Interfering with the Gears of Default & Restructure

Regulatory 04 Nov 2012

Argentina’s effort to get appellate relief–  from a district court’s injunction won by NML Capital and other holders of bonds that Argentina issued before its 2001 default – has failed. Or … mostly. It may have won something.

In a decision issued Friday, October 26, a three-judge panel of the U.S. Court of Appeals for the Second Circuit addressed both the substantive question of the meaning of the issuing documentation for these bonds and questions about remedy.

The issuing documentation includes pari passu (equal treatment) language. NML claims that this language prohibits Argentina from making payments pursuant to two rounds of restructuring, in 2005 and 2010, in any way that ranks holders of the restructured debt above the hold-outs from those restructurings, the holders of the defaulted instruments. The district court, in February, agreed, and issued an injunction accordingly.

Concerned that it would otherwise be open to Argentina simply to treat such an injunction with the same respect it has treated its original pre-2001 bonds, the district court also ordered as a matter of remedy that copies of the injunction be provided to “all parties involved, directly or indirectly, in advising upon, preparing, processing, or facilitating any payment on the Exchange bond,” including Argentina’s agents in New York, holding money in trust for the post-restructuring bondholders.  Thus, the New York agents cannot give out money to the latter without putting themselves in the position of aiding and abetting a violation of a court order.  It is a safe guess they won’t want to do that.

This order, then, is something more than another piece of paper that Argentina as a sovereign can ignore. It interferes with the mechanics by which Argentina might otherwise ignore it.

Bolder on Substance

On the substantive question, the meaning of pari passu, a panel of the appellate court has now upheld the lower court’s judgment. As to that sand-in-the-gears remedy … not so much.

Some readers will remember that my previous entry on this case issued the gratuitous prediction that the court would “take the hint” offered by an amicus brief, and find that it was Argentina’s Lock Law, enacted in 2005, that had the effect of involuntary subordination of NML’s claims.  Thus, the decision would not have an impact on other sovereigns, many of whom have issued bonds with analogous pari passu clauses, but few of whom have done so with that sort of legislative addendum.

I was wrong. These substantive portions of this decision are worded quite broadly, and unless the panel’s decision is overturned or modified by the full court or the U.S. Supreme Court it could have an impact across the world of emerging market nations. Let’s look at the key argument about pari passu.

The Significance of Sharing Clauses

Argentina has contended that the intended significance of pari passu language is quite limited. It prohibits only the creation, after issuance, of a legally enforceable preference for some of the bonds covered by the clause over others; it doesn’t prevent the de facto differential treatment of different bonds after a default and as a consequence of a restructuring.

The amicus brief from The Clearing House Association emphatically took Argentina’s side on this point, saying that a so-called “sharing clause” accomplishes the purpose that the plaintiffs here are trying to use the pari passu clause to accomplish.

Sharing clauses “are often found in loan agreements under which the creditors separately are protected against involuntary subordination through a pari passu clause, because these two types of clauses serve different purposes,” said TCH. In this case, there was a pari passu clause, but no sharing clause, and the courts ought to recognize and give significance to their different function. So ran the argument.

Judge B.D. Parker, for the three-judge panel of the 2d circuit court, dismissed this argument. Sharing clauses, he said, are simply agreements made among the lenders to divide payments from a debtor or other proceeds such as offsets. They are not agreements to which a debtor is a party.  A pari passu clause is an undertaking by the debtor.  The recognition of that point is adequate judicial recognition of the distinction between the two.

The court agreed with the plaintiffs that this pari passu clause, without the help of any sharing clause, works as a ban to either de jure or de facto discrimination by the debtor.

Less Bold on Remedy

The appeals panel didn’t give the bondholders an utterly unambiguous win, though.  It expressed “concerns about the Injunctions’ application to banks acting as pure intermediaries in the process of sending money from Argentina to the holders of the Exchange Bonds.”  Here Argentina may have pulled a bit of a win out of the jaws of defeat.

The appeals panel was unhappy about precisely the aspect of the district court ruling that proposed to throw sand into the gears of an eleven-year old default. It said in essence that it wanted a more complete record on that subject, so it remanded the matter to the district court for further proceedings.

It isn’t clear at this point whether further proceedings will move up or down the judicial ladder. Must Argentina wait until the remanded proceedings are done before appeal to the whole of the appellate court (en banc) or to the Supreme Court?

Stay tuned.

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One Comment

  1. sam
    November 5, 2012 at 2:55 pm

    Regarding the bonds affected by the court rulings, Argentina can offer investors the option of exchanging into a new but secured bond (ie on tax revenues or export receivables for example). The bond can have the same terms as the existing paper but it will rank senior to the existing unsecured bond. Pari Passu or equal treatment will then apply only to the older bonds and which will no longer exist and will not apply to the new bonds and most investors will be more than glad to accept a new secured bond. You do not have to pay holdouts, change jurisdictions, or reopen the exchange. problem solved.

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