Faculteit Rechtsgeleerdheid
Universiteit Gent
Academiejaar 2015-2016
The Pari Passu Clause in Sovereign Debt Restructuring:
A Short-Lived Victory of Holdouts Over Sovereigns
Masterproef van de opleiding
‘Master in de rechten’
Ingediend door
Karel Bevernaege
01103797
Promotor: Professor Dr. Michel Tison
Commissaris: Meester Yossaman Malekzadem
ACKNOWLEDGEMENTS
Writing a thesis is an arduous journey riddled with countless hours of research, reading and
rereading, writing and rewriting. Not to mention those teeny tiny moments of absolute horror
when your computer freezes for the umpteenth time and you are utterly convinced that this
time Word will crash forever, destroying your precious brainchild in the process. Fortunately,
it is not always a nerve-racking experience. At times I found myself enjoying a private
chuckle due to some witticism of an author, or being delighted when I finally tackled that
cumbersome sentence. Be that as it may, nothing compares to the immense feeling of
satisfaction when you finally deliver the finished product.
However, in order to achieve that savoury moment of victory and bliss, I relied on the help of
certain people without whom this thesis would never have seen the light of day.
First and foremost, I would like to thank my promoter, Prof. Dr. Michel Tison, for providing
me with an intriguing subject and giving me the necessary guidelines and advice to bring
about this thesis.
Furthermore, I am particularly grateful for the assistance given to me by to the staff of
Clifford Chance LLP. Xavier and Emily, your help was truly instrumental in finding the
necessary materials to write this thesis.
In addition, I would like to thank my parents for the endless support I received during my
studies. Especially my father, for the countless hours he spent proofreading every single
paragraph, word and syllable.
My special thanks, also, to my friends and family for sharing their previous experiences and
putting up with my ceaseless nagging.
Last but not least, a shower of gratitude to my girlfriend, Tia. Your witty puns, smiles and
unwavering confidence fuelled my inspiration.
i
TABLE OF CONTENTS
Acknowledgements .................................................................................................................................. i
List of Abbreviations ............................................................................................................................. vii
Introduction ..................................................................................................................................... 1
1.1.
Sovereign Debt Restructuring –A Brief Context ..................................................................... 1
1.1.1.
Problems During Restructuring Negotiations .................................................................. 1
1.1.2.
Solutions to These Negotiation Issues ............................................................................. 3
1.1.3.
Sovereign Debt Litigation ............................................................................................... 4
1.1.4.
Meticulous Drafting......................................................................................................... 6
1.2.
Problem Statement................................................................................................................... 6
1.3.
Research Method and Limitations ........................................................................................... 7
1.3.1.
Research Method ............................................................................................................. 7
1.3.2.
Limitations....................................................................................................................... 7
1.4.
Thesis Outline.......................................................................................................................... 8
Holdouts: the Bane or Boon of Sovereign Debt Restructuring ..................................................... 11
2.1.
The Basics of Sovereign debt ................................................................................................ 11
2.1.1.
The Why and the How ................................................................................................... 11
2.1.2.
The Risks Involved in Sovereign Debt .......................................................................... 13
2.2.
Restructuring: What Happens Upon a Default? .................................................................... 15
2.2.1.
Sovereign Default Options ............................................................................................ 15
2.2.2.
Contractual Restructuring in a Nutshell ........................................................................ 19
2.3.
Holdouts in Action ................................................................................................................ 21
2.3.1.
The Role of Holdouts .................................................................................................... 21
2.3.2.
Litigation as Leverage: The Sovereign Immunity Quandary ........................................ 22
2.4.
Vulture funds ......................................................................................................................... 27
2.4.1.
What are Vulture Funds? ............................................................................................... 27
2.4.2.
Vultures: A Different Sort of Holdouts ......................................................................... 29
2.4.3.
The Role of Vulture Funds ............................................................................................ 29
2.5.
Conclusion: Holdouts Are the Result of Market Failure ....................................................... 31
iii
Pari Passu Clauses: The Root of the Problem? .............................................................................. 33
3.1.
The History of the Pari Passu: the What, the Why and the When ......................................... 33
3.1.1.
The 19th Century: Pari Passu and ‘Secured’ Lending .................................................... 34
3.1.2.
The Mid-20th Century: Negative Pledges Supplant Pari Passu Clauses ........................ 35
3.1.3.
The 1970s: The Rise of Syndicated Loans and the Return of Pari Passu Clauses......... 36
3.2.
Ranking vs. Payment: The Pari Passu Conundrum ............................................................... 37
3.2.1.
Description .................................................................................................................... 37
3.2.2.
Corporate context .......................................................................................................... 38
3.2.3.
Sovereign Context ......................................................................................................... 39
3.3.
Waves of Litigation and their Consequences ........................................................................ 41
3.3.1.
Introductory Remarks .................................................................................................... 41
3.3.2.
New York State Law Litigation Waves ......................................................................... 42
3.3.3.
English Law Litigation .................................................................................................. 74
3.3.4.
Conclusion: Where Did the Waves of Litigation Lead Us? .......................................... 81
3.4.
Conclusion: Drafting Is Key? ................................................................................................ 81
Drafting Is Key to the Pari Passu-Holdout Issue ........................................................................... 85
4.1.
Tackling the Pari Passu issue ................................................................................................ 85
4.2.
Holding the Holdouts ............................................................................................................ 87
4.2.1.
Three Approaches to Curb Holdout Power ................................................................... 88
4.2.2.
The Statutory Approach................................................................................................. 88
4.2.3.
The Market-Based Approach: Exit Consents and Collective Action Clauses ............... 90
4.2.4.
The Contractual Approach: A Trust Structure, MDV and Restructuring Triggers ..... 103
4.3.
Conclusion: A Possible Approach to Address the Issue ...................................................... 108
General Conclusion: What to Expect in the Future? ................................................................... 111
References ................................................................................................................................... 115
Table of Cases ................................................................................................................................. 115
Australia ...................................................................................................................................... 115
Belgium ....................................................................................................................................... 115
United Kingdom .......................................................................................................................... 115
iv
United States of America............................................................................................................. 115
Case Documents .......................................................................................................................... 116
Table of Legislation......................................................................................................................... 117
Australia ...................................................................................................................................... 117
Argentina ..................................................................................................................................... 117
Belgium ....................................................................................................................................... 117
United Kingdom .......................................................................................................................... 117
United States of America............................................................................................................. 118
Bibliography .................................................................................................................................... 118
v
LIST OF ABBREVIATIONS
Act 1978
State Immunity Act of 1978 (United Kingdom)
BW
Burgerlijk Wetboek (Belgian Civil Code)
CAC
Collective Action Clause
F. R. App. Federal Rules Appellate Procedure
P.
F. R. Civ. P.
Federal Rules of Civil Procedure
FMLC
Financial Markets Law Committee
FSI Act
Foreign State Immunities Act of 1985 (Australia)
FSIA
Foreign Sovereign Immunities Act of 1976 (United States of America)
Ger. W.
Gerechtelijk Wetboek (Belgian Civil Procedure Code)
HIPC
Heavily Indebted Poor Country
ICMA
International Capital Market Association
LDC
Low Developed Countries
MDV
Minimum Default Value
MFCC
Most Favoured Creditor Clause
NIL
Negotiable Instruments Law
SDRM
Sovereign Debt Restructuring Mechanism
SEC
Securities and Exchange Commission
TIA
Trust Indenture Act of 1939
U.C.C.
Uniform Commercial Code
U.S.C.
United States Code
UAC
Unanimous Action Clause
UK
United Kingdom
US
United States of America
vii
INTRODUCTION
1.1.
SOVEREIGN DEBT RESTRUCTURING –A BRIEF CONTEXT
Most countries are continuously in need of financing. Therefore, countries use financing
mechanisms such as the issuance of bonds to obtain the necessary funds. Unfortunately, some
countries accumulate debt to unsustainable levels and as a result, they are faced with a
(possible) default.1
To resolve an impending crisis a sovereign state –theoretically– has three options: a bailout by
the official sector (i.e. the IMF, World Bank, ECB…), commencing restructuring negotiations
with its creditors, or a statutory approach.2 Unfortunately, there is no sovereign insolvency
framework at the moment.3 Although some voices cry out for a statutory approach, no
political consensus can be reached to implement one. However, it is not for lack of trying (e.g.
the SDRM).4
There are a number of reasons why a sovereign state chooses one option over the other. One
of those reasons is debtor and creditor moral hazard.5 A debtor might wonder why he should
bother restructuring when he can rely on the official sector to bail him out, while a creditor
might want to rely on a bailout to see his claim repaid at face value.6 In any case, even if a
sovereign state chooses restructuring over a bailout, its problems are far from over.
1.1.1. Problems During Restructuring Negotiations
The contractual approach has a fair share of problems of its own. It includes the sovereign
state entering into negotiations and trying to exchange the old bonds for new bonds at less
Katherine Crispi, ‘Not Just the Luck of the Irish: A Contractual Solution to the Problems of Sovereign Debt
Restructuring’ (2014) 37 FDMILJ 1859, 1868, (hereinafter: Crispi, ‘Not Just the Luck of the Irish’).
2
Ibid 1869; Rodrigo Olivares-Caminal, ‘Is there a Need for an International Insolvency Regime in the Context
of Sovereign Debt? A Case for the Use of Corporate Debt Restructuring Techniques’ (2009) 24 (1) JIBLR 21, 22
(hereinafter: Olivares-Caminal, ‘Is There a Need’).
3
Molly Ryan, ‘Sovereign Bankruptcy: Why Now and Why Not in the IMF’ (2014) 82 FDMLR 2473, 2482,
(hereinafter: Ryan, ‘Sovereign Bankruptcy’).
4
SDRM: Sovereign default restructuring mechanism. The IMF tried to implement a sovereign insolvency
procedure, based on national insolvency procedures. This project was benched due to the amount of criticism it
received. (see Olivares-Caminal, ‘Is There a Need’ (n 2) 29).
5
J. Andritzky, Sovereign default risk valuation (New York Springer 2006) 63.
6
Ibid.
1
1
Introduction
favourable terms (so-called ‘debt swaps’)7. During these negotiations the country is exposed
to issues such as holdouts, high costs, conflicts of interests and more.
First and foremost, the issue of ‘holdouts’ or ‘rogue creditors’.8 Though the majority of
bondholders usually agrees to exchange their bonds, some bondholders refuse to participate in
the restructuring procedure. Instead, they try to collect principal and accrued interest in full.
These bondholders are called ‘holdouts’.
To make matters even worse, so-called ‘vulture funds’9 purchase defaulted debt at a steep
discount and try to recover the debt’s par value in court. Obviously, this threat of holdoutlitigation makes the restructuring negotiations even more difficult.
Unfortunately for them, holdouts cannot rely on a sovereign bankruptcy regime. Therefore, to
achieve their objective of full repayment, holdouts require two things: a judgement and
enforcement of said judgement.10 However, this course of action includes surmounting yet
another issue, namely sovereign immunity. While obtaining a judgement is fairly easy
nowadays, sovereign immunity still thwarts holdouts when it comes to enforcement. In a
nutshell, the sovereign immunity-bankruptcy standoff forces holdouts to engage in (farfetched) self-help strategies.11
This is where pari passu clauses come into play. Though they have been around for decades,
it was not until the Elliott cases12 that they started to pose a problem. Elliott, being a vulture
fund, used a new interpretation of this clause to block Peru’s cash flow and convinced a
Belgian court to keep Peru from paying interest to the holders of ‘new bonds’. 13 All of this to
force Peru into a settlement concerning the sovereign debt that Elliott bought at a steep
Rodrigo Olivares-Caminal, ‘Understanding the Parri Passu Clause in Sovereign Debt Instruments: A Complex
Quest’ (2009) 43 INTLLAW 1217, 1218, (hereinafter: Olivares-Caminal, ‘Understanding the Pari Passu’).
8
Ibid 1218.
9
‘A “vulture fund” is a type of investment fund that operates in the distressed debt market.’ (Olivares-Caminal
‘Understanding the Pari Passu’ (n 7) 1235).
10
Olivares-Caminal ‘Understanding the Pari Passu’ (n 7) 1220.
11
Anna Gelpern, ‘Pari Passu Endgames’ (Credit Slips, 2012) <www.emta.org> accessed on 26 September 2015,
(hereinafter: Gelpern, ‘Pari Passu Endgames’); Gregory R Day, ‘Market Failure, Pari Passu, and the Law and
Economics Approach to the Sovereign Debt Crisis’ (2014) 22 Tul. J. Int'l & Comp. L. 225, 247, (hereinafter:
Day, ‘Market Failure’).
12
See infra 3.3.2.2.6 Elliott Associates v. Banco de la Nacion.
13
Tim R Samples, ‘Rogue Trends in Sovereign Debt’ (2014) 35 Nw. J. Int'l L. & Bus. 58, (hereinafter: Samples,
‘Rogue Trends’).
7
2
Sovereign Debt Restructuring –A Brief Context
discount.14 Simply put, this interpretation served as the bedrock for future holdouts and
vulture funds.
The second main issue is the dire circumstances in which these negotiations take place. As
mentioned before, sovereign debt restructuring is faced with a moral hazard issue. Usually,
this leads to no negotiations at all or tardy negotiations, which in turn results in unnecessary
stress levels.15 Other than that, a sovereign state also needs to consider the fact that a
restructuring is accompanied by a lot of reputational and economic costs.16
Finally, all parties are faced with a conflict of interest. These conflicts can be found both on
the level of creditor versus debtor as on the level of the creditors themselves. Some examples
to clarify:17
-
Holdouts will try to claim the debt at face value and block all payments to the other
bondholders, while exchange bondholders will wait for new interest payments to
become due.
-
A country will try to maintain its cash flow.
-
The IMF focuses on stabilizing the global economy, while banks and investment funds
are solely focused on financial gains.
In sum, starting restructuring negotiations is but the first step towards recovery. One thing is
for sure, it is definitely an intricate process.
1.1.2. Solutions to These Negotiation Issues
Since holdouts are a major stumbling block when it comes to sovereign debt restructuring,
countries have started using mechanisms such as collective action clauses (‘CACs’) and exit
consents to mitigate the issue.18 In general, these provisions try to improve creditor
coordination and in doing so, they –at least theoretically– provide for an orderly sovereign
debt restructuring.19
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1223.
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1873.
16
Ibid 1873.
17
Ibid 1872; Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222.
18
J. Choi and G. Mitu Gulati, ‘Innovation in Boilerplate Contracts: An Empirical Examination of Sovereign
Bonds’, (2004) Emory L.J. 929, (hereinafter: Choi and Gulati, ‘Innovation in Boilerplate Contracts’); J.
Andritzky, Sovereign default risk valuation (New York Springer 2006) 74; Crispi, ‘Not Just the Luck of the Irish’
(n 1) 1887.
19
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502.
14
15
3
Introduction
In addition, some argue that a country should be forced to enter into restructuring
negotiations.20 Due to the lack of a sovereign insolvency regime, sovereign debtors cannot be
forced to start any restructuring.21 Contractual ‘triggers’ might therefore be the solution.22
Triggers are certain events that are put into the contract.23 When these events occur, the debtor
is obligated to engage in restructuring negotiations. By doing so, both parties can reduce the
fear of moral hazard.24
Lastly, countries can rely on the use of ‘carrot features’ or ‘sweeteners’ to increase
bondholder participation.25 One of those sweeteners is the most favoured creditor clause or
‘MFCC’. If a sovereign state exchanges its bonds, this clause will prevent it from reaching a
settlement with holdouts. This way, a bondholder is sure that no one will get a better treatment
than he did and therefore more bondholders will be willing to exchange their bonds.
1.1.3. Sovereign Debt Litigation
As a preliminary point, it should be noted that both governing law and jurisdiction are of vital
importance in international transactions, especially in distressed debt situations where the
viable options for both debtor and creditor greatly depend on the chosen applicable law and
jurisdiction. For instance, a debtor has to be aware that the use of certain contractual
techniques differs under English law compared to New York state law.26 A creditor, on the
other hand, will often have to make do with remedies the enforcing court is already familiar
with, even though those are not necessarily the ones the governing law prescribes. Indeed, it is
known that judges tend to apply the law they know best. 27 Hence, it is of the utmost
Anna Gelpern, ‘Contract Hope and Sovereign Redemption’ (2013) 8 CMLJ 132, 148, (hereinafter: Gelpern,
’Contract Hope’); Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889.
21
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889.
22
Ibid.
23
Ibid.
24
Ibid.
25
Udaibir S. Das, Michael G. Papaioannou and Christoph Trebesch, ‘Sovereign Debt Restructurings 1950–2010:
Literature Survey, Data, and Stylized Facts’ (2012) IMF Working Paper No. 12/203 22 <https://www.imf.org/
external/pubs/ft/wp/2012/wp12203.pdf> accessed 22 March 2016, (hereinafter: Das and others, ‘Sovereign Debt
Restructurings’); Rodrigo Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments:
Developments in Recent Litigation’ (2013) 72 BIS Papers 121, 122 <http://econpapers.repec.org/bookchap
/bisbisbpc/72-23.htm> accessed 19 March 2016, (hereinafter: Olivares-Caminal, ‘The Pari Passu Clause in
Sovereign Debt Instruments’); Natalie A Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around: Can
Holdout Creditors Ever Have Equal Treatment?’ 2015 83 (4) FDMLR 2171, 2185, (hereinafter: Turchi,
‘Restructuring a Sovereign Bond Pari Passu Work Around’).
26
Olivares-Caminal, ‘Is There a Need’ (n 2) 33.
27
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause and the Argentine Case’ (2012) 13
<www.emta.org> accessed on 26 September 2015, (hereinafter: Allen & Overy Global Intelligence Unit, ‘The
Pari Passu Clause’).
20
4
Sovereign Debt Restructuring –A Brief Context
importance to determine which law is applicable, which court has jurisdiction and what that
entails for both debtor and creditor.
Although borrowers are free to choose, New York state law and English law are by far the
prime systems of governing law with regard to sovereign debt agreements.28 Consequently,
the landmark cases in sovereign debt litigation are also of New York or English descent.
Regarding New York case law, there are three waves of litigation resulting from holdouts’
efforts at enforcement of judgement: the Pravin cases, the Elliott and LNC cases, and finally,
the NML case.

Wave 1: Pravin Banker Associates v. Banco Popular Del Peru:
In essence, this case showed that the sovereign debtors are also subject to the Latin proverb
pacta sunt servanda. Although they can count on some leniency to allow an orderly
restructuring, they cannot avoid enforcement actions forever. Consequently, this case served
as the bedrock for future holdout/vulture fund litigation.

Wave 2: Elliott v. Peru and LNC Investment v. Nicaragua.
As stated before, a wrongful judicial decision concerning the pari passu clause paved the way
for holdouts to disrupt a country’s cash flow. Years later, the pari passu clause still poses a
threat to restructuring, because creditors still claim that ‘sovereigns should be prevented from
making payments to other creditors without paying the litigating creditors’. 29 This
interpretation of the pari passu clause is also called the ‘broad’ or ‘payment’ interpretation.

Wave 3: NML Captial Ltd. v. Argentina
This time there truly was a breach of the pari passu clause even in its ‘narrow’ or ‘ranking’
form.30 In casu the Argentinian government subordinated the bonds of the holdouts by
implementing the so-called ‘Lock Law’, which more or less prevented the Argentinian
Mitu Gulati and K N Klee, ‘Sovereign Piracy’ (2001) Bus. Law. 635, 646, (hereinafter: Gulati and Klee,
‘Sovereign Piracy’); Olivares-Caminal, ‘Is There a Need’ (n 2) 28.
29
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1223.
30
The ‘narrow’ or ‘ranking’ interpretation has to do with all kinds of ranking such as involuntary subordination
by law. See infra 3.2 Ranking vs. Payment: The Pari Passu Conundrum and 3.3 Waves of Litigation and Their
Consequences.
28
5
Introduction
government from entering into settlement negotiations with holdouts.31 Given that the bond
instrument did not provide an adequate remedy for the breach, the plaintiff –a vulture fund
called NML Capital Ltd– proposed a ‘rateable payment’ as remedy. Whenever exchange
bondholders get paid, Argentina should be forced to pay the holdouts as well. The US Court
of Appeals of the Second Circuit followed this line of reasoning due to the lack of remedies
provided by the bond instrument and because of Argentina’s disgraceful behaviour vis-à-vis
the court.32 As a result, the door to a brand-new wave of litigation was opened.
English courts, on the other hand, see the pari passu issue differently. A landmark case in this
context is Kensington International Ltd v. Republic of The Congo.33 Although the court only
implicitly rejected the ‘payment’ interpretation, most authors agree that such an interpretation
flouts basic contractual interpretation principles under English law.34
1.1.4. Meticulous Drafting
As the recent crisis of ‘07-‘09 has shown us, meticulously drafted contracts are a must. If your
contract is flawed, you will pay for it tenfold in dire times. Bond issuances are no exception.
