’s pari passu clause “protect against different forms of discrimination: the issuance of other superior debt (first sentence) and the giving of priority to other payment obligations (second sentence).”
[Editor’s Note: Part 2 of this article will be posted tomorrow.]