The ‘80s Language that Disappeared: Part of a Sovereign Debt Mystery

Regulatory 14 Nov 2012

In 2004, Lee Buchheit and Jeremiah Pam, of Clearly Gottlieb, wrote “The Pari Passu Clause in Sovereign Debt Instruments.” The “degree of agnosticism” that the authors heard from the lawyers who draft such documents, concerning “the precise denotation” of pari passu,  astonished them, so they sought the meaning historically.

An “Event of Default”

Buchheit-Pam contended that pari passu language appeared only in secured sovereign bonds until the 1970s. The problem that had motivated the clause in that context was this: when loans made at different times are secured by the same collateral, in the event of the liquidation of that collateral, the default rule without contrary language was that the earliest lenders’ claims to that collateral would have priority. The pari passu (“equal footing”) language was devised precisely to overcome that default rule, and give the later lenders equal standing.

Skipping ahead: As commercial lenders entered the world of unsecured sovereign debts in a big way in the 1960s they only gradually became aware that sometimes local laws allowed some unsecured debt holders to gain priority over others without the consent of those others. The point of the pari passu language, when it made its “great leap” into unsecured bonds in the 1970s, was to make it an event of default for the bond issuer to allow any unsecured lender to obtain priority over the others without the consent of those others. Since such involuntary subordination “remains a serious concern for the cross-border lender,” they wrote the language “persists as the contractual mitigant for that risk.”

This understanding makes the language irrelevant to the ongoing saga of NML v. Argentina. Since Argentina unequivocally did default in 2001, the discovery of a new “event of default” regarding the same bonds would be a redundancy.

Their argument has been quite influential. The U.S. government for example cited Buchheit-Pam in an amicus brief in the ongoing litigation over defaulted Argentina bonds.

Newer Scholarship

New scholarship throws doubt on this story though. Mark Weidemaier, of the University of North Carolina School of Law, Robert E. Scott, of Columbia University Law School, and G. Mitu Gulati, of Duke University School of Law (collectively WSG) addressed this and other such “origin myths” of pari passu in a paper for the 5th Annual Conference on Empirical Legal Studies in 2010.

WSG found pari passu language in unsecured sovereign debt much earlier than the Buchheit-Pam theory allows it, as early as 1899, and found it appearing as a matter of routine by the 1960s. There is a rather fuzzy border between unsecured and secured loans when the issuer is a sovereign, but by any understanding of a secured loan, including that implied in the Buchheit-Pam story itself, there are earlier instances of the unsecured usage of pari passu than there “should” be.

Even more intriguing, WSG’s data shows the rise and fall of a certain 1980s-era mutation of the pari passu language in bonds.

Though the standard language as of the 1970s provided that “the bonds will rank pari passu with all other unsecured External Indebtedness,” a new variation arose in that decade, adding specific language that the equal ranking would be “regardless of data of issue.” In the 1980s, the language became quite common, and sometimes more elaborate, that is, “regardless of date of issue and currency of payment.”

Out with Other 80s Fads

Such language was employed only once in the English law bonds surveyed by WSG from the 1970s, but it appears in nearly half of those bonds in their database in the 1980s (16 out of 35).

The golden age of such “date of issue” language was brief. It came in and went out with big hair and spandex. In the 1990s, only 39 of the 123 bonds (32 percent) surveyed by WSG had this ‘mutation’ of the pari passu language. The decline has continued in the new century.

Why does this matter? Because, WSG argue, it weakens the contention of Buchheit-Pam that the pari passu clause itself is aimed at blocking de jure preferences, such as preferences for first-in-time or local-currency lenders. If that was the point, then the new language emphasizing precisely that point, although perhaps redundant, surely did no harm. Why, these authors ask, would it have died out so quickly?

This and other patterns in their database suggest to WSG that “the pari passu clause has become less focused on involuntary subordination over time, rather than more.” This means that it has become less focused in the way that the Argentine government would like to keep it focused.

English law bonds aren’t directly relevant to the New York litigation over NML. But the authors add that New York bonds show a similar pattern, with this mutation appearing frequently in the 1970s and 1980s, less often the in the 1990s, and only twice out of a sample of 75 instances in the 21st century.

Although WSG don’t seem to mean their paper as a contribution to the discussion over the Argentine default and its consequences (their interests are in what one may call the sociology of the legal profession), their findings nonetheless must be heartening to the lawyers for the speculators who have held onto the Argentine bonds and waged this fight, for WSG’s view of the history is at least clearly compatible with a broader reading of the pari passu clause than the limited one Argentina’s attorneys have been presenting.

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  1. Mark Weidemaier
    November 14, 2012 at 8:47 pm

    Thanks for such a detailed discussion of our article, Christopher. (For nerds like me, it’s quite exciting for the pari passu clause to be a major news topic…!) I might add, for what it’s worth, that lawyers tell a number of stories about what the pari passu clause means in the context of sovereign bonds, and about just how it got into the bonds in the first place, and the Buchheit and Pam story holds up better than most. And while we don’t find the clause to be as readily confined to the meaning ascribed to it by Buchheit and Pam, we also don’t find anything specific to support the meaning ascribed by the plaintiffs in NML v. Argentina – which is that the clause represents a promise not to pay restructuring participants without also paying holdouts. You’re absolutely right, though, that the ambiguity of the clause has proven beneficial to the holdouts.

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