If the contract is badly written, the sovereign debtor will regret it because holdouts will
exploit the situation. For example, in NML vs. Argentina35 the MFCC clause lacked the word
‘settlement’ rendering it useless and opening the door to holdouts. So even though these
contractual solutions might resolve the holdout issue, all parties should still be careful and
choose detailed over boilerplate clauses.36
1.2.
PROBLEM STATEMENT
Sovereign debt restructuring is faced with the issue of ‘holdouts’, meaning creditors who
refuse to exchange their old bonds for new ones in the hope of getting a better deal or
repayment in full. Apparently, pari passu clauses are at the epicentre of this phenomenon and
more specifically, their different interpretations play a big part in the resulting litigation. To
counter this issue, sovereign states have started to use defence mechanisms such as collective
Rodrigo Olivares-Caminal, ‘To Rank Pari Passu or Not to Rank Pari Passu’ (2009) 15 Law & Business
Review of the Americas 745, 757.
32
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012).
33
[2003] EWHC 2331 (Comm). Upheld on appeal in Kensington International Ltd. v. Republic of the Congo
[2003] EWCA Civ 709, A3/2003/1036.
34
See infra 3.3.3 English Law Litigation.
35
Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 121.
36
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889.
31
6
Research Method and Limitations
action clauses and exit consents. At first glance these clauses might solve the issue, but deeper
analysis shows they may pose problems of their own.
1.3.
RESEARCH METHOD AND LIMITATIONS
1.3.1. Research Method
For the most part, this thesis is the result of desk research. This implies a study of papers,
books and monographs available on EMTA, LexisNexis and SSRN. Their subjects range from
sovereign default debt in general to specific materials on the history of pari passu clauses and
the purpose of CACs. To supplement this basic knowledge, recent articles from journals and
law firms’ client briefings were also reviewed.
In search for those reading materials, the focus lay on the authorities in the field.
Nevertheless, some innovative ideas were found in the works of less known authors.
Moreover, this thesis also provides a clear overview of recent pari passu –or related– holdout
litigation. As mentioned before, there are two kinds of applicable law that are common in
bond contracts: English law and New York law. Therefore, this thesis examined the
differences of opinion between the English courts and their American brethren. In the interest
of intelligibility, the following method for reviewing these cases was used: (i) relevant facts,
(ii) relevant arguments, (iii) reasoning of the court and (iv) impact or importance of the case
vis-à-vis the holdout-issue.
Finally, the empirical data found in this thesis are also the result of desk research. Ergo, data
such as the percentage of bond contracts containing pari passu clauses or CACs, are not the
result of empirical analysis done by the author. Instead, they were implemented after careful
consideration and critical reading.
1.3.2. Limitations
Due to the limited time and pages allotted to me, the scope of this thesis does not encompass
the possible existence of a statutory mechanism. Instead, the focus lay on contractual
sovereign debt restructuring. More specifically, how contractual mechanisms are initiated and
where pari passu clauses, collective action clauses and the like come into play.
7
Introduction
In addition, this thesis is limited to litigation and literature regarding the use of pari passu
clauses in an English or New York Law setting. This is due to the fact that most bond
issuances choose English or New York law as the applicable law.37
Furthermore, this thesis does not provide any empirical or extensive historical analysis of
contract provisions. This is partly due to the limited time available, but also due to the lack of
resources and connections to acquire the necessary materials.
As a final note, it should be pointed out that the conclusions in this thesis are primarily based
on contract mechanisms that are purely theoretical. At present, there is no way to determine if
any of the proposed countermeasures will be successful in practice. That would require a
sovereign default. Besides, every issuance of bonds has its own features and specificities,
which makes an all-round solution to the holdout issue virtually impossible.
1.4.
Thesis Outline
At the moment, there is quite a bit of uncertainty regarding the use of certain clauses or the
rationale behind certain techniques with regard to sovereign debt restructuring. This
uncertainty ultimately leads to increased borrowing costs, reputational damage and other
kinds of problems such as holdout creditors.
Therefore, this thesis provides a general overview of what happens when a sovereign debt
default is imminent. It discusses the holdout issue in a sovereign debt restructuring context by
explaining why restructurings are plagued by holdouts and how this issue can be prevented or
at least mitigated. More specifically, it examines the part pari passu clauses play in this
context and determines if countermeasures such as collective action clauses and exit consents
really do help or not.
In Chapter 2, this thesis starts out with some essential background information on sovereign
debt and the holdout issue, beginning with the whys and wherefores of sovereign immunitybankruptcy standoff and then turning to the rise of vulture funds and their (far-fetched)
strategies. Chapter 3 examines sovereign debt litigation at length and shows how vultures
make use of a pari passu clause to force a sovereign state to settle. It discusses the
consequences of said litigation and highlights the differences between the English courts and
their American brethren. Chapter 4 introduces some legislative and contractual techniques to
37
8
Olivares-Caminal, ‘Is There a Need’ (n 2) 8.
Thesis Outline
prevent or at least mitigate the holdout issue and determines the pros and cons of each
solution. In addition, it suggests which approach should be endorsed to address the holdout
situation and what challenges this approach faces. Finally, chapter 5 summarises the present
situation and discusses what we can expect in the future.
9
HOLDOUTS: THE BANE OR BOON OF SOVEREIGN DEBT RESTRUCTURING
To know who or what holdouts are and why they exist, one needs to determine how they tie
into the whole sovereign debt scenario. Therefore, this chapter starts out with a basic
overview of sovereign debt and its terminology. Then, it gives a succinct enumeration of
restructuring options and provides an analysis of the immunity-bankruptcy standoff.38 Finally,
it examines the role of vulture funds, their existence and their goals.
2.1.
THE BASICS OF SOVEREIGN DEBT
2.1.1. The Why and the How
Sovereign states are continuously in need of financing for a wide array of state activities,
ranging from education, healthcare and infrastructure to war, economy and humanitarian
aid.39 Obviously, their first course of action is taxation, but that only goes so far. That is why
sovereigns have been ‘borrowing from time immemorial’.40 Hence the existence of the
‘sovereign debt’ market.
In general, sovereign debt consists of two types of debt instruments, namely (commercial)
loans and sovereign bonds. The fact that bonds are predominant at the moment, is largely due
to historical events. During the 1970s most developing countries used commercial loans to
finance their operations.41 This was the result of multiple factors, but chief among them was
the existence of so-called ‘petrodollars’.42 Starting in 1973, the oil prices rose sharply and oilexporting countries were faced with a ‘surplus’ in revenue which they deposited in large
commercial banks located in the United States and Western Europe.43 These banks became
flush with cash and seeking high returns, they decided to recycle the petrodollars into loans
Gelpern, ‘Pari Passu Endgames’ (n 11).
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2177.
40
Mitu Gulati and Robert E Scott, The Three and a Half Minute Transaction: Boilerplate and the Limits of
Contract Design (University of Chicago Press 2013) 18, (hereinafter: Gulati and Scott, The Three and a Half
Minute Transaction).
41
Olivares-Caminal, ‘Is There a Need’ (n 2) 21.
42
Jill E Fisch and Caroline M Gentile, ‘Vultures or Vanguards?: The Role of Litigation in Sovereign Debt
Restructuring’ (2004) 53 Emory L.J. 1048, 1058, (hereinafter: Fisch and Gentile, ‘Vultures or Vanguards’);
Jonathan I Blackman and Rahul Mukhi, ‘The Evolution of Modern Sovereign Debt Litigation: Vultures, Alter
Egos and Other Legal Fauna’ (2010) 73 LCPR 47, 50, (hereinafter: Blackman and Mukhi, ‘Vultures, Alter Egos
and Other Legal Fauna’).
43
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1058.
38
39
11
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
for Latin-American countries.44 The sovereign debtors were only too happy to oblige, since
they were being strangled by the ever increasing oil-prices.45
Unfortunately, the oil crisis raged on and the world was plunged into a global recession
between 1980 and 1982.46 In addition, commodity prices fell and the US dollar hardened by
about 25 per cent.47 Consequently, servicing debt became impossible for many LatinAmerican sovereign debtors and they defaulted.48
However, their creditors were also in a predicament. These large banks had granted enormous
loans to sovereign debtors who were now unable to pay.49 As a result, the banks were facing
potential insolvency and the sovereign debt crisis suddenly became a banking crisis.50
To solve this issue, US Treasury Secretary Nicholas F. Brady came up with the ‘Brady
Plan’.51 In essence this plan consisted of securitization. It replaced all the commercial loans by
new ‘Brady Bonds’ which were then sold publicly on the international market.52 The resulting
proceeds were then used to repay the loans.53 Not only did this solve the banking crisis, this
also marked the end of banks monopolizing the sovereign debt market.54 Instead, they were
replaced by investors.55
Creditors and debtors quickly realised the benefits sovereign bonds provided.56 Compared to
traditional commercial loans, bonds provided longer maturities and were easily listed and
traded on the international market.57 In addition, rating agencies assigned credit ratings to
sovereign bonds, which benefitted the investors twofold.58 On the one hand, it alleviated the
Ibid 1058; Anthony Mauger, ‘Sovereign Debt Restructuring: the practical background’ (1986) JIBL 100, 100
(hereinafter: Mauger, ‘Sovereign Debt Restructuring’); Alexander Shapos, ‘Breaking the Impasse: A TwoPronged Approach for Resolving Sovereign Debt Holdout Disputes’ (2015) 17 CDZJCR 243, 243, (hereinafter:
Shapos, ‘Breaking the Impasse’).
45
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 42) 50.
46
Mauger, ‘Sovereign Debt Restructuring’ (n 44) 100.
47
Ibid 101, Olivares-Caminal, ‘Is There a Need’ (n 2) 21.
48
Ibid 101; Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 42) 50.
49
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1061.
50
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178.
51
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1071; Olivares-Caminal, ‘Is There a Need’ (n 2) 21;
52
Ibid.
53
Ibid.
54
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1071; Blackman and Mukhi, ‘Vultures, Alter Egos and
Other Legal Fauna’ (n 42) 50.
55
Ibid.
56
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178.
57
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1072.
58
Ibid.
44
12
The Basics of Sovereign Debt
issue of information asymmetry by allowing them to assess their risks better.59 On the other
hand, this information enhanced the pricing and trading of the bonds.60 As a result of all these
benefits the sovereign debt market blossomed and ever since the 1990s bonds have been the
primary source of sovereign debt.61
To make their bonds even more appealing, sovereign states often use legal or financial
‘sweeteners’.62 These terms include covenants regarding jurisdiction, applicable law or even
sovereign immunity waivers.63 The latter can be of utmost importance in the event of a
default, especially for foreign creditors.
Indeed, more often than not, sovereign bonds take on the form of so-called ‘external debt’.
Simply put, this means sovereign bonds issued under a foreign applicable law and/or
denominated in foreign currency and/or issued to foreign creditors.64 However, this type of
sovereign bonds raises concerns about all kinds of matters, chief among them ‘inter-creditor
equity in the treatment of foreign and domestic creditors’.65
To sum up, sovereign debt is incurred to finance a wide range of state activities, generally by
way of sovereign bonds and this is a widespread phenomenon.66 For instance, recent figures
published by the Emerging Markets Trade Association show that the sovereign debt market
holds up to US$ 1.137 trillion in value.67 A blossoming market indeed.
2.1.2. The Risks Involved in Sovereign Debt
Although sovereign debt offers a lot of benefits for investors, it is not a bed of roses. For
starters, certain situations or events can lead to debt at unsustainable levels. The Latin
American sovereign debt crisis of the 80s is a prime example of that fact. Investors faced with
such a default situation are hardly in an enviable position. While corporate debtors might be
declared bankrupt, there is no statutory framework whatsoever when it comes to sovereign
59
Ibid.
Ibid.
61
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1073; Turchi, ‘Restructuring a Sovereign Bond Pari Passu
Work Around’ (n 25) 2178.
62
Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122; Turchi, ‘Restructuring a
Sovereign Bond Pari Passu Work Around’ (n 25) 2185.
63
For example, Argentina’s Fiscal Agency Agreement of 1994.
64
Anna Gelpern and Brad Setser, Domestic and External Debt: The Doomed Quest for Equal Treatment’ (2004)
35 Geo. J. Int'l L.795, 796; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2176.
65
Ibid 2177.
66
Ibid 2178.
67
EMTA, ‘EMTA Survey: Quarterly Emerging Markets Debt Trading Drops to Six Year Low at US$1.137
trillion’ <www. emta.org> accessed 19 March 2016.
60
13
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
debtors.68 Instead, the parties involved have to rely on voluntary restructuring negotiations
organised on a case-by-case basis.69
Moreover, in the event of a default there is also the matter of sovereign immunity to consider
and this issue is twofold. Creditors might be unable to obtain a judgement against a sovereign
debtor or they might be unable to enforce a judgement obtained.70
Then, there is also the possible issue of discrimination. As stated before, foreign creditors face
the risk of being discriminated against in the event of a default. 71 A sovereign debtor might –
for political reasons– decide to give domestic creditors a preferential treatment. For instance, a
law might be passed that involuntarily subordinates foreign creditors.72
In addition, some sovereign debtors might find it politically more appealing to opt for a
default rather than making internal financial sacrifices that might not sit well with the local
populace.73 Besides, their position as default-debtor is practically unassailable due to a lack of
bankruptcy regime and their sovereign immunity. So, there is definitely something to be said
for the whole ‘debtor moral hazard’ issue.74 Countries do get incentives to ‘opportunistically
default’.75
Nevertheless, it should be noted that the official sector76 imposes severe austerity measures
when it bails out a sovereign debtor.77 Not to mention the fact that any default situation results
in significant reputational costs, which, according CRISPI, makes future fundraising very
difficult for the sovereign debtor in question.78 She asserts that the biggest cost of a sovereign
default is its effect on future access to capital market, because investors are reluctant to invest
for fear of a new default.79 So, one could say that the consequences of a default are so severe
that it discourages ‘opportunistic defaults’.
Olivares-Caminal, ‘Is There a Need’ (n 2) 29; Robert A Cohen, ‘”Sometimes a Cigar Is Just a Cigar”: the
Simple Story of the Pari Passu (2011) 40 Hofstra L. Rev. 11, 16, (hereinafter: Cohen, ‘Cigar’).
69
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2180.
70
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220.
71
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2177.
72
See infra 3.3.2.3.8 NML Capital Ltd v Argentina.
73
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1048.
74
Ibid 1053.
75
Ibid; William Bratton, ‘Pari Passu and a Distressed Sovereign’s Rational Choices’ (2004) 53 Emory L.J. 823,
843 (hereinafter: Bratton, ‘Pari Passu and a Distressed Sovereign’).
76
E.g. IMF, World Bank, ECB…
77
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1874.
78
Ibid 1873.
79
Ibid 1874.
68
14
Restructuring: What Happens Upon a Default
Be that as it may, the fact remains that the sovereign-default-debtor can be in a strong
bargaining position. Due to their sovereign immunity and the lack of a bankruptcy regime,
they are well-nigh unassailable. This signifies yet another risk for their creditors, because they
might be faced with unreasonable restructuring terms without any viable recourse to other
remedies.
Finally, much like the corporate context, agency conflicts also plague the sovereign debt
context.80 For example, the ‘government-creditor agency problem’ and the ‘intergenerational
agency problem’.81 A politician’s primary concern is staying in office and obtaining the
necessary votes to do so. Therefore, he might not have the correct incentive to use the
proceeds of the fundraising wisely, instead he might rather do things to please his voters.82
Similarly, politicians sometimes choose to incur sovereign debt now and leave the problems
to the future generations.83 So, these agency conflicts are definitely something to keep in mind
when dealing with sovereign debt.
Obviously some of the risks mentioned here are hedged by way of bond or loan covenants,
but the fact remains that no contractual system is perfect. These risks do exist and need to be
factored in when deciding to invest in sovereign debt.
2.2.
RESTRUCTURING: WHAT HAPPENS UPON A DEFAULT?
2.2.1. Sovereign Default Options
When faced with a default, a sovereign has few options available. It can either hope for a
bailout by the official sector, or it can initiate sovereign debt restructuring.
2.2.1.1.
A Bailout
In order to stabilize the international financial system, institutions such as the IMF or the ECB
might decide to provide a sovereign debtor with new loans.84 However, this might fuel the
‘opportunistic default’ issue and in addition it discourages (imminent) default-debtors from
80
Gulati and Scott, The Three and a Half Minute Transaction (n 40) 20.
Ibid 19-20.
82
Ibid 19.
83
Ibid 20; J. Andritzky, Sovereign default risk valuation (New York Springer 2006) 63.
84
William W. Bratton and G. Mitu Gulati, ‘Sovereign Debt Reform and the Best Interest of Creditors’ (2004) 57
Vand. L. Rev. 1, 3 (hereinafter: Bratton and Gulati, ‘Sovereign Debt Reform’).
81
15
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
making concessions or even starting restructuring negotiations.85 So, the official sector should
tread carefully and impose the necessary measures to prevent any misuse.
2.2.1.2.
Sovereign Debt Restructuring
Lacking a bailout, a sovereign debtor’s only other course of action is a sovereign debt
restructuring. OLIVARES-CAMINAL superbly defines it as ‘the mechanism used by a sovereign
to prevent or resolve debt issues and to achieve debt sustainability levels’.86 Nevertheless, a
distinction must be made between the statutory approach and the contractual approach.
2.2.1.2.1. ‘Statutory’ Sovereign Debt Restructuring
A statutory approach refers to a bankruptcy reorganisation procedure or a court-supervised
debt restructuring using equitable powers.87 However, this is where sovereign debt differs
from corporate debt. As stated before, there is no such thing as a sovereign insolvency regime,
nor is there any other court-supervised restructuring available for sovereign defaults.
Still, it should be noted that there is a widespread agreement on the need for a ‘revamped’
sovereign debt restructuring process.88 Unfortunately, the creation of such a framework has
proven to be politically impossible.89 For instance, the IMF has come up with the Sovereign
Debt Restructuring Mechanism (the ‘SDRM’), but this initiative was never endorsed.90 Other
authors such as GELPERN and DAY advocated a contractual reform, in combination with a
statutory reform or otherwise.91 Lamentably, their proposals never surpassed the theoretical
stage. In sum, a statutory approach is not really an option for a sovereign debtor.
2.2.1.2.2. ‘Contractual’ Sovereign Debt Restructuring
Absent any other recourse, debtors and creditors willing to resolve the default situation need
to come to the bargaining table.92 In case of sovereign bond restructuring, their negotiations
will revolve around the exchange of outstanding bonds for new bonds under less favourable
85
Ibid.
Olivares-Caminal, ‘Is There a Need’ (n 2) 29.
87
Ibid.
88
Ibid.
89
Ibid; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1094; Blackman and Mukhi, ‘Vultures, Alter Egos and
Other Legal Fauna’ (n 42) 48; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2180.
90
Anna Gelpern and Mitu Gulati, ‘Public Symbol in Private Contract: A Case Study’ (2006) 84 Wash. U. L.
Rev. 1627, 1649, (hereinafter: Gelpern and Gulati, ‘Public Symbol’); Olivares-Caminal, ‘Is There a Need’ (n 2)
29; 1649- Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2206.
91
Gelpern, ’Contract Hope’ (n 20) 148; Day, ‘Market Failure’ (n 11) 262.
92
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3.
86
16
Restructuring: What Happens Upon a Default
terms for creditors.93 Such a ‘debt swap’ or ‘debt exchange’ is usually characterised by a ‘debt
rescheduling’, a ‘debt reduction’, or a combination of both.94
DAS and others define a debt rescheduling as ‘a lengthening of maturities of the old debt,
possibly involving lower interest rates.’95 They add that this offers some form of relief to the
sovereign, because payments are shifted to the future.96 A debt reduction, on the other hand,
means a decrease in the actual face value of the debt, namely a reduction of the principal or
the interest rate.97 As such it offers an immediate form of relief that perhaps is more preferable
and definitely more visible than that of a debt rescheduling.
In addition, it should be noted that both types of debt operations require some kind of
‘haircut’, i.e. a ‘decrease in the amount of repayment owed to the creditors as a result of the
restructuring’.98 In case of a debt rescheduling, the lowering of interest rates lessens the value
of repayment,99 while in case of a debt reduction the actual face value of the bonds is
curtailed.100
However, there are quite a few bumps on the road to successful renegotiations. These issues
include getting parties to the table, being faced with unreasonable terms and multiple conflicts
of interest.
First of all, getting parties around the bargaining table might not be as easy as it sounds. Even
though restructuring negotiations are usually the last viable course of action, there are some
reasons why both parties might not want to give it a try. For instance, there is the issue of
‘debtor-creditor moral hazard’.101 As stated before, some countries might opt for an
‘opportunistic’ default, especially if they think a bailout is a distinct possibility. Creditors, on
the other hand, might also be tempted to await a bailout. Instead of risking unreasonable terms
and severe haircuts, a bailout provides a sovereign with fresh cash to service its debt
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work
Around’ (n 25) 2184.
94
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1218; Crispi, ‘Not Just the Luck of the Irish’ (n 1)
1869; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184.
95
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 7.
96
Ibid; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869.
97
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184.
98
Ibid.
99
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869.
100
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 3.
101
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1053.
93
17
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
payments.102 Consequently, the prospect of a bailout might not incentivise creditors or
sovereign debtors to come to the bargaining table.103
In addition, the bargaining position of sovereign debtors is disproportionally strong compared
to that of creditors. Due to sovereign immunity and the lack of a bankruptcy regime,
sovereigns are well-nigh unassailable. As a result, some of those debtors might be tempted to
impose unreasonable terms. This is another reason why creditors –who do not have the time
or money to litigate– might be discouraged from entering into restructuring negotiations.
Then, there is also the issue of creditor coordination. A major downside of the switch from
syndicated loans to sovereign bonds is the atomisation of bond ownership.104 In the olden
days, large institutions such as major commercial banks monopolised the sovereign debt
market.105 Their limited number made it easier to coordinate any restructuring negotiations.
Nowadays, bondholders are spread wide around the globe.106 The investors include banks,
hedge funds or even retail investors.107 Hence, any restructuring operation is faced with a
coordination issue, namely getting these parties to negotiate. In addition, the existence of
unanimous action clauses (‘UACs’) makes things even worse. Prior to 2003, these clauses
were boilerplate in bonds issued under New York law.108 In essence, they required the
agreement of every creditor before any bond alteration could take place.109 Consequently, this
boilerplate term hampered the success of many a restructuring.110
Finally, restructuring negotiations are also plagued by conflicts of interests. Sovereign debtors
for one have interests that are completely contrary to those of their creditors. In the event of a
default, a sovereign will want to limit its payment obligation, while creditors will obviously
want to see their payment in full. However, this issue is not necessarily limited to debtors
versus creditors. Indeed, a lot of conflicts arise from creditors’ non-aligned interests.111 The
increased diversity in the composition of lenders is mirrored in their various concerns and
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1870.
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3.
104
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182.
105
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 50; Das and others, ‘Sovereign
Debt Restructurings’ (n 25) 17.
106
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182.
107
Ibid.
108
Choi and Gulati, ‘Innovation in Boilerplate Contracts’ (n 18) 932-933.
109
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work
Around’ (n 25) 2183.
110
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3.
111
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871.
102
103
18
Restructuring: What Happens Upon a Default
interests.112 For instance, the IMF might want to resolve a crisis as soon as possible for fear of
a ‘contagion’ that spreads to the global economy.113 Banks and investment funds, on the other
hand, are solely focused on financial gains and will be trying to make the best of the sovereign
default situation.114
In sum, a contractual restructuring is hardly a walk in the park. Moreover, even if a debt swap
occurs, a sovereign debtor’s problems are far from over. Bondholders who want to take the
deal might see their new interest payments blocked by creditors suing the sovereign debtor
and trying to get paid in full by way of litigation.115 These last ones are called holdout
creditors or rogue creditors and are discussed in detail below.
2.2.2. Contractual Restructuring in a Nutshell
Assuming that parties do get around the table, a restructuring process can be boiled down to
four key moments: (i) a trigger event, (ii) some form of negotiations, (iii) an exchange offer
and (iv) a debt swap.116
The sovereign debt restructuring process starts with a trigger event. 117 This event can either be
a default on payment obligations or an announcement that the sovereign debtor will no longer
be able to service its debt.118 Thereafter, negotiations119 ensue with the key purpose of solving
the default debt situation.120 In the 80s, when syndicated loans were restructured, these
negotiations were usually led by a committee of banks.121 At that time, the limited number of
investors made that practice possible. Nowadays, however, sovereign bonds are the primary
source of sovereign debt and, as mentioned before, dispersed bond-ownership creates a
creditor-coordination problem. As a result, the process requires reconciling all parties’
interests and it makes restructuring operations extremely time-consuming. Sometimes
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182.
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871.
114
Ibid.
115
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222.
116
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 12.
117
Ibid; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184.
118
Ibid; Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1868.
119
It should be noted that before or during negotiations the sovereign debtor will often contact the official sector
(i.e. the IMF, the ECB, the World Bank…). This is beneficial for the sovereign debtor, because the official sector
will either help to structure the negotiations, or provide a bailout if necessary. (Mauger, ‘Sovereign Debt
Restructuring’ (n 44) 103).
120
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 12; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1868.
121
Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1059.
112
113
19
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
negotiations take years to finalise. Eventually, if parties do reach an agreement, their solution
might range from a temporary standstill of payments to a fully-fledged debt swap.122
A solution involving a debt swap has one major objective: a high participation rate.123 In order
to achieve that goal, the terms of the agreement might hold some ‘carrot features’ or
‘sweeteners’ to convince the bondholders.124
These incentives come in a wide variety.
Creditors might be swayed by financial sweeteners such as upfront cash repayments, or they
might prefer advantageous legal provisions included in the new bonds. In 2005 Argentina
even tried its hand at a regulatory sweetener, but the ‘Lock Law’ turned out to be a disaster. 125
Be that as it may, the phenomenon of legal or financial sweeteners is definitely widespread
and statistics do show a significant increase in the participation rate because of them.126
Unfortunately, the voluntary nature of a sovereign debt restructuring results in some
bondholders who refuse to participate in the debt swap. These bondholders are called
‘holdouts’ or ‘rogue creditors’.127 It is safe to say that these holdouts are responsible for the
biggest disruptions in sovereign debt restructurings.128 They hope to achieve better terms by
making life difficult for the sovereign debtor. Though some are content with merely refusing
to participate, others take it up a notch and sue the sovereign demanding full payment.129 How
they manage that, is discussed below.
In a nutshell, the contractual restructuring process can be summarized in a comprehensive
figure:
Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Das and others, ‘Sovereign Debt Restructurings’ (n 25)
12.
123
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 22.
124
Ibid; Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instrument’ (n 47) 122; Turchi,
‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185.
125
See infra 3.3.2.3.8 NML Capital Ltd v Argentina.
126
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 24-26.
127
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1218.
128
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872.
129
Ibid; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079.
122
20
Holdouts in Action
Figure 1: Contractual Restructuring
•Default on (interest)
payments
•Restructuring
announcement
Trigger Event
2.3.
Negotiations
•Contacting the official
sector
•Starting (in)formal
negotiations with (major)
creditors
•Negotiating terms
•Debt reduction or debt
rescheduling
•Haircut of x %
•Legal or financial
'sweeteners'
Debt Swap
•Creditors either agree or
refuse to swap
•Participation rate of x %
Exchange
Offer
HOLDOUTS IN ACTION
2.3.1. The Role of Holdouts
Holdouts are often characterised as the major stumbling block in a sovereign debt
restructuring process.130 It is said that they have a disruptive effect, because their refusal to
cooperate lengthens the restructuring process and in doing so it increases legal and
reputational costs.131 Furthermore, if holdouts achieve their goal of better restructuring terms,
the actual burden falls on the distressed country’s citizens.132 Finally, it must be noted that
their actions create a disincentive for sovereigns and creditors alike to enter into restructuring
negotiations.133 On the whole, the majority of authors view them as ‘mavericks’ in the
sovereign debt market.134
Samuel E Goldman, ‘Mavericks in the Market: The Emerging Problem of Holdouts in Sovereign Debt
Restructuring’ (2000) 5 UCLA J. Int'l L. & Foreign Aff. 159, 164, (hereinafter: Goldman, ‘Mavericks in the
Market’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 22; Fisch and Gentile, ‘Vultures or Vanguards’
(n 42) 1092; Olivares-Caminal, ‘Is There a Need’ (n 2) 29; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872;
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185; Shapos, ‘Breaking the Impasse’
(n 44) 246.
131
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1092; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872.
132
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1092.
133
Ibid; Christopher C Wheeler and Amir Attaran, ‘Declawing the Vulture Funds: Rehabilitation of a Comity
Defense in Sovereign Debt Litigation’ (2003) 39 Stan. J. Int'l L. 253, 260, (hereinafter: Wheeler and Attaran,
‘Declawing the Vulture Funds’).
134
Goldman, ‘Mavericks in the Market’ (n 130) 164.
130
21
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
However, this mainstream view of holdouts is not shared by everyone. FISCH and GENTILE,
for example, argue that holdouts act as ‘vanguards’ vis-à-vis a sovereign’s misuse of
power.135 According to them, the existence of holdouts keeps the sovereign debtor in check by
preventing opportunistic defaults and by precluding abuse of sovereign immunity.136 So, one
could argue that holdouts do serve an essential role in the whole sovereign debt scenario.
Even though it is often viewed as distasteful or unfair.
2.3.2. Litigation as Leverage: The Sovereign Immunity Quandary
Holdouts try to achieve better terms or full repayment, but how do they realise that goal? In a
corporate context, a creditor faced with a default would try to obtain a money judgement and
enforce it by seizing a debtor’s assets.137 Similarly, a sovereign debt creditor can use litigation
as leverage during restructuring negotiations.138 However, in a sovereign context this
approach faces a couple of hurdles.139 Some even go as far as claiming that sovereign debt is
well-nigh unenforceable.140
In fact, GELPERN aptly surmises that holdouts find themselves in a sovereign ‘immunitybankruptcy standoff’.141 They simply cannot rely on bankruptcy remedies such as those found
in the Chapter 11 USC, nor can they easily obtain an enforceable judgement.142 Indeed,
sovereigns try to prevent any enforcement from happening by invoking their sovereign
immunity. Although the courts have become more lenient over the years, sovereign immunity
remains a formidable hurdle to clear.143
In a nutshell, holdouts will try to achieve better terms or full repayment by finding ways to
circumvent the sovereign ‘immunity-bankruptcy standoff’. In particular, they will use tactics
that eat away at the sovereign immunity defence.144
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1051.
Ibid.
137
Samples, ‘Rogue Trends’ (n 13) 49.
138
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185.
139
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220.
140
Gelpern, ’Contract Hope’ (n 20) 132; Samples, ‘Rogue Trends’ (n 13) 55.
141
Gelpern, ‘Pari Passu Endgames’ (n 11).
142
Ibid; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50; Day, ‘Market Failure’ (n 11) 232.
143
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1101.
144
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 51; Turchi, ‘Restructuring a
Sovereign Bond Pari Passu Work Around’ (n 25) 2185.
135
136
22
Holdouts in Action
2.3.2.1.
Forum Options
Holdouts seeking a money judgement have three forum options.145 They can either try their
luck in the sovereign debtors’ domestic courts, or they will have to find recourse in foreign
courts and arbitral bodies. Due to the risk of prejudicial treatment, chances are slim for
creditors to get lucky in a sovereign’s domestic courts.146 Moreover, most sovereign bonds do
not include an arbitration clause, which makes arbitration highly unlikely. 147 Instead, creditors
usually seek judgement in foreign courts even though that requires clearing the hurdle of
sovereign immunity.148
2.3.2.2.
Double trouble: The Sovereign Immunity Issue
The problem with sovereign immunity is actually twofold.149 A foreign court might refuse to
claim jurisdiction and even if a creditor obtains a money judgement, sovereign immunity will
most likely protect the sovereign debtors’ assets from attachment.
2.3.2.2.3. Jurisdictional Immunity
Nowadays, the jurisdiction issue has largely been done away with, but until the mid-twentieth
century sovereigns enjoyed ‘absolute’ immunity from suit in national courts.150 The rationale
behind this approach was that it offended a sovereign’s dignity to be brought before foreign
courts.151 However, over the course of years, sovereigns liberalised their policy vis-à-vis
sovereign immunity. The United States, for example, adopted a ‘restrictive theory’ via the
‘Tate Letter’ in 1952 and a few years later, this new policy was codified in the Foreign
Sovereign Immunities Act of 1976 (the ‘FSIA’).152
In essence, this new approach held to the basic idea of sovereign immunity, but it enumerated
a few important exceptions. For instance, a sovereign retained its immunity for public acts,
but private litigants obtained the right to sue the foreign sovereign in US Courts in the event
Day, ‘Market Failure’ (n 11) 232.
Ibid; W Mark C Weidemaier, ‘Contracting for State Intervention: The Origins of Sovereign Debt Arbitration’,
(2010) 73 Law & Contemp. Probs. 335, 337, (hereinafter: Weidemaier,’Contracting for State Intervention’).
147
Weidemaier,’Contracting for State Intervention’ (n 146) 336.
148
Ibid 335; Day, ‘Market Failure’ (n 11) 233.
149
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220; Shapos, ‘Breaking the Impasse’ (n 44) 252-253.
150
W Mark C Weidemaier, ‘Sovereign Immunity and Sovereign Debt’ (2014) U. Ill. L. Rev. 67, 68, (hereinafter:
Weidemaier, ‘Sovereign Immunity’).
151
Simon James, Julia Machin, Tim Morris and Andrew Yianni, ‘Sovereign Immunity: Don’t Cry for Me’
(Clifford Chance Client Briefings, July 2011) <http://www.cliffordchance.com/briefings.html> accessed 13
March 2016, (hereinafter: James, Machin, Morris and Yianni, ‘Sovereign Immunity’).
152
28 U.S.C. §1604-1605; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079; Shapos, ‘Breaking the
Impasse’ (n 44) 252.
145
146
23
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
of an immunity waiver or a commercial act.153 As a matter of fact the reference point for such
a ‘commercial act’ is a private party.154 If the latter could have engaged in the same behaviour
as the sovereign, then it is deemed ‘commercial act’ by the court.155 In other words, under the
restrictive theory sovereign immunity only shields explicit acts of state.156
Furthermore, in Republic of Argentina v Weltover157 the Supreme Court clarified the
commercial act exception and specifically stated that issuing sovereign bonds is a commercial
act, regardless of the activity’s purpose.158 Some considered this a huge win for holdouts, but
WEIDEMAIER points out that most sovereign bonds include immunity waivers anyway, thus
fulfilling another FSIA exception.159 In any event, regulation, case law and practices (such as
‘carrot features’)160 have done away with the absolute sovereign immunity in the United
States.
However, the restrictive theory did not limit itself to the FSIA. Other countries soon followed
the United States’ example. In the United Kingdom and Australia similar laws were enacted
that implemented the ‘restrictive theory’, namely the State Immunity Act of 1978 and the
Foreign State Immunities Act of 1985 (the ‘FSI Act’).161 Just like their American counterpart,
these acts enumerated a couple of exceptions, such as the ‘commercial act’ exception, while
holding to the basic rule of sovereign immunity.
In brief, it is nowadays globally accepted that in principle foreign states have immunity from
suit, unless certain criteria are fulfilled. For instance, if it pertains to a ‘commercial activity’,
or if an immunity waiver is in play. Consequently, these days it is rather easy for holdouts to
arraign a sovereign before a national court.
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079; Weidemaier, ‘Sovereign Immunity’ (n 150) 69;
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 52; Day, ‘Market Failure’ (n 11)
234; Shapos, ‘Breaking the Impasse’ (n 44) 252.
154
Day, ‘Market Failure’ (n 11) 234.
155
Ibid.
156
Ibid; Samples, ‘Rogue Trends’ (n 13) 56.
157
504 U.S. 607 (1992).
158
Day, ‘Market Failure’ (n 11) 234.
159
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1080; Blackman and Mukhi, ‘Vultures, Alter Egos and
Other Legal Fauna’ (n 27) 51; Weidemaier, ‘Sovereign Immunity’ (n 150) 69; Day, ‘Market Failure’ (n 11) 234;
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185; Samples, ‘Rogue Trends’ (n 13)
56.
160
See supra 2.2.2 Contractual Restructuring in a Nutshell.
161
Diana Chang, Jason Mendens, Julia Dreosti, Laura Sheridan Mouton and Rossalyn Warren, ‘Australian High
Court Gives Guidance on Sovereign Immunity for Foreign State Owned Entities’ (Clifford Chance Client
Briefings, September 2012) <http://www.cliffordchance.com/briefings.html> accessed 26 September 2016;
James, Machin, Morris and Yianni, ‘Sovereign Immunity’ (n 151) 1; Samples, ‘Rogue Trends’ (n 13) 57.
153
24
Holdouts in Action
This brings us to the content of money judgements. Most sovereign debt instruments include
‘acceleration’ as remedy for a default, but no way to enforce it. 162 How then do judgementholders get a sovereign debtor to pay in full, especially since the debtor cannot even pay in
part (i.e. interest and principal)? In other words, obtaining a ‘money judgement’ might no
longer be the real issue, but enforcement of said judgement is. Lacking any other course of
action, a holdout is left with trying to attach a sovereign debtor’s assets, even though
sovereigns are quite skilled at sheltering them.163 Small wonder that so-called ‘asset hunting’
is considered the centrepiece of a sovereign debt dispute these days.164
2.3.2.2.4. Enforcement Immunity: The Hunt for Assets
Under normal circumstances, a debtor’s refusal to comply with a court order to pay would result in a
seizure of his assets.165 In a sovereign debt context, however, this is seldom the case.166 Usually the
assets are beyond the reach of creditors, because the process of attachment is extremely difficult or
virtually impossible.167
A holdout’s first course of action will be an attempt at executing the money judgement before
a sovereign debtors’ domestic courts. 168 However, it is highly unlikely that a national court
will enforce a foreign judgement due to the risk of prejudicial treatment.169 Therefore, the next
step will be an execution abroad, but unfortunately that is often just as unsuccessful.170
In the olden days, a sovereign’s assets enjoyed an absolute sovereign immunity similar to that
of immunity from suit.171 Even the Tate Letter, which introduced a restrictive immunity
policy, did not provide judgement-holders with rights to enforce a judgement.172 It was not
until the FSIA that enforcement became possible with a legal framework akin to that of the
Tate Letter.173 In principle, a sovereigns’ property was immune from execution, unless an
exception applied.174 For instance, if a sovereign waived its immunity from execution, or if its
Day, ‘Market Failure’ (n 11) 230.
Weidemaier, ‘Sovereign Immunity’ (n 150) 69.
164
Samples, ‘Rogue Trends’ (n 13) 57.
165
Day, ‘Market Failure’ (n 11) 230; Samples, ‘Rogue Trends’ (n 13) 55.
166
Ibid.
167
Ibid.
168
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220.
169
Ibid.
170
Ibid.
171
Weidemaier, ‘Sovereign Immunity’ (n 150) 78.
172
Ibid 78-79.
173
Ibid.
174
28 U.S.C. § 1609-1610(a).
162
163
25
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
assets were used for a commercial activity.175 Unfortunately, the FSIA does not provide
judgement-holders with an ironclad guarantee of success.176 A fortiori, if a sovereign debt
instrument does not include a specific immunity waiver for execution then judgement-holders
are back to square one.
For starters, the exception under §1610(a) FSIA only grants a right to attach ‘commercially
used’ assets.177 A landmark case in this context is Connecticut Bank of Commerce v. Republic
of Congo178 in which the Fifth Circuit specifically emphasised the words ‘used for’.179 The
fact that the money is raised by means of a commercial activity such as sovereign bonds is
irrelevant.180 What matters is how it is spent.181 Besides, the targeted assets need to be used
for ‘the commercial activity upon which the claim is based’.182 As a result, courts have been
reluctant in permitting holdouts to attach a sovereign’s property, since the activity is
borrowing and that money has usually been spent.183 Lacking any other assets that fall under
the FSIA exception, judgement-holders often see their enforcement claims blocked.184
Nowadays, the criterion of ‘commercially used assets’ is used globally to break through
sovereign immunity. By way of example, article 1412quinquies of the Belgian Civil
Procedure Code and article 13(4) of the UK’s State Immunity Act 1978 specifically exclude
175
Ibid.
Weidemaier, ‘Sovereign Immunity’ (n 150) 80; Day, ‘Market Failure’ (n 11) 234.
177
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Day, ‘Market Failure’ (n 11)
236.
178
309 F.3d 240.
179
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Day, ‘Market Failure’ (n 11)
236;
180
309 F.3d 240 at 253.
181
Ibid.
182
28 U.S.C. § 1610(a)(2).
183
Day, ‘Market Failure’ (n 11) 236.
184
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Samples, ‘Rogue Trends’ (n
13) 61.
176
26
Vulture Funds
such assets.185 Consequently, holdouts find themselves on a veritable hunt for commercially
used assets, which can lead to ridiculous little squabbles. For instance, in 2012 a holdout
named NML Capital persuaded Ghanaian authorities to seize Argentina’s sailing frigate the
‘ARA Libertad’.186 Some time later, Argentina saw its presidential plane grounded and to top
it off, even its central bank funds were targeted.187 Futility and ridiculousness set aside, these
skirmishes are hardly efficient or even effective. With costs easily running in the millions and
reputational damage skyrocketing, this tactic is both extremely expensive and ever so timeconsuming.188
Enter the vulture funds. The emergence of the sovereign bond market in the 1980s also
marked the rise of vulture funds.189 These big investors saw a new business opportunity and
started buying distressed debt at a discount. With time and money on their side, these
investors were far better placed to endure the hardships of being a holdout. Consequently, the
number of sovereign debt litigation increased.
2.4.
VULTURE FUNDS
As mentioned before, holdouts are the major stumbling block of a sovereign debt
restructuring. They try to receive full repayment by way of litigation, often to the detriment of
the exchange bondholders and the debtor’s citizens. However, the sovereign-immunitybankruptcy situation makes enforcing judgements virtually impossible. Why then does
sovereign debt litigation occur? More specifically, how do vulture funds tie into this whole
scenario?
2.4.1. What are Vulture Funds?
A sovereign debt restructuring usually results in an exchange offer. Upon such a debt swap
there are two types of creditors, namely exchange bondholders and those who refuse to
cooperate. The latter are called holdouts. In general, holdouts can be subdivided into
‘institutional or sophisticated’ creditors such as investment funds, retirement funds or vulture
Day, ‘Market Failure’ (n 11) 238.
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2496; Samples, ‘Rogue Trends’ (n 13) 61.
187
Anna Gelpern, ‘Sovereign Damage Control’ (2013) PB13-12 Peterson Institute for International Economics
Policy Brief at 5 <http://www.iie.com/publications/pb/pb13-12.pdf> accessed 7 March 2016, (hereinafter:
Gelpern, ‘Sovereign Damage Control’).
188
Samples, ‘Rogue Trends’ (n 13) 61.
189
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50.
185
186
27
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
funds, and ‘retail or individual’ creditors.190 Consequently, holdouts might therefore be
vulture funds, but the opposite is not necessarily true.
The term vulture fund refers to a certain type of holdout-creditor that operates in the sovereign
debt market in a –according to most authors– morally deplorable way.191 More specifically, it
buys up the distressed debt of poor countries at a steep discount with the sole intention of
suing the sovereign debtor for repayment at par value.192 Unsurprisingly, advocates of the
vulture funds’ operations usually refer to them as ‘distressed debt investors’ rather than
vultures.193
According to SOOKUN the key features of a vulture fund can be summarised as follows:194
(i).
It is not the primary lender of the money.
(ii).
It purchases distressed debt on the secondary market at a steep discount; and
(iii).
It sues the sovereign debtor for full value of the debt, including interest, generating
a return of 300 to 2000 per cent.195
Understandably, most authors view ‘vulturing’ is morally deplorable. These funds pray on
financially distressed countries and bleed them dry. However, SAMPLES justly points out that
‘[f]airness and ethics aside, vulturing is [still] a legal activity’.196 Therefore, it is up to
regulators and drafters to take note of this risk.
The most famous vulture fund, the rock star of the bunch as it were, is Elliott Associates,
which was founded by billionaire Paul Singer.197 This vulture fund gained notoriety for its use
of a creative enforcement device based on the pari passu clause, i.e. a boilerplate clause in
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1235.
Devi Sookun, Stop Vulture Fund Lawsuits (the Commonwealth Secretariat 2010) 7, (hereinafter: Sookun,
Stop Vulture Fund Lawsuits).
192
Ibid; Manmohan Singh, ‘Recovery Rates from Distressed Debt –Empirical Evidence from Chapter 11 Filings,
International Legislation, and Recent Sovereign Debt Restructurings’ (2003) IMF Working Paper No. 03/161 9
<http://www.imf.org/external/pubs/ft/wp/2003/wp03161.pdf> accessed 6 April 2016, (hereinafter: Singh,
‘Recovery Rates’); Wheeler and Attaran, ‘Declawing the Vulture Funds’ (n 133) 254; Fisch and Gentile,
‘Vultures or Vanguards’ (n 42) 1049; Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27)
49; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50; Cohen, ‘Cigar’ (n 68) 12; Ryan, ‘Sovereign
Bankruptcy’ (n 3) 2496; Samples, ‘Rogue Trends’ (n 13) 59.
193
Sookun, Stop Vulture Fund Lawsuits (n 191) 7.
194
Ibid.
195
Singh, ‘Recovery Rates’ (n 192) 9.
196
Samples, ‘Rogue Trends’ (n 13) 59. In the same sense: Goldman, ‘Mavericks in the Market’ (n 130) 171 and
Sookun, Stop Vulture Fund Lawsuits (n 191) 12.
197
Sookun, Stop Vulture Fund Lawsuits (n 191) 7; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2495-2496.
190
191
28
Vulture Funds
debt instruments.198
Backed by this devastating new technique Elliot managed to force
sovereign debtors into settling cases such as Elliot v Peru and NML Capital v. Argentina.199
2.4.2. Vultures: A Different Sort of Holdouts
Vulture funds have the time and the money to act upon the litigation threat. They are able to
withstand the hardships of obtaining and enforcing a judgement in any possible way. Besides,
in contrast to commercial banks during the ‘80s, vulture funds cannot be cajoled or coerced
into an exchange offer.200 During the Latin American sovereign debt crisis of the ‘80s banks
were willing participants in the restructuring negotiations.201 They simply did not opt for
litigation. This was largely due to the fact that they risked bankruptcy themselves, but also
because but they faced peer/political pressure to accept the exchange offers.202 When the
sovereign debt landscape evolved from syndicated loans to sovereign bonds, this all changed.
Although there are still some banks in the mix that are subject to the same old coercion
techniques, there are others types of bondholders as well. These atomised bondholders are far
more ‘independent’ and they have diverging interests.203 As a result, it is virtually impossible
to coerce them, especially vulture funds whose sole purpose is to force sovereign debtors into
settlements by way of litigation.
2.4.3. The Role of Vulture Funds
Advocates for vulture funds and holdouts in general claim that holdouts play an essential role
in a sovereign default scenario.204 To support that claim, they proffer several arguments.
First of all, they assert that vulture funds provide liquidity to the market which encourages
market participation and benefits retail investors.205 By buying up distressed debt, they free up
Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 55.
For a detailed overview of the pari passu clause in sovereign debt litigation, see infra 3 Pari Passu Clauses:
The Root of the Problem?
200
Lee C Buchheit, Mitu Gulati and Ignacio Tirado, ‘The Problem of Holdout Creditors in Eurozone Sovereign
Debt Restructurings’ (2013) 4 JIBFL 191.
201
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1064-65; Samples, ‘Rogue Trends’ (n 13) 56.
202
Ibid; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178.
203
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1093; Samples, ‘Rogue Trends’ (n 13) 56.
204
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1235; Fisch and Gentile, ‘Vultures or Vanguards’ (n
42) 1047; Elizabeth Broomfield, ’Subduing the Vultures: Assessing Government Caps on Recovery in Sovereign
Debt Litigation’ (2010) Colum. Bus. L. Rev. 473, 514, (hereinafter: Broomfield, ‘Subduing the Vultures’);
Aaron L Warren and Ryan E Avery, ‘Investors of Prey: Seeking Relief in Distressed Debt Markets’ (2010) 18 U.
Miami Int'l & Comp. L. Rev. 213, 227, (hereinafter: Warren and Avery, ‘Investors of Prey’); Cohen, ‘Cigar’ (n
68) 13-14; Shapos, ‘Breaking the Impasse’ (n 44) 246; Samples, ‘Rogue Trends’ (n 13) 59.
205
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1104; Cohen, ‘Cigar’ (n 68) 13; Samples, ‘Rogue Trends’
(n 13) 59; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2188.
198
199
29
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
cash for bondholders who cannot afford to await the outcome of court proceedings or even the
end of restructuring negotiations. Secondly, these authors claim that issuers benefit from
having a distressed debt market where they can sell new debt to investors. Particularly since
those investors are aware that an investment in sovereign debt might not be lucrative in the
long run.206 Finally, the proponents are of the opinion that vulture funds’ existence keeps
sovereign debtors in check. According them, vulture funds prevent opportunistic defaults and
unreasonable restructuring terms.207 Or as COHEN puts it: ‘[vultures] maintain balance in the
sovereign debt market. The threat of enforcing the terms of the contract […] gives them
leverage [and as such it keeps] sovereign debtors […] cocooned in sovereign immunity in
check.’208 Moreover, BROOMFIELD and others even assert that vulture funds serve as a check
on corruption.209 In the oft-cited case of Kensington International v Congo210 Kensington’s211
team of private investigators and forensic accountants laid bare a corruption scandal that
otherwise would have continued undisturbedly.212 In sum, there are a number of reasons why
vulture funds could be considered ‘essential’ for the sovereign debt market.
Be that as it may, critics are of the opinion that vulture funds –being holdouts– disrupt the
restructuring process, needlessly burden a sovereign debtor’s citizens and create a disincentive
for creditors and sovereign debtors to negotiate.213 Moreover, one cannot deny a certain
distaste for the whole vulture operation, even though they only hold sovereigns to their
contractual obligations. The fact that they bleed the country dry and make an outrageous
amount of money in the process, only strengthens the dismalness of the situation.
In addition, the critics refute the proponents’ arguments. Regarding the ‘check’ on
opportunistic defaults, they assert that sovereigns have multiple compelling reasons to pay.214
For instance reputational costs, political consequences and access to the market. 215 Also, the
Cohen, ‘Cigar’ (n 68) 13; Sookun, Stop Vulture Fund Lawsuits (n 191) 11.
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1053 and 1103; Bratton, ‘Pari Passu and a Distressed
Sovereign’ (n 75) 843; Broomfield, ‘Subduing the Vultures’ (n 204) 514; Warren and Avery, ‘Investors of Prey’
(n 204) 227; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2188.
208
Cohen, ‘Cigar’ (n 68) 13.
209
Broomfield, ‘Subduing the Vultures’ (n 204) 516; Warren and Avery, ‘Investors of Prey’ (n 204) 227.
210
[2005] EWHC 2684 Queen’s Bench Division (Commercial Court).
211
It is worthy of note that Kensington International Ltd is in fact an affiliate of Elliott Associates.
<https://en.wikipedia.org/wiki/Elliott_Management_Corporation#Affiliates_and_units>
212
Broomfield, ‘Subduing the Vultures’ (n 204) 516; Warren and Avery, ‘Investors of Prey’ (n 204) 227.
213
See supra 2.3.1 The Role of Holdouts.
214
Ibid 63.
215
Ibid.
206
207
30
Conclusion: Holdouts Are the Result of Market Failure
corruption argument is utterly absurd.216 Claiming that one person’s or one government’s
activities reflect the situation of an entire continent is ridiculously far-fetched.217
Given these arguments, it is quite clear that this whole issue is a matter of perspective. Neither
critics nor advocates can give any conclusive evidence to support their assertions.
Nevertheless, no matter what side you are on, there is one simple truth you cannot deny:
‘Fairness and ethics aside, vulturing is [still] a legal activity.’218 Consequently, the only way
forward is a regulatory response or a contractual solution to resolve or mitigate the holdout
issue in general.
2.5.
CONCLUSION: HOLDOUTS ARE THE RESULT OF MARKET FAILURE
When faced with a sovereign debt default situation there are simply no contractual or
regulatory mechanisms in place to resolve the debtor-creditor dispute. As a result, sovereign
debtors are practically obliged to enter into restructuring negotiations. Often these
restructurings lead to an exchange offer whereupon the creditors have the opportunity to
exchange their old debt for new debt at different –often inferior– terms. Usually, the majority
of bondholders participate in the debt swap. The chief reason behind this is that a bird in the
hand is worth two in the bush. Since sovereign debtors cannot be declared bankrupt and since
they are virtually cocooned in sovereign immunity, it is often deemed cheaper to accept a
‘haircut’ than to hope for a positive outcome in lengthy ‘asset hunt’ litigation. However, due
to the voluntary nature of sovereign debt restructuring, some creditors refuse to cooperate.
These so-called holdouts do not shirk from the sovereign-immunity bankruptcy situation and
seek repayment in full via the courts.
Vulture funds go even one step further. These holdouts actually purchase distressed debt with
the sole intention of making a profit by way of litigation, simply because they have the time
and money to withstand the hardships of being a holdout. Nevertheless, vulture funds still find
themselves in a sovereign-immunity-bankruptcy standoff situation. Therefore, they try to find
creative ways of piercing or circumventing a sovereigns’ defences. One of those tactics, is
suing states for alleged breaches of the pari passu clause, which –if successful– forces
sovereign debtors to choose between defaulting on exchanged bonds or paying holdouts. In
TransAfrica Forum, ‘Stop Vulture Culture’ <http://www.jubileeusa.org/fileadmin/user_upload/Resources/
Vulture_Funds/Vulture_Funds_TAF_7_09.pdf> accessed 8 April 2016.
217
Ibid.
218
Samples, ‘Rogue Trends’ (n 13) 59.
216
31
Holdouts: The Bane or Boon of Sovereign Debt Restructuring
essence, this tactic completely bypasses the issue of ‘asset hunting’ and has been a favourite
of vulture funds ever since its first appearance in Elliott v. Peru.219 A detailed overview of the
pari passu clause, its history and (mis)use, can be found in the next chapter.
219
32
Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
PARI PASSU CLAUSES: THE ROOT OF THE PROBLEM?
In the previous chapter it became apparent that holdouts are caught between a rock and a hard
place, namely sovereign immunity and the lack of a sovereign bankruptcy regime.
Consequently, they had to resort to all kinds of (far-fetched) strategies to force a sovereign
state to its knees. One of those so-called self-help stratagems220 is blocking cross-border
payments through litigation based on an alleged breach of the pari passu clause.
Hence, this chapter will shed some light on the history of the pari passu clause, its meaning
portrayed in litigation and the implications of the different interpretations from both a New
York and English law perspective. All that in order to identify the actual problem and how it
might be resolved or mitigated.
3.1.
THE HISTORY
OF THE
PARI PASSU:
THE
WHAT,
THE
WHY
AND THE
WHEN
Before delving into the technicalities of a matter, it is often advisable to take a look at the
bigger picture. Pari passu clauses are no exception. Nowadays they are considered boilerplate
in international bond issues and syndicated loan agreements221, but this was not always the
case. Once upon a time, this little Latin phrase meaning ‘in equal step’ or ‘equally’, was
introduced into these debt instruments for a very specific reason.222 The question therefore
becomes: What was that reason and what does the clause mean today?
The evolution of the pari passu clause can be boiled down to three stages.223 It first appeared
in secured lending in the 19th century, was replaced in the middle of the 20th century by
negative pledges and later re-emerged in the ‘70s with the rise of the syndicated loan
agreement. Closely linked to these three stages is the wording of the clause, which underwent
Day, ‘Market Failure’ (n 10) 247.
Philip R Wood, ‘Pari Passu Clauses –What Do They Mean’ (2003) JIBFL 371, 371 (hereinafter: Wood, ‘Pari
Passu clauses –What do they mean?’).
222
Francis B Palmer, Company Precedents 109-110 (8th ed. Stevens and Sons, 1900); C. DE KONINCK, Latijnse
rechtstermen, Maklu, Antwerpen, 2003, 83; Lee C Buchheit and Jeremiah S Pam, ‘The Pari Passu Clause in
Sovereign Debt Instruments’ (2004) 53 Emory L.J. 869, 871, (hereinafter: Buchheit and Pam, ‘Sovereign Debt
Instruments’).
223
Clifford Chance LLP, ‘Pari Passu Clauses –Do you really know what they mean’ (Clifford Chance Client
Briefings, 2004) at 1, 2 <www.emta.org> accessed 26 September 2015 (hereinafter: Clifford Chance LLP, ‘Pari
Passu Clauses’); Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 894.
220
221
33
Pari Passu Clauses: The Root of the Problem?
significant changes as well. It evolved from “pari passu in point of priority and security” to its
present version of “pari passu in priority of payment”.224
The following paragraphs will address these stages in more detail and indicate how this
evolution has served as the bedrock for the holdout-issue we are faced with today.
3.1.1. The 19th Century: Pari Passu and ‘Secured’ Lending
Originally, the pari passu clause was only present in (sovereign) debt instruments when they
included collateral security. At that time, companies often issued multiple series of bonds and
secured them against a common pool of collateral.225 However, bondholders wishing to
enforce their claims were faced with the ‘first-to-be-issued’ rule, which applied under English
law.226 This rule created priorities in claims depending on the date of issue of the bond series.
Here is an example by BUCHHEIT and PAM of how this rule operated in practice:
[A] series of bonds issued in 1876 would have had a priority claim over the disposition of
the common collateral as against a second series issued, say, in 1877.227
Evidently, bondholders sought to protect themselves against this bothersome rule and this is
where the pari passu clause comes into play. English law stated that the ‘first-to-be-issued’
rule could be changed by contract.228 Thus, the pari passu clause was intended to ensure that
enforcement of the security would result in all bondholders sharing equally and rateably in the
proceeds of a liquidation.229 For example, a typical clause at that time might have read:
[A]nd will rank pari passu in point of charge, without preference or priority as to the date
of issue.230
Still, it should be noted that the scope of the clause was exclusively limited to enforcement. It
did not prohibit the creditor from obtaining (judgement and) payment from the debtor directly,
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 894 and 902.
Ibid 895;
226
Ibid 895; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 833; Clifford Chance LLP, ‘Pari Passu
Clauses’ (n 223) 2.
227
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 895.
228
Ibid 896.
229
Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2; Buchheit and Pam, ‘Sovereign Debt Instruments’ (n
222) 896.
230
Example of debenture stock of Adelaide Electric Supply Company Limited in 191. (See ‘Share Market and
Mining’ (1911, July 4), The Register (Adelaide, SA: 1901 - 1929) 4 <http://nla.gov.au/nla.newsarticle58444025> accessed November 29 2015 (Emphasis added).
224
225
34
The History of the Pari Passu: The What, Why and When
without resorting to the liquidation of the collateral.231 Hence, the first kind of ‘ranking’
interpretation of the pari passu clause was born.
3.1.2. The Mid-20th Century: Negative Pledges Supplant Pari Passu Clauses
While the 19th century was characterised by secured lending, the early 20th century clearly
was not. In those days, countries often resorted to the technique of ‘earmarking’ instead. 232
These aptly named ‘quasi-security interests’233 consisted of tagging certain revenues or assets
for individual creditors without actually creating any formal security interest. Even though
these commitments were questionable at best, pari passu clauses were often included to
prevent them.234
Lacking the security of olden times, ‘secured’ lending to sovereign states quickly diminished.
Especially after the Great Crash of 1929, which had shown lenders how difficult it was to
actually enforce collateral.235 With the decline of secured lending, the pari passu clause lost
its purpose and thus became redundant.
To fill the void, negative pledges were introduced. These clauses essentially prohibited both
sovereign states and governmental agencies from pledging any collateral at all. 236 Although
they were already common in U.S. domestic bond issues237, they only gained ground
following the development lending after World War II.238 Particularly so when it became the
World Bank’s policy to lend without seeking any collateral security.239 On the other hand, the
231
Francis B Palmer, Company Law, 197 (2nd ed. 1898).
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 897; Bratton, ‘Pari Passu and a Distressed
Sovereign’ (n 75) 834.
233
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 834.
234
Andrew Shaw, ’Ways to get paid in a sovereign default’ (2014) 10 JIBFL 629, 629, (hereinafter: Shaw,
’Ways to get paid in a sovereign default’); EMTA, ‘The Pari Passu Clause – What is Fair Treatment’ (2004) 3
<www.emta.org> accessed 26 September 2015; FMLC, ‘Analysis of the role, use and meaning of pari passu
clauses in sovereign debt obligations as a matter of English law’ (2005) 79 FMLC Papers 1, 7,
<www.fmlc.org/uploads/2/6/5/8/26584807/79.pdf> accessed on 26 September 2015, (hereinafter: FMLC,
‘Analysis of the role, use and meaning of pari passu clauses’).
235
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 898.
236
Ibid 899; Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2.
237
Francis W Jacob, ‘The Effect of Provision for Ratable Protection of Debenture Holders in Case of Subsequent
Mortgage’ (1938) 52 Harv. L. Rev. 77, 78.
238
Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2.
239
As referenced by Devesh Kapur, John Prior Lewis and Richard Webs in The World Bank: History, vol 1
(Brookings Institution Press 1997) 921:
232
As a general principle the Bank does not seek or accept liens on specific revenues or assets as
security for loans to member governments. (From IBRD, ‘Bank’s Policy on Security for Loans to
Member Governments’, Resolution 145, M-208, June, 26 1950.
35
Pari Passu Clauses: The Root of the Problem?
World Bank used a very strict negative pledge to compensate for that lack of collateral. 240
Consequently, the “unsecured” lending trend had begun.241
3.1.3. The 1970s: The Rise of Syndicated Loans and the Return of Pari Passu Clauses
The final stage of the pari passu evolution coincides with the appearance of two novelties:
commercial banks and syndicated loan agreements.242 Using money that was raised on the
Eurodollar market, this new type of lender started using the Syndicated Eurodollar Loan
Agreements in the late ‘60s, early 70s.243 Boilerplate amongst these agreements were the
negative pledge and pari passu clause. Early on, these clauses were often combined into one,
but later they appeared as stand-alone clauses.244
Since these Eurodollar Agreements often did not request collateral, there was no need to
protect the commercial banks from the ‘first-to-be-issued’ rule.245 This raises the question:
‘What were pari passu clauses doing in those agreements?’ The answer can be found in the
brand-new danger commercial banks had to face, namely (involuntary) subordination.246
Under New York and English law, involuntary subordination was impossible.247 Domestic
credit agreements therefore did not include pari passu clauses. Cross-border lending on the
other hand, was subject to national law regimes that differed from the US and English
approach. For example, Spain and the Philippines both allowed unsecured creditors to achieve
priority over other unsecured creditors simply by notarising their credit agreements.248
Moreover, creditors were faced with the possibility that sovereign states might pass a law
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 899; Clifford Chance LLP, ‘Pari Passu Clauses’ (n
223) 2.
241
Georges R Delaume, Legal Aspects of International Lending and Economic Development Financing (1967),
233 n. 52; Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900.
242
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900, Clifford Chance LLP, ‘Pari Passu Clauses’ (n
223) 2.
243
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900; Philip R. Wood, ‘Sovereign Syndicated Bank
Credits in the 1970s’ (2010) 73 Law & Contemp. Probs. 7, 21.
244
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 902.
245
Ibid 902.
246
Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2.
247
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 834.
248
William Tudor John, ‘Sovereign risk and immunity under English Law and Practice’, (1983) 1 International
Financial Law 79, 95; Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371.
240
36
Ranking vs. Payment: The Pari Passu Conundrum
subordinating all foreign lenders in favour of others.249 Needless to say, creditors quickly
became aware of these risks and started to use pari passu clauses to protect themselves.
This new rationale was also reflected in the wording of the clause, which had changed
remarkably compared to the pari passu clauses found in the 19th century secured debt
agreements. For instance, the words ‘rank pari passu in point of charge/in point of security’
were exchanged for ‘rank and will rank pari passu in point of priority of payment/in right of
payment’. Apparently, the legal ‘ranking’ of the debt had become a priority for drafters.250
To conclude, history clearly shows one and only one interpretation of the pari passu clause,
namely anything that has to do with ‘ranking’. Where one form focussed on a rateable interest
in a common pool of assets, the other focussed on preventing subordination of debt. Be that as
it may, recent litigation251 has introduced a brand-new interpretation of the clause, the
‘payment’ interpretation. What this entails and how this came to be, will be discussed below.
3.2.
RANKING VS. PAYMENT: THE PARI PASSU CONUNDRUM
3.2.1. Description
For decades, pari passu clauses have been present in secured and unsecured, corporate and
sovereign debt obligations. Their function ranging from a representation or covenant in credit
agreements to terms and conditions in bond issues.252 Below are some examples of typical
pari passu clauses:
The bonds and the coupons are direct, unconditional and unsecured obligations of the
issuer and rank and will rank at least pari passu, without any preference among
themselves, with all other outstanding, unsecured and unsubordinated obligations of the
issuer, present and future.253
The Notes rank, and will rank pari passu in right of payment with all other present and
future unsecured and unsubordinated External Indebtedness of the Issuer.254
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 905.
Ibid 902 and 905.
251
Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/; Brussel (9e Kamer) 19 maart 2004, Republiek
Nicaragua t/ LNC Investments LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831; NML
Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
252
Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 1.
253
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 4.
254
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 902 and 871
249
250
37
Pari Passu Clauses: The Root of the Problem?
Clearly, the wording of this type of clause is very vague and differs from drafter to drafter.
Not to mention the fact that it appears in both a corporate and a sovereign context, which
makes divining the actual meaning of the clause even more of a chore. Nevertheless, there are
a few things which can be derived from the words themselves.
(i).
The key word is ‘rank’; 255 and
(ii).
There are two limbs to this clause (in case of bond issues).256
a. an internal limb: bonds rank pari passu with each other.
b. an external limb: bonds rank pari passu with other (unsecured) debt.
Still, it must be noted that studies have revealed that the meaning of the clause does not
change, regardless of the wording.257 Hence, the question: What does this clause actually
mean? Particular because it appears in two very distinct situations, namely the corporate and
the sovereign context.
3.2.2. Corporate context
In a corporate context, the notion of ‘ranking equally’258 is closely linked to bankruptcy.259
When a company goes bankrupt, its assets are liquidated. Insolvency regulation then provides
for an orderly distribution of the resulting proceeds and ensures that every ‘equally ranking’
unsecured creditor gets his proportional share. However, there are a number of ways whereby
an unsecured creditor might see his claim subordinated. For example: 260
(i).
In many jurisdictions taxes and wages rank senior to other unsecured claims.
(ii).
Retail depositors with banks, or holders of insurance policies might also benefit
from a statutory seniority.
Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372;
Ibid; FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 4.
257
Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372; FMLC, ‘Analysis of the role, use and meaning
of pari passu clauses’ (n 234) 5.
258
Pari Passu means ‘in equal step’ in Latin. (See C. DE KONINCK, Latijnse rechtstermen, Maklu, Antwerpen,
2003, 83).
259
Benjamin Chabot and Mitu Gulati, ‘Santa Anna and his Black Eagle: The Origins of the Pari Passu?’ (2014) 9
(3) CMLJ 216, 220 <http://cmlj.oxfordjournals.org/content/9/3/216.full.pdf+html> accessed 16 February 2016
(hereinafter: Chabot and Gulati, ‘Santa Anna and his Black Eagle’).
260
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 6.
255
256
38
Ranking vs. Payment: The Pari Passu Conundrum
(iii).
Some countries (e.g. the Philippines and –formerly– Spain)261 even allow
involuntary subordination.262
(iv).
The date of issue might play a part in the ranking for payment in liquidation.
There is little a creditor can do to prevent seniority resulting from statutory rules but, as
explained above,263 involuntary subordination can be averted by inserting a pari passu clause
in the agreement.
In short, the purport of the pari passu clause in a corporate context is to obtain a promise, a
commitment or warranty that the status of the unsubordinated debt will remain unchanged and
that unsecured lenders will be entitled to a pro rata payment in case of a distribution of assets
resulting from insolvency.264
3.2.3. Sovereign Context
The crucial difference between a corporate and a sovereign context, is the lack of an
insolvency regime for sovereign debtors.265 They simply cannot be declared bankrupt266 under
any domestic or international law. It follows that there must be a different reason for the
presence of pari passu clauses in such a cases. Said reason will be discussed below.
Until a few years back, no one really made a fuss about the presence of the clause. Some even
asserted that its presence was the result of ignorant copy-pasting of drafters.267 Nevertheless,
over the course of years two interpretations of the pari passu clause have surfaced: the
‘ranking’ interpretation and the ‘payment’ interpretation.268
(i).
Ranking or narrow interpretation
For a long time, the ruling interpretation was the so-called ‘ranking’ or ‘narrow’
interpretation. Simply put, this interpretation argues that the pari passu clause merely seeks to
261
In the meantime, the law in Spain has been changed. Involuntary subordination is no longer possible under the
‘Ley Concursal’, which states that every unsecured creditor must be paid on a pro rata basis upon insolvency of
a debtor. (See FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 6).
262
See supra 3.1.3 The 1970s: The Rise of Syndicated Loans and Return of the Pari Passu Clause.
263
Ibid.
264
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7.
265
Ibid; Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 5.
266
Theoretically they cannot even become insolvent, because they have the ability to keep raising taxes (See
Olivares-Caminal, ‘Is There a Need’ (n 2) 21).
267
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 875; Olivares-Caminal, ‘Understanding the Pari
Passu’ (n 7) 1233; Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 219.
268
Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372; Buchheit and Pam, ‘Sovereign Debt
Instruments’ (n 222) 876; FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7.
39
Pari Passu Clauses: The Root of the Problem?
prevent a borrower from performing actions that would result in a change of legal ranking of
the debt,269 i.e. preventing actions ‘having the effect of preferring one set of creditors against
the others’.270 For example, preventing the sovereign state from ‘earmarking’ certain revenues
or assets, or from involuntarily subordinating a debt via domestic law.
(ii).
Payment or broad interpretation
The Elliott case, however, introduced a brand new interpretation.271 The so-called ‘payment’
or ‘broad’ interpretation essentially argues that ‘a borrower will not pay one creditor anything
without also paying its other creditors pro rata so that nobody is preferred’, i.e. an obligation
for the borrower to pay all its equally-ranking debt on a strictly lockstep basis.272
This interpretation clearly raises a few questions: (i) Where does this interpretation stem
from? How did the ranking interpretation suddenly evolve into a payment interpretation? (ii)
Who would benefit and (iii) what is there to gain from such an interpretation? The answer lies
in vulture funds, self-help strategies and the subsequent waves of litigation: Pravin, Elliott,
LNC and NML.273
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 876.
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7.
271
Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363 (2d. Cir. 1999).
272
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 876; Wood, ‘Pari Passu clauses –What do they
mean?’ (n 221) 372.
273
Pravin Banker Associates v Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997); Brussel 26 September
2000, 8e Kamer, AR nr. 2000/QR/; Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments
LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831.; NML Capital Ltd. v. Republic of
Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
269
270
40
Waves of Litigation and their Consequences
3.3.
WAVES OF LITIGATION AND THEIR CONSEQUENCES
3.3.1. Introductory Remarks
Before delving into the case-law, it should be noted that both governing law and jurisdiction
are of vital importance in international transactions, especially in distressed debt situations
where the viable options for both debtor and creditor greatly depend on the chosen applicable
law and jurisdiction. For instance, a debtor has to be aware that the use of exit consents274 or
CACs275 significantly differs under English law compared to New York state law.276 A
creditor, on the other hand, will often have to make do with remedies the enforcing court is
already familiar with, even though those are not necessarily the ones the governing law
prescribes. Indeed, it is known that judges tend to apply the law they know best.277 Hence, it is
of the utmost importance to determine which law is applicable, which court has jurisdiction
and what that entails for both debtor and creditor.
Although borrowers are free to choose, New York state law and English law are by far the
prime systems of governing law with regard to (sovereign) debt agreements.278 For instance,
in notional value English law represents approximately 40 percent of international sovereign
bonds.279 Therefore, the cases discussed below are the most prominent ones of those two law
regimes. First, we will take a look at the three waves of litigation under New York state law.
This means analysing Pravin Banker Associates v. Banco Popular Del Peru280, followed by
Elliott v. Peru, LNC Investment v. Nicaragua
281
and finishing up with NML Capital v
Argentina.282 Then we shall cross the Big Pond to take a look at things from an English law
perspective in Kensington International v Congo.283
274
For a full discussion on exits consents see infra 4.2.3.2 Exit Consents.
For a full discussion on CACs see infra 4.2.3.1 Collective Action Clauses or CACs.
276
Olivares-Caminal, ‘Is There a Need’ (n 2) 33.
277
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 13.
278
Gulati and Klee, ‘Sovereign Piracy’ (n 28); Olivares-Caminal, ‘Is There a Need’ (n 2) 28.
279
International Monetary Fund, ‘Strengthening the Contractual Framework to Address Collective Action
Problems in Sovereign Debt Restructuring’ IMF 40 <http://www.imf.org/external/pp/ppindex.aspx> accessed 15
December 2015, (hereinafter: IMF, ‘Strengthening the Contractual Framework’).
280
Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997).
281
Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92; Brussel (9e Kamer) 19 maart 2004, Republiek
Nicaragua t/ LNC Investments LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831.
282
NML Capital, Ltd. v. Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
283
Kensington International, Ltd. v. Republic of the Congo, [2003] EWCA Civ 709, A3/2003/1036.
275
41
Pari Passu Clauses: The Root of the Problem?
In the interest of intelligibility, the method for reviewing these cases will be as follows: (i) relevant
facts, (ii) relevant arguments, (iii) reasoning of the court and (iv) impact or importance of the case visà-vis the holdout-issue.
3.3.2. New York State Law Litigation Waves
3.3.2.1.
The First Wave: Dear Sovereign, Pacta Sunt Servanda.
3.3.2.1.5. Pravin Banker Associates v. Banco Popular Del Peru:
The Pravin cases are considered to be the starting point of (successful) sovereign debt
litigation;284 paving the way for Elliott and associates in the infamous Elliott cases. Hence,
they rightly deserve the title of ‘first wave of litigation’ and merit a closer look.
RELEVANT FACTS285
In 1983, Banco Popular del Peru (“Banco Popular”), a Peruvian state-owned bank, had
accumulated debt to an unsustainable level and as a result, the Peruvian government was
forced to renegotiate with its creditors. One of those creditors was Mellon Bank (“Mellon”)
that, over the course of years, had extended a number of loans to Banco Popular. After intense
negotiations, the Mellon Letter Agreements were signed. These letters extended the maturity
dates of the loans for 365 days. In return for this leniency, Peru agreed to collateralize the debt
and become guarantor.
Unfortunately, extending these loans was to no avail. In the following year, 1984, the
negotiations for a longer-term solution failed and Peru subsequently imposed new restrictions
on the payment of foreign exchange. As a result, Banco Popular stopped making principal
payments and from then on only paid interest. Essentially, this meant that Banco Popular del
Peru defaulted on its loans and that Peru became liable as guarantor. Consequently, Mellon
decided to sue for the outstanding debts.
Following a change of government,286 a stay on proceedings and the start of Brady Plan287
negotiations under the auspices of the IMF, Mellon decided to sell its debt to Pravin Banker
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222.
Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d
(https://casetext.com/case/pravin-banker-assoc-ltd-v-banco-popular) (4 February 2016).
284
285
850,
852-854.
286
In 1990, after Alberto Fujimori was elected President of Peru, Peru's economic policies changed
dramatically. President Fujimori began a major reform of the Peruvian economy and in doing so
attempted to comply with International Monetary Fund (“IMF”) policies. Following these changes,
42
Waves of Litigation and their Consequences
Associates (“Pravin”) at a steep discount. The Peruvian government and Banco Popular were
informed of this assignment and Banco Popular started making interest payments to Pravin
directly, until suddenly those payments stopped.
Consequently, Pravin demanded to be paid in full (at face value) on both principal and unpaid
interest. When this demand was not met, Pravin declared Banco Popular in default on the
debt. Subsequently, the Peruvian Central Bank decided that Banco Popular should be
liquidated and liquidation proceedings (negotiations) were started. Pravin, however, refused to
enter into either Brady or insolvency negotiations. So, in 1993 Pravin Banker decided to file
an action against Peru as guarantor.288
In the ensuing proceedings (Pravin I and II) the courts decided that the circumstances called
for leniency. These decisions were largely based on the fact that granting a stay would allow
for an orderly winding up of Banco Popular under Peruvian law, without actually endangering
the long-term enforceability of the debt.289 Essentially, Peru got an eight months reprieve to
get its affairs in order.
Nevertheless, the deadline came and went and Peru asked for leniency once more. A further
stay, however, was denied in Pravin III and the court granted Pravin’s motion for summary
judgement,290 thereby allowing enforcement of the debt. This resulted in a judgement (Pravin
the Bank Advisory Committee, a committee of Peru's creditors headed by Citibank, N.A., signed
an agreement with Peru to stay all pending lawsuits in order to promote negotiations to resolve the
entire problem of the unpaid foreign debts.(See Pravin Banker Associates v. Banco Popular Del
Peru, 109 F.3d 850, 852 <https://casetext.com/case/pravin-banker-assoc-ltd-v-banco-popular>
(accessed 4 February 2016)).
287
The Brady Plan was a plan designed by the Bush Administration in 1989 to tackle the issue of the Low
Developed Countries (LDC) Debt Crisis. Although the terms and conditions of every Brady negotiation was
unique, some major aspects were common in all Brady restructurings. (i) There was some form of substantial
debt reduction. (ii) This reduction was linked to ambitious economic reform programmes. (iii) The resulting
Brady Debt was more highly tradable, which allowed creditors to diversify their risk more widely. As a result of
the Brady Plan, the participating LDCs (Brady Countries such as Mexico, Peru and Argentina) were able to
significantly reduce their debt levels, while being able to re-access the international capital markets.
(See EMTA, ‘the Brady Plan’<http://www.emta.org> accessed on 29 September 2015; Olivares-Caminal, ‘Is
There a Need’ (n 2) 21; Natalie Wong, ‘NML Capital, Ltd. v. Republic of Argentina and the Changing Roles of
the Pari Passu and Collective Action Clauses in Sovereign Debt Agreements’ (2015) Colum. J. Transnat'l L. 396,
401, (hereinafter: Wong, ‘NML Capital, Ltd. v. Republic of Argentina’).
288
Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 at 852, https://casetext.com/case/pravinbanker-assoc-ltd-v-banco-popular (visited on 4 February 2016); EMTA, ‘Preliminary Analysis of Creditor
Litigation in the Non-HIPC Sovereign Debt Restructuring Context’ 3 <www. emta.org> accessed on 29
September 2015.
289
Charles Proctor, ‘Sovereign Debt Restructuring and The Courts –Some Recent Developments, Part 1’ (2003)
8 JIBFL 302.
290
A motion for summary judgement is subject to two conditions under Fed. R. Civ. P. 56(c):
43
Pari Passu Clauses: The Root of the Problem?
IV) in favour of Pravin, sentencing Banco Popular to pay $US 2,161,539.78 along with preand post-judgement interest.
Faced with this judgement, Peru yet again asked for another stay due to the ongoing Brady
Plan Negotiations. When the district court denied this request, they appealed, which brings us
to the case before the United States Court of Appeals for the Second Circuit.291
RELEVANT ARGUMENTS
Pravin essentially argued that Banco Popular (and Peru as guarantor) had failed in its
obligation under the Mellon Letter Agreements and as such, was liable for non-payment of the
debt.292 Peru, on the other hand, argued that the courts had erred, in Pravin III and IV, by
‘failing to extend international comity to Peru’s negotiations’.293 Besides, enforcement would
‘result in a creditor stampede to find and attach Peruvian assets, and such a stampede would,
in turn disrupt Peru’s structural reform.’294 Therefore, Peru argued that an (indefinite) stay
was necessary.
REASONING OF THE COURT
Taking note of the Peru’s arguments, the court based its decision on the analysis of the
principles of international comity. It explained in short the meaning of those principles and
which exceptions applied.
International comity is “the recognition which one nation allows within its territory to the
legislative, executive or judicial acts of another nation.” […] Under the principles of
international comity, United States courts ordinarily refuse to review acts of foreign
governments and defer to proceedings taking place in foreign countries, allowing those
acts and proceedings to have extraterritorial effect in the United States. [e.g. insolvency
proceedings] […]
a) No genuine issue as to any material fact exists; and
b) The moving party is entitled to a judgement as a matter of law.
If granted, there will be no trial and the judge will immediately enter judgement. Moreover, judges are free to
grant partial summary judgement.
See ‘What is Summary Judgment?’ <https://www.litigation.findlaw.com> and <https://www.law.cornell.edu/
wex/summary_judgment> both accessed on 17 December 2015.
291
Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 at 853.
292
Ibid 852.
293
Ibid 853.
294
Ibid 852.
44
Waves of Litigation and their Consequences
Comity [however] remains a rule of “practice, convenience, and expediency” rather than
of law. […] Courts will [therefore] not extend comity to foreign proceedings when doing
so would be contrary to the policies or prejudicial to the interests of the United States
[…].295
After this brief overview, the court applied these rules to the facts. Whereupon the court came
to the following conclusions:296
(i).
Peru’s negotiation efforts were acts of a foreign government with extraterritorial
effect in the United States;
(ii).
It is the policy of the United States’ government to encourage Brady Plan
negotiations;
(iii).
Ensuring enforceability of valid debt under principles of contract law, is of vital
interest to the United states, especially when it concerns foreign debt owed to
United States lenders; and
(iv).
Brady Plan negotiations are strictly voluntary and debts remain enforceable
throughout the negotiations.
As such, the court decided that an indefinite stay would not be in the interest of the United
States and that the lower courts had not erred with regard to international comity.
IMPORTANCE OF THE CASE
In essence, this case clearly shows that the Latin proverb pacta sunt servanda also applies to
sovereign borrowers. Although they can count on some leniency and obtain a stay on
enforcement, thereby allowing for an orderly restructuring, they cannot avoid enforcement
actions forever. The basic principles of contract law also apply to sovereigns.297 Contractual
reform is still strictly voluntary and –from a holdout’s point of view– contracts should
therefore remain enforceable before as well as after restructuring.298
Needless to say, this ‘successful’ case has served as the bedrock for future holdout/vulture
fund litigation in the context of sovereign debt.299 For instance, the Elliott cases and LNC
Investment v. Nicaragua.
295
Ibid 853 (emphasis added).
Ibid 854.
297
EMTA, ‘Preliminary Analysis of Creditor Litigation (n 94) 4.
298
Ibid 4.
299
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222.
296
45
Pari Passu Clauses: The Root of the Problem?
3.3.2.2.
The Second Wave: The Rise and Fall of the Payment Interpretation
3.3.2.2.6. Elliott Associates v. Banco de la Nacion
The Pravin cases might have been the starting point of (successful) sovereign debt litigation,
but it were the Elliott Cases that truly affected the sovereign debt market. In one of those
cases the ‘broad’ or ‘payment’ interpretation of the pari passu clause saw the light of day and
in doing so, holdouts/vulture funds obtained a viable way to pressure a sovereign state into
reaching a settlement. How this came to be, is discussed below.
RELEVANT FACTS
It should be noted that the facts of the Elliott cases are fairly similar to those of the Pravin
cases.300
In 1995, the Peruvian Government announced that it would enter into Brady Negotiations301
concerning defaulted Peruvian commercial bank loans. Shortly thereafter, Elliott –a vulture
fund based in New York– began purchasing the distressed debt at a steep discount. The
vulture fund only paid ca. US$ 11.4 million instead of US$ 20.7 million.
Similarly, to the situation in the Pravin cases, Peru had guaranteed the debt. Only this time, it
concerned debt that had been accumulated by Banco de la Nacion.302
After acquiring the debt, Elliott adamantly refused to take part in any ‘Brady Negotiations’.
Instead, it decided to sue Peru and Banco de la Nacion and demand the payment of the debt at
face value.303 Interestingly enough Elliott had started to buy debt merely two weeks after the
(successful) Pravin Case.304 Allegedly, this suggested an intention to litigate from the start,
instead of considering other options such as the Brady Deal.305 In this context, it must be
noted that New York Courts allowed for the “Champerty” defence.306 According to case law,
this doctrine was ‘developed hundreds of years ago to prevent or curtail the commercialization
300
See supra 3.3.2.1.5 Pravin Banker Associates v. Banco Popular Del Peru:.
See note 287 for more info on the Brady Plan.
302
Eduardo Luis Lopez Sandoval, ‘Sovereign Debt Restructuring: Should We Be Worried About Elliott?’ (2002)
8 <http://www.finanzaonline.com/forum/attachments/obbligazioni-titoli-di-stato/1672493d1352831920-argentin
a-obbl-emesse-cambio-dei-titoli-default-4-x-gli-onesti-scambisti-sovereign-debt-restructuring-hal-scott-howelljackson-.pdf.> accessed on 5 February 2016, (hereinafter: Sandoval, ‘Sovereign Debt Restructuring’).
303
Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 401.
304
See supra 3.3.2.1.5 Pravin Banker Associates v. Banco Popular Del Peru:.
305
Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9.
306
Ibid 9.
301
46
Waves of Litigation and their Consequences
of or trading in litigation.’307 Needless to say, the facts referred to above did suggest such a
pattern. No wonder that the New York District Court followed this line of reasoning and
decided that:
[…] the timing of Elliott's purchases of Peruvian debt and the closing of the assignment
agreements paralleled key events in Pravin Banker Assocs., Ltd. v. Banco Popular del
Peru, Civ. No. 93-0094 (S.D.N.Y.). 308 […] Assignments taken for the purpose, or motive,
of stirring up litigation and profiting thereby are prohibited. 309
Thus, the acquisition of debt by Elliott was found to be in violation of the Champerty doctrine
codified in §489 of the New York Judiciary Law. As a result, this case allowed a debtor to
successfully use a Champerty defence for the first time.310
Elliott, however, filed an appeal and (quite easily) obtained a reversal of the District Court’s
Ruling. The United States Court of Appeals for the Second Circuit, decided that §489 of the
New York Judiciary Law was not violated by Elliott. It reasoned that “the accused party's
‘primary goal’ is found to be satisfaction of a valid debt and its intent is only to sue absent full
performance”.311 Moreover, it stated that the District Court’s decision would create ‘a
perverse result’ by allowing a Champerty defence under such circumstances.
The interpretation posited by the district court would also create "a perverse result"
because it "would permit defendants to create a champerty defense by refusing to honor
their loan obligations." […] An obligor could simply declare unwillingness to pay,
thereby making it plain that no payment would be received without suit. Under such
circumstances, prospective purchasers would not be able to acquire the debt instruments
without opening themselves up to the defense that their purchase or assignment
necessarily was made "with the intent and for the purpose of bringing an action or
proceeding thereon," as barred by Section 489.312
At first, Elliott’s strategy was clearly focussed on attaching collateral, which would prevent
the Peruvian government from successfully closing the Brady Deal and would subsequently
307
Bluebird Partners, L.P. v. First Fidelity Bank, N.A., 94 N.Y.2d 726, 733 (2000).
<https://casetext.com/case/bluebird-partners-lp-v-first-fidelity-bank-na>
308
Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363, 367 (2d. Cir. 1999),
<https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion> (accessed on 5 February 2016).
309
Ibid 369.
310
Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9.
311
Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363, 381 (2d. Cir. 1999),
<https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion> (accessed on 5 February 2016).
312
Ibid 380.
47
Pari Passu Clauses: The Root of the Problem?
force the government to settle. The court, however, denied the motion for attachment and Peru
succeeded in closing the Brady Deal.313
After litigating back and forth, Elliott finally obtained judgement versus Peru in June 2000.
Essentially, the court ordered Peru to pay US$ 55.7 million and allowed Elliott to attach all
property used for commercial activity in the USA.314 Thus, Peru was forced to circumvent
New York in order to fulfil its payment obligations under the Brady Bonds. In turn, this
evasive action caused Elliott to devise new strategies. As a result, Elliot gave attachment a go
in other countries such as Germany, Belgium and Luxembourg, but all to no avail.315
On September 7th 2000, the first Peruvian Brady coupon was due. Elliott was aware of this
and therefore sought to intercept the funds, which would then result in a default on Peru’s
Brady Bonds.316 Ultimately, this strategy was aimed at forcing Peru into a settlement. In order
to do so, Elliott initiated legal proceedings against clearinghouses based in three separate
jurisdictions, namely Depository Trust Company (DTC) in New York, Euroclear in Belgium
and Clearstream in Luxemburg.317 However, it should be noted that the only relevant case in
the context of the pari passu clause, is the one before the Belgian Court.318 There, the pari
passu clause received an (erroneous) new interpretation.
In said case, the Commercial Court of Brussels was asked to grant an ex parte motion319
seeking to restrain Morgan Guaranty Trust Company –the operator of the Euroclear System–
from processing payments intended for the Brady Bondholders. However, the Court decided
to deny the ex parte motion due to a lack of ‘absolute necessity’ and ‘extreme urgency’. This
meant that Elliott had only one shot left to intercept the payments. It had to file for an appeal
and convince the court that the conditions for an ex parte motion were met.320
Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9.
Ibid 11.
315
Ibid 12.
316
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 877.
317
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 877; Sandoval, ‘Sovereign Debt Restructuring’ (n
302) 16.
318
Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
319
Under Belgian law, an ex parte motion will –if granted– result in a provisional measure, without causing any
actual passing of judgement on the underlying dispute. In order to obtain a favourable judgement, the motion
itself needs to comply with two conditions, namely absolute necessity and extreme urgency. If those are not
present, the judge will deny the motion. (Art. 584 Ger. W.)
320
Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
313
314
48
Waves of Litigation and their Consequences
RELEVANT ARGUMENTS
Since this was an ex parte motion ex art. 584 Ger. W., only Elliott proffered any arguments.
First of all, it provided the Court of Appeals with a summary of the facts: (i) Elliott had a
claim of $US 55 million against Peru, (ii) Elliott was not obligated to enter into Brady
Negotiations, due to their strictly voluntary nature, and (iii) there were already two
enforceable judgements in place from a New York judge.321 Other than that, Elliott came
forward with a brand new argument to address the situation, namely a brand new
interpretation of the pari passu clause. This argument, intended to convince the court, was the
result of an affidavit that Elliott had commissioned from a New York University professor,
Andreas F. Lowenfeld.322 Regarding the pari passu clause, LOWENFELD opined:
I have no difficulty in understanding what the pari passu clause means: it means what it
says – a given debt will rank equally with other debt of the borrower, whether that
borrower is an individual, a company or a sovereign state. A borrower from Tom, Dick
and Harry can’t say “I will pay Tom and Dick in full, and if there is anything left over I’ll
pay Harry”. If there is not enough money to go around, the borrower faced with a pari
passu provision must pay all three of them on the same basis. 323
In sum, LOWENFELD claimed that a sovereign state could not pay one creditor without also
paying the others. Therefore, all payments must be made on a pro rata basis. To support this
statement, LOWENFELD added the following example:
Suppose, for example, the total debt is $50,000 and the borrower has only $30,000
available. Tom lent $20,000 and Dick and Harry lent $15,000 each. The borrower must
pay three fifths of the amount owed to each one – i.e., $12,000 to Tom, and $9,000 each
to Dick and Harry. Of course the remaining sums would remain as obligations of the
borrower. But if the borrower proposed to pay Tom $20,000 in full satisfaction, Dick
$10,000 and Harry nothing, a court could and should issue an injunction at the behest of
Harry. The injunction would run in the first instance against the borrower, but I believe
(putting jurisdictional considerations aside) to Tom and Dick as well.324
321
Ibid.
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878; International Monetary Fund, ‘Involving the
Private Sector in the Resolution of Financial Crises –Restructuring International Sovereign Bonds’ 12
<http://www.imf.org/external/pubs/ft/series/03/IPS.pdf> accessed 8 February 2016.
323
A declaration of Prof. Andreas F. Lowenfeld, dated Aug. 31, 2000, filed in Elliott Assocs., L.P. v. Banco de la
Nacion, U.S.D.C., S.D.N.Y. 96 Civ. 7916 (RWS) as referenced in Buchheit and Pam, ‘Sovereign Debt
Instruments’ (n 222) 878. (hereinafter: the ‘Lowenfeld Decleration’).
324
Lowenfeld Decleration (n 323).
322
49
Pari Passu Clauses: The Root of the Problem?
At first glance, this literal reading of the pari passu clause seems sensible. However,
LOWENFELD did not cite any authorities supporting his opinion.325 The question therefore
becomes: ‘Did this keep the Belgian court from agreeing with his line of reasoning?’
REASONING OF THE COURT
The court started out with recognizing the facts provided by Elliott, but quickly addressed the
issue at hand, namely the interpretation of the pari passu clause in view of Peru’s
obligations.326 It stated that:
The basic agreement regulating the reimbursement of the Peruvian foreign debt, also
indicates that the different creditors enjoy a “pari-passu clause”, which has as a result that
the debt should be paid down equally towards all creditors in proportion to their claim.
From this, one seems to have to conclude that, in case of the payments of interests, no
creditor can be excluded from its proportional part.327
The court then used this reasoning to justify a reversal of Commercial Court’s judgement.
[…] Petitioner is acting in order to prevent the violation of a right that is seriously
threatened, and the requested relief appears reasonable to resist such a threat. […] The
appeal is substantiated. The request must be granted. 328
Clearly, the court did not mind the lack of substantiated evidence to support a ‘payment’
interpretation. It did not even consider any other options, but merely endorsed professor
LOWENFELD’S declaration simply to justify its decision to grant an ex parte motion.329
According to the court, Elliott had an enforceable claim against Peru and interest payment via
Euroclear facilitated Peru to escape the enforcement.330 However, simply deciding that the
pari passu clause constituted a pro rata rule made it quite easy to prevent such an ‘escape of
enforcement’, especially if a violation of the judgment resulted in a monetary penalty
(‘dwangsom’).
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878.
Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
327
Unofficial translation of Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92 <www.emta.org.>
accessed 26 September 2015, (emphasis added).
328
Ibid.
329
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 879; Cohen, ‘Cigar’ (n 68); Sandoval, ‘Sovereign
Debt Restructuring’ (n 302) 16; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 402.
330
Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
325
326
50
Waves of Litigation and their Consequences
IMPORTANCE OF THE CASE
The Belgian decision was instrumental to the final outcome of the Elliott cases. In the end,
Elliott managed to realise its goal and forced the Peruvian government to settle.331 However,
what did this actually mean for the future? Was the interpretation correct? What about future
litigation?
Some argue that if Peru had been able to proffer its own arguments, the outcome of the case
might have been a different story altogether.332 This line of reasoning deserves credit, because
there are a lot of reasons why the ‘payment’ interpretation should be considered a faulty one.

‘Broad/Payment’ Interpretation v. Historical Meaning and Market Understanding
First of all, LOWENFELD did not cite any authorities to support his claim.333 Moreover, history
has repeatedly shown that it was never the intention of the drafters to create a pro rata equal
treatment for creditors via the pari passu clause.334 Unfortunately, drafters did insert
additional ‘payment’ language and later drafters mindlessly copy-pasted it. The pari passu
clause of Peru’s guaranty was not any different. It read:
[…] The Guarantor [i.e. Peru] represents and warrants as follows: […] The obligations of
the Guarantor hereunder do rank and will rank at least pari passu in priority of payment
with all other External Indebtedness of the Guarantor, and interest thereon.335
Understandably, the vague wording of the pari passu clause might have given the impression
that the ‘payment’ interpretation was indeed what the drafters meant. In fact, the actual
purpose of the ‘payment language’ was accentuating the different purposes of the pari passu
clause depending on the context. Where at first the pari passu sought to protect creditors from
the ‘first-to-be-issued’ rule, it later sought to prevent sovereigns from taking actions that
might subordinate creditors or classes of creditors.336 In any event, it always concerned some
sort of ‘ranking’ rather than ‘payment’.
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 879; Sandoval, ‘Sovereign Debt Restructuring’ (n
302) 20.
332
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 638.
333
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878.
334
See 3.1 The History of the Pari Passu: the What, the Why and the When.
335
Lowenfeld Decleration (n 323) (emphasis added).
336
Supra Paragraph…
331
51
Pari Passu Clauses: The Root of the Problem?
Under normal circumstances New York law defers to the standard market understanding to
divine the meaning of a certain clause.337 It generally does not get into the specific intentions
of the parties. The reasoning behind this stems from a case before the United States Court of
Appeals for the Second Circuit. In Sharon Steel it said:
Whereas participants in the capital market can adjust their affairs according to a uniform
interpretation, whether it be correct or not as an initial proposition, the creation of
enduring uncertainties as to the meaning of boilerplate provisions would decrease the
value of all debenture issues and greatly impair the efficient working of capital markets.
Such uncertainties would vastly increase the risks and, therefore, the costs of borrowing
with no offsetting benefits either in the capital market or in the administration of
justice.338
In other words, the court concluded that boilerplate provisions ought to be interpreted
uniformly, irrespective of parties’ intentions. Indeed, if everyone in the market understands
and knows what the standard terms mean and if they can rely on the courts to defer to this
standard market understanding, then that will increase certainty and in turn promote
efficiency.339
Although the Sharon Steel reasoning sounds quite sensible and easy, the tricky part is actually
finding out what the ‘standard market understanding’ is. Unfortunately, the search for the
actual meaning of the pari passu has thus far been unsatisfying. Prominent members of the
academia, such as BUCHHEIT and GULATI, concluded that the market is far from crystal-clear
when it comes to the standard meaning of the pari passu clause.340 Nevertheless, LOWENFELD
and the Belgian court knowingly disregarded this fact and blindly applied the ‘plain-meaning’
understanding.341 Even though this approach is not unprecedented in the context of contracts,
they should at least have considered other interpretation options such as a historical approach,
especially if you take into account the peculiar situation of the sovereign debt context. 342
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 643.
Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F2d 1039, 1048 (2d Cir. 1982). (emphasis added)
339
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 643.
340
Lee C. Buchheit, ‘the Pari Passu Clause Sub Specie Aeternitis’ (1991) 10 Int'l Fin. L. Rev. 11, 11; Buchheit
and Pam, ‘Sovereign Debt Instruments’ (n 222) 875; Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646.
341
Cohen, ‘Cigar’ (n 68) 14.
342
MHR Capital Partners LP v. Presstek, Inc., 912 N.E.2d 43, 47 (N.Y. 2009).
337
338
52
Waves of Litigation and their Consequences

The (Absurd) Consequences of ‘Payment’ Interpretation
The consequences of this interpretation could lead to absurd outcomes. For instance, countries
tend to prioritise certain payments in the event of economic distress.343 This so-called
‘financial triage’344 includes paying the IMF, the World Bank and any other multilateral
organisation who de facto enjoy a status as preferred creditor.345 In practical terms, these
essential payments help governments to prevent the economy from grinding to a halt.
Whereas the ‘payment’ interpretation would result in countries being unable to pay for
commodities and public services such as police forces, judges and teachers. To put it bluntly,
it would render them unable to pay the milk man.346
Furthermore, the ‘payment’ interpretation of the pari passu clause would render some loan
agreement clauses completely meaningless, because, in practice, parties occasionally do draft
clauses that actually provide for ‘equality of payment’.347 These so-called ‘equality’ clauses,
basically come in all shapes and sizes, sometimes even three or four pages long.348 According
to GULATI and KLEE at least five clauses can be distinguished, namely:349
(i).
a ‘mandatory prepayment clause’, which imposes a restriction on non-rateable
prepayments;
(ii).
a ‘turnover clause’, which essentially forces the beneficiaries of prepayments to
hand them over to other creditors;
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 13; Joe Kogan, ‘Pari Passu and
the Ecuador 15s’ (2009) Barclays Capital Research 2 <www.emta.org> accessed 16 December 2015,
(hereinafter: Kogan, ‘Pari Passu and the Ecuador 15s’); Allen & Overy Global Intelligence Unit, ‘The Pari Passu
Clause’ (n 27) 2.
344
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 883; Lee C Buchheit and Sofia D Martos, ‘What to
Do about Pari Passu’ (2014) B.J.I.B.& F.L. 491, 491.
345
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 2. However, due to the limited scope
of this thesis, I will not elaborate on the (de facto) preferred status of the IMF.
346
Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371.
347
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884; Gulati and Klee, ‘Sovereign Piracy’ (n 28)
646; NML Plaintiffs’ Brief 37-38; Dechert LLP_Case 109-cv-01708-TPG at 19; Allen & Overy Global
Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10.
348
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884.
349
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646. Other ‘equality clauses’ include: the most favoured
debt/nation/creditor clause or a cross default clause (See also Olivares-Caminal, ‘Understanding the Pari Passu’
(n 7) 1232; Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10).
343
53
Pari Passu Clauses: The Root of the Problem?
(iii).
a ‘pro rata sharing clause’, which basically guarantees that if one creditor receives
a greater (i.e. disproportionate) payment, he has to share rateably with the
others;350
(iv).
a ‘negative pledge clause’, which precludes debtors from pledging any
collateral;351 and
(v).
an ‘acceleration clause’, which enables creditors to demand the immediate
payment of all debt in the event of a default.
Other than that, it should also be noted that parties sometimes modify the pari passu clause
itself to specifically include a pro rata payment rule.352 However, drafting such a pari passu
clause is no walk in the park. For instance, the parties need to provide detailed carve-outs
regarding ‘financial triage’.
Clearly, contracts contain these clauses for a reason. If parties really do intend to provide for
‘equality of payment’, they would insert such clauses in their contracts. Elliott’s claim that the
basic pari passu clause implicitly contains ‘equality of payment’, is simply a bridge too far.
Lawyers would not waste their time in drafting other clauses with the same effect, for time is
money.353 Hence the ‘payment’ interpretation once again shows its lack of efficiency.
Last but not least, the ‘payment’ interpretation might have potential systemic consequences. If
Elliott’s tactic of intercepting cash flows would be left unchallenged, the international
payment and securities settlement systems could be interrupted.354
To summarise, most authors agree that the practical consequences of a ‘payment’
interpretation are so extreme, so far-reaching that they can never have been the intention of
the parties. In other words, parties would never have agreed to such terms and if they did, they
would have set it out in the contract expressly.355
Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2; Allen & Overy Global Intelligence Unit, ‘The Pari Passu
Clause’ (n 27) 10; Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1231; United States Court of
Appeals_NML, p 38; Essay Sovereign Syndicated Bank Credits in 1970s, 25.
351
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10.
352
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646; Allen & Overy Global Intelligence Unit, ‘The Pari Passu
Clause’ (n 27) 10.
353
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884; Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646.
354
Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371.
355
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 886; Wood, ‘Pari Passu clauses –What do they
mean?’ (n 221) 371; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 825; FMLC, ‘Analysis of the role,
use and meaning of pari passu clauses’ (n 234) 13; Allen & Overy Global Intelligence Unit, ‘The Pari Passu
Clause’ (n 27) 12; Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 270.
350
54
Waves of Litigation and their Consequences
However, as stated before, not everyone is on the same page. Some authors, such as BRATTON
and COHEN, proclaim the ‘payment’ interpretation as the correct one.356 In his argumentation,
BRATTON does offer some interesting points regarding potential positive consequences of a
‘payment’ interpretation. If we follow his line of reasoning, we come to the following benefits
of a ‘payment’ interpretation: (i) it would tackle the moral hazard of a sovereign state, by
making it less likely that sovereigns would externalize effects of economic reverses, (ii) it
would discourage a sovereign from putting the burden of restructuring on a particular series or
class of bonds and (iii) it would greatly improve a holdout’s bargaining position. In other
words, the ‘payment’ interpretation constrains a sovereign’s choices, enhances enforcement
powers of holdout-creditors and lowers the long-run costs of sovereign debt capital. 357
COHEN on the other hand merely reiterates the plain-meaning argument. According to him, “a
cigar is just a cigar”.358 The pari passu clause just means what it says. It provides equal
treatment protection for creditors. Thereby, he clearly endorses LOWENFELDS’ view on the
matter.359 Moreover, he claims this interpretation fits in with “common sense and business
realities”. For what use is a mere right not to be ‘legally’ subordinated? How can you possibly
enforce that?360 A ‘payment’ interpretation on the other hand prevents a sovereign from
‘functionally’ subordinating the debt by choosing one creditor over the other. Therefore, it
provides essential protection and encourages investors to trade in destressed sovereign debt.361
Furthermore, he completely disagrees with prominent figures such as BUCHHEIT and WOOD,
claiming that their legal ranking interpretation does not find any support in the actual text of
the pari passu clause362. But, just like LOWENFIELD and the Belgian Court, he completely
disregards the historical context of the clause. Whereas the historical context clearly shows
the whys and wherefores regarding the ranking interpretation.363
It must be noted however that COHEN was legal counsel for Elliott and is currently
representing NML Capital Ltd. in its sovereign debt litigation with Argentina.364 So, his view
on the matter is far from neutral, but, as KOGAN rightly puts it, there are arguments on both
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 826; Cohen, ‘Cigar’ (n 68) 17.
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 827.
358
Cohen, ‘Cigar’ (n 68) 17.
359
Ibid 14-15.
360
Ibid 17.
361
Ibid 14 and 17.
362
Ibid 18.
363
See supra 3.1 The History of the Pari Passu: the What, the Why and the When.
364
Cohen, ‘Cigar’ (n 68) 11.
356
357
55
Pari Passu Clauses: The Root of the Problem?
sides of the discussion. Either party has an interest in supporting their pari passu
interpretation.365 The ‘broad’ interpretation would clearly benefit the holdouts creditors and
incentivize them to buy up debt for litigation purposes, whereas ‘narrow’ would greatly
support the sovereigns and take away a strategy for the holdouts altogether.
In sum, most critics initially thought of the Elliott case as an aberration.366 They opined that
‘[the] decision was [made] by an obscure commercial court in Brussels that probably [did] not
even know what a sovereign bond [was]. No English or New York court (and most foreign
issued sovereign bonds today are governed by the laws of one of those two jurisdictions)
would ever rule in that fashion.’367 Unfortunately, the opposite proved true. The ‘obscure’
Belgian Decision henceforth served as the bedrock for holdout litigation. It was not even
limited to debt governed by New York law, instead it quickly spread to debt governed by
English Law.368
Ever since, sovereigns have been forced to rely on more drastic measures to keep the holdouts
at bay. For instance, practitioners under New York and English law have addressed the
situation with exit consents and collective actions clauses respectively.369 Both solutions,
however, have their own downsides to deal with, which will be discussed in Chapter 4
Drafting Is Key to the Pari Passu-Holdout Issue.
3.3.2.2.7. LNC Investment v. Nicaragua
As set out above, the potential implications of the Elliott case were enormous. The Belgian
Court had inadvertently provided holdouts with a veritable sledgehammer in terms of
settlement coercion.370 Needless to say, litigation soon ensued and LNC Investment (“LNC”)
found itself before the same Belgian Court as Elliott years before.371 To LNC’s dismay,
however, the court did not adhere to its previous ‘payment’ interpretation and refused to
freeze the payments passing through Euroclear. Why the court suddenly had that change of
heart, is set out below.
Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2.
Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75)
825.
367
Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 220.
368
Kensington…&
369
Gulati and Klee, ‘Sovereign Piracy’ (n 28) 637.
370
Ibid 638.
371
Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 882.
365
366
56
Waves of Litigation and their Consequences
RELEVANT FACTS
In 1980 Nicaragua entered into loan agreements under New York law. These agreements
contained a pari passu clause and also prevented creditors from enforcing their claims on
Nicaraguan territory.372 When Nicaragua defaulted, sovereign debt restructuring ensued and
although the Nicaraguan offer was extremely low (only 8% of the principal amount was
offered), 70% of the creditors agreed to it. In the interest of completeness, it must also be
noted that Nicaragua issued bonds in 1990.373
Meanwhile, LNC Investment (“LNC”) had bought some of the defaulted debt and thus had
become creditor. Nevertheless, it was no surprise when it adamantly refused Nicaragua’s 8%
offer and chose to sue instead. Just like Elliott before it, LNC successfully obtained a
judgement against Nicaragua. It convinced a New York judge to order Nicaragua to pay $US
86.9 million of principal and interest in the light of the defaulted debt. However, enforcement
proved to be very difficult.374
So, it took a page from Elliott’s book and tried its hand at an ex parte motion before Belgian
commercial court in the summer 2003. This time, however, the holdout-creditor did not seek
to strike at the creditors who had participated in the restructuring. Instead, it targeted another
set of creditors altogether, namely the bondholders of Nicaragua’s bonds. In order to do so,
LNC asked for measures precluding payments via Euroclear. Obviously, it sought to coerce
Nicaragua into a settlement and, just like Elliott, LNC used the ‘payment’ interpretation of the
pari passu to do it.
On July 25th 2003 the Belgian Commercial Court granted the ex parte motion. As a result,
payments passing through Euroclear were frozen and Euroclear also needed to adhere to some
other measures. Since these measures were all under penalty of €1-2 million, Euroclear
obeyed the court.375
Needless to say, Nicaragua was far from happy with this court order. So, in August of 2003
Nicaragua filed for third-party opposition (‘derdenverzet’). However, the court denied the
motion.376 In the meantime, however, Nicaragua risked a default on its bonds, which would
372
Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en NV Euroclear
Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831, §1-2, (hereinafter: the ‘LNC Decision’).
373
LNC Decision (n 372) §4.
374
Ibid §2,3 and 5.
375
Ibid §8-9.
376
Ibid §10.
57
Pari Passu Clauses: The Root of the Problem?
expose it to a cross-default on other international loans.377 Faced with this risk, Nicaragua
filed for an appeal and asked the court to:
(i).
Annul the decision of 11 September 2003 (which had denied Nicaragua’s motion);
(ii).
declare LNC’s demands unfounded;
(iii).
retract the judgement of 25 July 2003; and
(iv).
condemn LNC to pay for all the costs that the measures had caused for
Nicaragua.378
RELEVANT ARGUMENTS
To convince the court, LNC claimed that the loan agreements of 1980 precluded any issuance
of bonds. Additionally, according to LNC, the agreements also prevented that Nicaragua
could pay bondholders to the detriment of the loan-creditors, because in doing so it would
breach the pari passu clause contained in the loan agreement.379
Nicaragua and Euroclear, however, did not agree with LNC’s view. They claimed that (i) the
conditions for an ex parte motion were not met, because there was no absolute necessity, nor
extreme urgency and (ii) that LNC pursued illegitimate interests, namely it illegitimately
asserted pressure on Nicaragua in order to coerce it into a settlement (cf. Elliott and Peru).380
REASONING OF THE COURT
The court started out with the alleged illegitimate interests of LNC and it concluded:
While it is true that LNC appears to have established a strategy that deprived Nicaragua
of all possibility of annulling the [ex-parte] decision before 1 August 2003 so that it could
honour its payment obligations under the Bonds, it remains the case, as is stated below,
that this strategy was the only one that could have assured the efficacy of the ordered
measures, […] As the final objective of the measures being sought through the ex-parte
mechanism was to obtain payment of a debt that was due and certain, one must ascertain
that LNC had a legitimate interest to act.381
377
Ibid §13.
Ibid §14.
379
Ibid §7.
380
Ibid §15-16.
381
Unofficial translation Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en
NV Euroclear Bank, A.R. nr. 2003/KR/334, §16 <www.emta.org> accessed 30 September 2015, (emphasis
added).
378
58
Waves of Litigation and their Consequences
So, even though LNC clearly waited to file its ex parte motion and in doing so prevented
Nicaragua from annulling it, the strategy was deemed necessary to ensure efficacy of the
measures. Moreover, the objective of the measures was to obtain payment of a due and certain
debt. Thus, LNC did have a legitimate interest to act and its recourse to an ex parte motion
was justified by absolute necessity.382
However, the Court of Appeals did not agree with LNC’s recourse to the pari passu
argument. On the one hand, it recognised that the ‘payment’ interpretation was heavily
contested.383 On the other hand, it refused to see Euroclear as a proper party to the litigation.
According to the court, Euroclear was not a third party accomplice to a breach of contract. It
stated that, under Belgian law, the principle of ‘privity of contract’ applied, which precludes
measures that would make a third party a guarantor of a contractual performance. Hence, the
Court of Appeals decided that the lower court had violated Belgian law by passing the
injunction and consequently annulled the lower court’s order.384
IMPORTANCE OF THE CASE
The Brussels Court of Appeals did not choose one pari passu interpretation over the other.
Instead, it relied on another legal basis altogether to deny LNC’s motion to freeze Euroclear’s
assets, namely civil and procedural law. So, claiming that the court had reversed the
‘payment’ interpretation in LNC v Nicaragua, would be a bridge too far.
However, the case did put pari passu clauses on the radar. Following the case, the Settlement
Finality Law385 was amended in such a way that it would prevent any future attempt to
intercept payments at Euroclear.386 The new provision read:
Any cash settlement account maintained with the operator of a system or with a cash
settlement agent, as well as any cash transfer, through a Belgian or foreign credit
institution, to be credited to such cash settlement account, cannot be attached, put under
382
Ibid §17-18.
Ibid §21.
384
Ibid §22.
385
Wet van 28 april 1999 houdende omzetting van Richtlijn 98/26/EG van 19 mei 1998 betreffende het
definitieve karakter van de afwikkeling van betalingen en effectentransacties in betalings- en
afwikkelingssystemen (de ‘finaliteitswet’).
386
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1234; Euroclear Amicus Brief for NML 10
<www.emta.org> accessed 16 December 2015; Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott
Case: A Brilliant Strategy but an Awful (Mid-Long Term) Outcome?’ (2011) 40 Hofstra L. Rev. 39, 52-53,
(hereinafter: Rodrigo Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott Case’); IMF, ‘Strengthening
the Contractual Framework’ (n 279) 40.
383
59
Pari Passu Clauses: The Root of the Problem?
sequestration or otherwise blocked by any means by a participant (other than the operator
or the settlement agent), a counterpart or a third party.387
This amendment effectively thwarted any further impediments to the proper functioning of
payment or settlement system and hence safeguarded the credibility and liquidity of the
financial markets.388 Still, the success of this provision should not be overestimated.
OLIVARES-CAMINAL rightly points out that the ‘payment’ interpretation is still out there. The
Belgian law might have prevented Belgian courts from passing similar judgements to the
Elliott case, but this does not rule out other jurisdictions, for instance, NML Capital’s beef
with Argentina. 389
3.3.2.3.
The Third Wave: The Return of the Pari Passu?
3.3.2.3.8. NML Capital Ltd. v Argentina
Pravin led to more sovereign debt litigation. Elliott’s ‘payment’ interpretation paved the way
for even more holdout disputes, but in LNC the court clearly took a step back. Nevertheless,
the ‘payment’ interpretation of the pari passu clause was still out there and when Argentina
defaulted in 2001, NML Capital came to the fore. Litigation ensued, but the outcome was far
from certain. The ‘payment’ interpretation was either about to solidify its position, or about to
be dealt yet another blow. Little wonder that some dubbed this the ‘sovereign debt trial of the
century’.390 In the end, the ‘rateable payment’ won the day and the holdouts managed yet
again to coerce their sovereign debtor into a settlement offer. How this came to be and what
this means for the future, is set out below.
RELEVANT FACTS
NML Capital, Ltd. v. Argentina391 is the story about Argentina’s staggering US$ 100 billion
default in 2001 and the subsequent holdout litigation. It all started with the Fiscal Agency
Agreement of 1994 or ‘FAA’. Pursuant to this agreement, bonds were issued (‘FAA Bonds’)
to finance Argentina. However, in order to enhance the marketability of the FAA Bonds the
Unofficial translation from Euroclear’s amicus brief for NML at 10 <www.emta.org> accessed 16 December
2015. It should be noted, however, that the Settlement Finality Law was amended again in 2011. Although the
wording of the provision was tweaked a bit, the essence remained the same.
388
Euroclear amicus brief for NML at 10 (available at www.emta.org) (visited on 16 December 2015).
389
Rodrigo Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott Case’ (n 286) 52-53; IMF,
‘Strengthening the Contractual Framework’ (n 279) 40; NML Capital Ltd. v. Republic of Argentina, No. 08-cv6978 (S.D.N.Y. Nov. 21, 2012).
390
FT Alphaville, 16th November 2012 <http://ftalphaville.ft.com/2012/11/16/> accessed 24 February 2016.
391
NML Capital, Ltd. v. Argentina, 699 F.3d 246, 251 (2d Cir. 2012).
387
60
Waves of Litigation and their Consequences
Argentinian government decided to provide the creditors with a few (financial) ‘sweeteners’
and therefore it made a few promises.392
(i).
The FAA bonds would be governed by New York law;
(ii).
Any dispute would be adjudicated before New York Courts;
(iii).
Periodically, interest would be paid and in the event of default an acceleration
clause would be activated, meaning any unpaid interest –along with principal–
would immediately become due in full;
(iv).
The bonds would be freely transferable and payable to a transferee, regardless of
his/her status. Even if the transferee was a ‘vulture’ fund; and
(v).
A pari passu clause would ensure the equal treatment of the creditors and read:
The Securities will constitute […] direct, unconditional, unsecured and unsubordinated
obligations of the Republic and shall at all times rank pari passu and 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 […].393
Unfortunately, in 2001 Argentina was struck by a devastating economic crisis and
consequently it defaulted.394 As a result, the acceleration clause was activated and lacking a
sovereign insolvency regime, Argentina was forced to take measures. While entering into debt
restructuring negotiations, the President of Argentina declared a ‘temporary moratorium’ on
all principal and interest payments, thus preventing the FAA bondholders from reaping the
benefits of their acceleration clause.395
Eventually, the negotiations led to an exchange offer in 2005. Basically, this offer allowed the
FAA bondholders to exchange their bonds for new unsecured and unsubordinated external
debt at 25 cents to the dollar.396 Obviously, this was a bitter pill to swallow, but the
Argentinian government went even further.
392
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 5.
Paragraph 1 c) Fiscal Agency Agreement of 1994 <http://www.shearman.com/~/media/Files/Services
/Argentine-SovereignDebt/2013/FiscalAgency AgreementOct191994.pdf> accessed 25 February 2016.
394
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2197.
395
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 251; S Gee, ‘Injunctions, non-parties and
default on sovereign bonds’ (2013) 10 JIBFL 609, 609, (hereinafter: Gee, ‘Injunctions‘); Wong, ‘NML Capital,
Ltd. v. Republic of Argentina’ (n 287) 404.
396
Ibid.
393
61
Pari Passu Clauses: The Root of the Problem?
To induce FAA bondholders to accept the deal the new prospectus contained a section on
‘Risks of Not Participating in [the] Exchange Offer’. In it, Argentina made the following
declaration: ‘The Government […] has no intention of resuming payment on any [FAA]
bonds […] Consequently, if you elect not to tender your bonds in an exchange offer there can
be no assurance that you will receive any future payments.’397 Additionally, to assert even
more pressure, the Argentinian legislature also enacted Law 26,017 (the ‘Lock Law’) which
‘prohibited [the state] from conducting any type of in-court, out-of-court or private settlement
with respect to the bonds’.398 Essentially, this Lock Law made non-payment of holdouts
mandatory by law.399 Faced with this kind of pressure, a lot of FAA bondholders succumbed
to the will of Argentina. The end result was an acceptance rate of 76% that represented
roughly US$ 62 billion of the outstanding debt.400
In 2010 the remaining FAA bondholders got a second chance at an exchange offer. 401 The
terms were more or less the same as before and the Lock Law was temporarily suspended to
make this offer possible.402 A lot of bondholders chose to exchange bonds and Argentina
successfully restructured up to 91% of the defaulted debt of 2001. However, a few holdout
creditors still remained.
Meanwhile, NML Capital Ltd. (‘NML’), an affiliate of Elliott Management Corporation, had
bought the FAA Bonds at a steep discount on the secondary market. This vulture fund refused
to participate in the exchange offers and opted to sue instead.403 Just like Elliott and countless
others before it, NML tried to force Argentina into a settlement by way of injunctions based
on an alledged pari passu breach.404 However, the main objective of the vulture fund was to
assert pressure on third parties such as Bank of New York Mellon.405 While the injunctions
would obviously bind Argentina itself, they would also affect non-parties because of Fed. R.
Civ. P. 65(d)(2).406 According to said rule, injunctions also bind ‘agents’ and ‘other persons
397
Argentina, Prospectus Supplement to Prospectus Dated December 27, 2004 <http://www.mecon.gov.
ar/finanzas/download/us_prospectus_and_prospectus_supplement.pdf> accessed 25 February 2016.
398
Ley 26.017 de fecha 9 de febrero de 2005 [30.590] B.O., (hereinafter: ‘Lock Law’).
399
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 5.
400
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 252.
401
Ibid.
402
Ibid.; Gee, ‘Injunctions‘ (n 395) 609.
403
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 253; Wong, ‘NML Capital, Ltd. v. Republic
of Argentina’ (n 287) 404.
404
Ibid.
405
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 239; Sovereign pari passu clauses:
don’t cry for Argentina- yet; Gee, ‘Injunctions‘ (n 395) 609.
406
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 239.
62
Waves of Litigation and their Consequences
who are in active concert or participation’. Therefore, anyone assisting Argentina in evading
the court’s injunctions, would risk being held in contempt of court.407 In sum, the pari passu
remedy sought by NML was not intended to target Argentina at all, but rather indirectly force
it into a settlement.408
After years of litigation, Judge GRIESA finally ruled in December 2011 that Argentina had
breached the pari passu clause included in the FAA.409 As a result, Argentina was enjoined on
23 February 2012 by a court order (‘the 2012 order’) which prohibited any payment of
‘exchanged’ bondholders, unless the FAA bondholders (such as NML) got a rateable share as
well. Furthermore, third parties were also bound, which increased the pressure on Argentina
even more.410 Needless to say, Argentina tried to wriggle out of this situation and appealed.
Pending the appeal, Argentina requested for a stay on enforcement of the 2012 order and
Judge GRIESA granted it.411
When the United States Court of Appeals of the Second Circuit eventually ruled in October
2012, GRIESA’s order was only partly affirmed and partly remanded. 412 The Court of Appeals
agreed with the breach as such, but required more details concerning the actual
implementation of the payment prohibition. Soon thereafter, in November 2011, GRIESA
amended his original order.413 Seemingly, Argentina was finally with its back against the wall.
However, Argentina appealed again. This time to request the Court of Appeals for a rehearing
en banc.414 Meanwhile, the stay on enforcement remained in force.415
Some months passed and in August of 2013 the Court of Appeals denied the motion for an en
banc rehearing.416 Again, this seemed the end of the line for Argentina, but it still had one
407
Ibid.
Gelpern, ’Contract Hope’ (n 20) 134.
409
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Feb. 23, 2012).
410
Ibid.
411
Ibid.; Transcript of Court Hearing at 52 (10-11), NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978
(S.D.N.Y. Feb. 23, 2012), (hereinafter: ‘Transcript of Court Hearing (Feb. 23, 2012)’).
412
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 265.
413
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
414
A rehearing en banc is a rehearing by a court consisting of all the appeal judges. It can either be requested by
the parties and agreed to by the court, or it may be ordered by a majority of circuit judges. The only reason why
such a rehearing would take place, is to secure uniformity of the court’s decisions, or when there is a significant
issue at stake. (see Fed. R. App. P. 35)
415
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012); Transcript of Court
Hearing at 22 (4-7), NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012),
(hereinafter: ‘Transcript of Court Hearing (Nov. 21, 2012)’).
416
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013).
408
63
Pari Passu Clauses: The Root of the Problem?
final ace up its sleeve: a petition for a writ of certiorari.417 Furthermore, it convinced the Court
of Appeals to extend the stay on enforcement pending the Supreme Court’s decision.418
On June 16th 2014, the Supreme Court finally ended the NML debacle and denied the petition
for a writ of certiorari.419 However, this did not come as a surprise since the Supreme Court
only grants a limited amount of the writs. Some say it grants only four percent of cert
petitions, others say it grants but one percent.420 So all in all, this outcome was to be expected.
As a consequence of the Supreme Court’s decision, the enforcement of the 2012 order finally
became possible. This meant that Argentina could no longer pay the exchange bondholders,
without paying the remaining FAA bondholders as well. Hence, it had to choose between
doing away with its anti-holdout policy, or defaulting on the Exchanged Bonds.
Unfortunately, it opted for the latter.421
As the pressure on Argentina slowly increased, a settlement offer seemed the only way out.
Still, the FAA bondholders had to wait until February 2016 to receive an offer.422
RELEVANT ARGUMENTS
Due to the possible impact of this case, there were a lot of briefs, letters, and other supportive
documents from both the parties and amici curiae such as banks, governments (USA), the
emerging markets association, and so on. Therefore, it deserves merit to give a brief overview
of their interpretation of the facts.
NML claimed that Argentina had breached the pari passu clause included in the FAA.423
More specifically, it argued that Argentina had intentionally subordinated the FAA
bondholders by enacting the Lock Law. For that reason, NML asked the court to grant a
417
A petition for a writ of certiorari is a petition whereby a party asks the Supreme Court to exercise its
discretionary appellate function. The conditions for granting a cert are set in the Supreme Court’s Rules (Rule
10). (See H Weisburg, A E Stolper and P Clancy, ‘Don’t Cry for Me Argentine Bondholders: Argentina and
Exchange Bondholders File Certiorari Petitions’ (Shearman & Sterling LLP Client Briefings, 25 February 2014)
<www.emta.org> accessed 26 September 2015, (hereinafter: Weisburg, Stolper and Clancy, ‘Don’t Cry for Me
Argentine Bondholders: Argentina and Exchange Bondholders File Certiorari Petitions’).
418
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013).
419
Republic of Argentina v NML Capital Ltd, 573 U. S. (2014).
420
K S Bhatia, ‘Likelihood of a Petition Being Granted’ (Daily Writ, 10 January 2013)
<http://dailywrit.com/2013/01/likelihood-of-a-petition-being-granted/> accessed 28 February 2016; Weisburg,
Stolper and Clancy, ‘Don’t Cry for Me Argentine Bondholders: Argentina and Exchange Bondholders File
Certiorari Petitions’ (n 417) 2.
421
Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 83.
422
See supra 3.3.2.3.8 NML Capital Ltd. v Argentina.
423
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Dec. 7, 2011).
64
Waves of Litigation and their Consequences
summary judgement, since there was no dispute to any material fact and therefore it was
entitled to a judgement as a matter of law.424 As remedy for this breach NML requested
injunctive relief and/or specific performance of the pari passu clause. According to the
plaintiff, the ‘payment’ interpretation of the pari passu clause was to be upheld and
consequently, Argentina was to be prohibited from paying any Exchange bondholders, unless
the remaining FAA bondholders (such as NML) received a rateable payment as well.425
Moreover, NML asserted that in doing so, the court would not just add another piece of paper
to the pile of judgements and obligations Argentina already ignored. Instead, they asserted
that this new injunctive approach would seriously impede Argentina to comply with the
payment obligations under the Exchanged Bonds of 2005 and 2010, because pursuant to Rule
65 of the Federal Rules of Civil Procedure also people ‘aiding and abetting Argentina’ would
be bound by the order.426 In sum, NML claimed that this order would force Argentina to settle
and end the litigation once and for all.
Obviously, the Republic of Argentina refuted the rateable payment theory set forth by the
plaintiffs. It did admit that it had two obligations, namely paying the exchange bondholders
and paying the FAA bondholders. However, according to the Republic there was no legal
authority, no legal basis whatsoever to condition one payment on the other.427 It added that
such mechanisms did exist (e.g. sharing clauses), but that those required specific language in
the contract.428 Besides, the text of the FAA’s pari passu clause could not be used to support a
rateable payment theory, simply because the clause only meant that ‘you can’t create a senior
rank of debt’.429 In other words, the republic proclaimed the ‘ranking’ interpretation of the
clause.
Nevertheless, the Republic did (eventually) recognize the breach of the pari passu clause. The
only thing it refuted was the remedy. According to the Republic, the remedy was
‘acceleration’ and not mandatory payment.430 In other words, by requesting specific
performance, NML essentially asked for a ‘turnover order’ ex Fed. R. Civ. P. 69, which is
limited by the Foreign Sovereign Immunities Act (‘FSIA’). The court can order a sovereign
424
Fed. R. Civ. P. 56(a).
Transcript of Court Hearing (Feb. 23, 2012) (n 411) 3 (13-19).
426
Ibid 4 (18-19).
427
Ibid 28 (6-15).
428
Ibid 28 (18-20).
429
Ibid 28 (16-17).
430
Ibid 36 (13-15).
425
65
Pari Passu Clauses: The Root of the Problem?
debtor to turn over certain assets, but only if it concerns assets located in the United States of
America and if those are used for a commercial activity.431 In brief, the Republic asserted that
acceleration was the only possible remedy and a that payment order would be in direct
violation of the FSIA.
As previously mentioned, there were a lot of amici curiae present in this litigation, needless to
say the biggest victims were the Exchange Bondholders who claimed that they were
essentially being held hostage by vulture funds.432 Next in line were intermediaries such as
Euroclear Bank SA/NV. Euroclear asserted that it was not a ‘participant’ under Fed. R. Civ. P.
65(d), but an intermediary and as such it could not be bound by the order of 2012.433
Moreover, it claimed that the order was in direct violation of Belgian law.434 After the LNC
Investment v. Nicaragua –where the court ostensibly dismissed the ‘payment’ interpretation–
Belgian law was amended to prevent future holdouts from attacking the settlement systems.435
By making this order binding for Euroclear, the court allows NML to do just that which
Belgian law prohibits.436 Other amici included the United States government, Clearing House
of New York and Bank of England, all of whom said the ‘payment’ interpretation was
incorrect.437
It should be noted, however, that NML had some supporters too. Amongst others, these
included Argentinian and American professors. The Argentinian professors mainly supported
NMLs claim that by enacting the Lock Law the Republic of Argentina had breached the pari
passu clause, because (i) it rendered the claims of NML (and others) meaningless and (ii) it
was a sovereign binding act rather than an intention not to pay NML. 438 In turn, Professor K.
DAM pointed out that the order of 2012 would not affect the future ability of countries to
restructure and besides, Argentina was perfectly capable of paying NML.439 Other amici
431
Ibid 39 (3-9).
Transcript of Court Hearing (Nov. 21, 2012) (n 415) at 27 (12, 21-25).
433
Affidavit in support of motion for permission to file letter brief as amicus curiae, NML Capital Ltd. v.
Republic of Argentina, No. 12-105 (2d Cir. 2012) at 6.
434
Ibid 7.
435
Ibid 7; Art. 9 Finaliteitswet.
436
Ibid 8.
437
Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 29 (1-9).
438
Brief of amici curiae Argentine law professors in support of affirmance, NML Capital Ltd. v. Republic of
Argentina, No. 12-105 (2d Cir. 2012) at 5 and 16.
439
Brief of amici curiae Kenneth W. Dam in support of affirmance, NML Capital Ltd. v. Republic of Argentina,
No. 12-105 (2d Cir. 2012) at 5 and 16.
432
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included professor Mann, the Washington Legal Foundation and EM Ltd.440 It is clear that
NML’s views were supported by a lot of people.
REASONING OF THE COURT
In 2011, the court decided that the Republic of Argentina had breached the FAA’s pari passu
clause. In fact, its ruling on the matter was crystal-clear.441
It is declared, adjudged, and decreed that the Republic is required under of Paragraph 1(c)
of the FAA at all times to rank its payment obligations pursuant to NLM’s Bonds at least
equally with all the Republic’s other present and future unsecured and unsubordinated
External Indebtedness. […]
It is declared, adjudged, and decreed that the Republic lowered the rank of NML’s bonds
in violation of Paragraph 1(c) of the FAA when it enacted Law 26,017.
The court reasoned that by enacting legislation, which forbade future payment on the old
bonds, while at the same time continuing to pay interest on subsequently issued debt,
Argentina had breached its promise of equal treatment.442 Consequently, the court agreed in
February 2012 that something needed to be done, although at first it did not see any merit in
yet another judgement ordering Argentina to pay.443
I have no doubt that an order should be entered […], but […] I cannot help but wonder
what good such an order will be. The Republic has already been obligated to pay these
bondholders and they won’t do it. […] I have already entered an order saying the
Republic has violated the pari passu clause. […] Now, […] if I enter an order requiring
payment, which I think should be done, is there anything going to happen except they will
default on this obligation?444
Moreover, it initially doubted that NML’s ‘rateable payment’ solution had any legal basis.
While the Republic did have two obligations, namely an obligation to pay the Exchange
Bondholders and an obligation to pay NML, the court did not see how one payment could be a
condition for the other.
440
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012).
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Dec. 7, 2011).
442
Ibid.
443
Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 3.
444
Ibid at 3 (22-25) and 4 (1-11).
441
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Pari Passu Clauses: The Root of the Problem?
I accept the idea, […] that the Republic has two obligations; […] but that […] does not
necessarily mean that as a condition of paying the exchange offers they must pay an
amount [to NML]. […] I don't understand the pari passu clause to mean that the Republic
is forbidden to pay the exchange offers.445 I don't see a legal authority for me saying to the
Republic, you cannot pay the exchange offer people unless you pay NML.446
Besides, the court initially refused to accept that banks and intermediaries, who fulfilled their
obligations for a legal payment of the exchange bondholders, could be seen as ‘aiding and
abetting’ Argentina.447
However, after a brief recess and hearing NML’s counsel, the court reached a different
conclusion altogether. It actually badgered the opposing counsel to come up with answers for
the real issue, namely the remedy required for the pari passu breach. Time and time again it
repeated the same questions: ‘Tell me what remedy they are entitled to […]. The pari passu
clause is in there. Is it meaningless?’.448
Unfortunately for the Republic, the court did not take kindly to their counsel’s answers. It
refused to see acceleration as a remedy for a pari passu breach.449 Instead, it decided that
desperate times, called for desperate measures.
The republic has flagrantly violated its legal obligations. […] Now if there was any belief
that the Republic would honestly pay its obligations, there wouldn’t be any need for these
kinds of [strategies]. If there is merit to the pari passu argument, then there could be a
court order. […] Nobody really has any hope that the Republic will honestly honor its
obligations without some unusual mechanisms. That's why this is being done.450
According to the court, both parties had been jumping through hoops and twisting things for
years on end.451 It was time to end this farce once and for all and the pari passu clause was the
way to do it. Although the court recognized the potential problems the rateable payment
remedy would create, it argued that ending the Republic’s lawfulness was the ‘bigger
445
Ibid at 11 (17-25) and 12 (1-8).
Ibid 9.
447
Ibid 16.
448
Ibid 34, 37.
449
Ibid 38.
450
Ibid 30 (9, 21-25) and 31 (1-3).
451
Ibid 30.
446
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overriding problem’.452 Hence, it decided to grant NML’s request and prohibited Argentina to
pay the Exchange Bondholders without paying the FAA Bondholders rateably.453
Next came the Court of Appeals. While it mainly reiterated judge GRIESA’s contempt for the
whole situation and partly reaffirmed his decision, one cannot fail to notice that the court
emphasized the remedy issue rather than that of the pari passu breach. According to the court
‘NML [did] not interpret the pari passu clause as requiring ‘ratable’ payments, [NML]
proposed ratable payments as a remedy for Argentina’s breach’.454
Moreover, the court added that:
‘[E]ven under Argentina’s interpretation of the [pari passu clause], as preventing only
“legal subordination” of the FAA Bonds to others, the Republic breached the
Provision.’455 […] [T]he combination of Argentina's executive declarations and legislative
enactments have ensured that plaintiffs' beneficial interests do not remain direct,
unconditional, unsecured and unsubordinated obligations of the Republic and that any
claims that may arise from the Republic's restructured debt do have priority in
Argentinian courts over claims arising out of the Republic's unstructured debt. Thus we
have little difficulty concluding that Argentina breached the Pari Passu Clause of the
FAA.456
Evidently, the Court of Appeals saw eye to eye with judge GRIESA on the matter of the pari
passu breach, regardless of the arguments made by both Argentina and its amici.
Since a breach had been ascertained, the only thing left to do was find an appropriate
remedy.457 The Court of Appeals did consider the Argentina’s counterarguments, but
dismissed them rather quickly. First of all, according to the Court, the FAA did not
specifically limit the available remedies to acceleration.458 Therefore, in accordance with New
York case law, the Court could consider other remedies.459 Secondly, the FSIA argument did
not stick either. The mere fact that the injunctions would incidentally affect Argentina was
452
Ibid 48-49.
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Feb. 23, 2012).
454
NML Capital, Ltd. v. Argentina, 699 F.3d 246, 259 (2d Cir. 2012).
455
NML Capital, Ltd. v. Argentina, 699 F.3d 246, 260 (2d Cir. 2012).
456
Ibid.
457
Ibid 261.
458
Ibid 262.
459
Ibid.
453
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Pari Passu Clauses: The Root of the Problem?
insufficient for the court to determine a violation of Section 1609 of the FSIA.460 Finally, the
Court was not convinced that the injunction would ‘plunge the republic into a new financial
economic crisis’, because there was no evidence to support that claim.461 On the contrary, the
fact that the Republic was able to pay the Exchange Bondholder was proof that it did have the
required funds to uphold its obligation vis-à-vis the FAA bondholders. 462
However, the Court of Appeals did take issue with the injunctions’ effect on third parties, in
particular intermediaries.463 In the eyes of the Court, ‘pure’ intermediaries fell under the scope
of article 4A of the U.C.C. and as such, these intermediary banks –which have no obligations
to any party with whom they do not deal directly– cannot be subject to injunctions relating to
payment orders.464 With these remarks in mind, the Court of Appeals remanded the
injunctions to the District Court, for clarification regarding the Injunctions' application to third
parties and to address the operation of the payment formula.465
Other than affirming and remanding the District Court’s decisions, the Court of Appeals also
pointed out the existence of CACs and their potential vis-à-vis holdouts.466 The Court even
went as far as to assert that ‘collective action clauses [would] effectively eliminate the
possibility of “holdout” litigation.’467 Although this might have been a premature conclusion,
it definitely shows that the Court urged sovereigns to try and prevent future holdout-charades.
When the injunctions came back before the District court, Judge GRIESA made short work of
his amendment order and addressed the Court of Appeals’ remarks.468 Other than that, he
mainly repeated his previous frustration with the situation and rebuked the Republic for the
umpteenth time.469 Nevertheless, he did show some sympathy for the Exchange Bondholders
who were ‘being held hostage’, but basically saw them as ‘collateral damage’.470 According to
460
Ibid.
Ibid 263.
462
Ibid.
463
Ibid 264.
464
Ibid.
465
Ibid 265.
466
Ibid 264.
467
Ibid.
468
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
469
Transcript of Court Hearing, NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21,
2012) at 30.
470
Ibid 28.
461
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him, the real issue was Argentina’s behaviour. It could pay the Exchange Bondholders, if it
did so in accordance with his court order.471
It is clear from both the judgements and the transcripts that judge GRIESA and the Court of
Appeals were fed up with Argentina’s behaviour. More than once did the words lawbreaker,
disrespect and dishonest debtor appear.472 Obviously, their main goal was finding a way to
remedy to pari passu breach situation and the ‘rateable payment’ remedy was their solution.
IMPORTANCE OF THE CASE
In this case, the US Courts ostensibly endorsed the ‘payment’ interpretation, but as Romain
ZAMOUR has justly pointed out, there is a ‘crucial distinction between […] the issue of a [pari
passu] breach and the issue of a remedy’.473 While the pari passu clause was undoubtedly
breached in this case, the court did not actually rule on the interpretation of the clause.
Instead, it followed the NML’s line of reasoning and applied a ‘rateable payment’ as remedy
for the pari passu breach. Besides, it should be noted that the court realised that this was not a
perfect solution. On the contrary, the court admitted that this use of the pari passu clause
caused a lot of problems in itself, but nevertheless served a ‘higher purpose’, namely ending
the lawlessness and disrespect of Argentina. In sum, the court’s outbursts make it clear that it
figured it was time for Argentina to pay the piper and finally bring an end to this charade of
litigation.
The court order did have its desired effect. Recently, Argentina was blessed with a new
government that brought about winds of change and threw open the doors of settlement
negotiations.474 After fifteen years of intense litigation President Mauricio Macri decided to
present the holdout creditors with a new exchange offer.475 Mainly, the new government
reasoned that the country had suffered enough because of this protracted dispute which
restricted the country’s access to international credit.476 So, to induce the holdouts, it offered
to pay 75% of the amount awarded by US courts in 2012 which is approximately US$ 6.5
471
Ibid.
Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 14; Transcript of Court Hearing, NML Capital Ltd. v.
Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012) at 15
473
Romain Zamour, ‘NML v. Argentina and the Ratable Payment Interpretation of the Pari Passu Clause’ (2013)
Yale J. Int'l L. 55, 64, (hereinafter: Zamour, ‘NML v. Argentina’).
474
H Bronstein and S Marsh, ‘Argentina's Macri sworn in as president, ousting Peronists’ (Reuters, 11 December
2016) accessed on 26 February 2016; ‘Argentina's Macri says wants to resolve debt fight with U.S. creditors’
(Reuters, 12 January 2016) accessed on 26 February 2016.
475
‘Argentina makes offer to foreign creditors’ (BBC News, 6 February 2016) <http://www.bbc.com/news/world
-latin-america-35508907> accessed 6 February 2016;
476
Ibid.
472
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Pari Passu Clauses: The Root of the Problem?
billion.477 On March 1st 2016 the settlement negotiations finally came to an end and this
nightmarish case was finally put to rest.478
One thing is for sure, the holdouts ‘won’ again, but some might classify it as a pyrrhic victory
because of the years of waiting they have had to endure.479 However, where does NML leave
us? What can we expect in the future?
GELPERN puts it this way: ‘NML v Argentina may or may not change the world of sovereign
debt restructuring as we know it.’480 For instance, according to the United States’ government,
judge GRIESA’s reasoning ‘threatens core U.S. policy regarding international debt
restructuring [and its] effect could well extend beyond Argentina.’481 By creating new ways of
enforcement, the court has taken away all leverage a sovereign has over holdouts.482 Thus, ‘if
enough creditors adopt this strategy, sovereign debt restructuring will become impossible.’483
This view was endorsed by Allen & Overy’s Global Law Intelligence Unit that pointed out
that the decision ‘could have disruptive implications for work-outs and the resolution of
financial difficulties in the case of sovereign debtors.’484 GELPERN goes into detail on the
matter. First of all, she argues that both debtors and creditors will suffer from this decision in
future restructurings.485 Countries that are not capable of enduring prolonged litigation and
reputational costs, will be ‘temped to settle’, while creditors will have to consider the
possibility that they will not see any money if they agree to an exchange offer.486 Thus,
restructuring negotiations will henceforth be even more of a chore. Secondly, third parties
such as trustees, fiscal agents and clearing systems, become vulnerable to injunctions.487
Lastly, the so-called official sector (i.e. the ECB, the IMF and the World bank) might lose its
de facto preferential status. Thus far vulture funds have not attacked such payments, but
‘Argentina offers $6.5 billion cash deal to end debt battle’ (Reuters, 5 February 2016)
<http://www.reuters.com/article/argentina-debt-idUSL2N15K2KB> accessed 6 February 2016.
478
Daniel Bases, Richard Lough and Sarah Marsh, ‘Argentina, lead creditors settle 14-year debt battle for $4.65
billion’ (Reuters, 1 March 2016) <http://www.reuters.com/article/us-argentina-debt-idUSKCN0W2249>
accessed 2 March 2016.
479
EMTA, ‘Preliminary Analysis of Creditor Litigation (n 94) 3.
480
Gelpern, ‘Sovereign Damage Control’ (n 187) 9.
481
Brief for the United States of America as Amicus Curiae in Support of Argentina’s Petition for Panel
Rehearing and Rehearing En Banc, NML Capital, Ltd. v. Republic of Argentina, No. 12-105 (2d Cir. Dec. 28,
2012) at 9.
482
Ibid 10.
483
Ibid.
484
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 3.
485
Gelpern, ‘Sovereign Damage Control’ (n 187) 10.
486
Ibid.
487
Ibid.
477
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theory might yet become practice. The preferential status is not a matter of law, so courts can
decide to disregard it at any time.
However, not everyone seems to think that this decision constitutes the ‘end of sovereign debt
restructuring as we know it’.488 ZAMOUR justly emphasises the fact that this case is all about a
remedial issue and that such issues are highly fact based.489 Consequently, since the outcome
of this case was hugely dependant on the facts, its impact on future cases should be
minimal.490
ZAMOUR does not stand alone in this. A lot of authors support his view.491 Even GELPERN
provides some support, since she points out that the pari passu remedy is arbitrary and that
courts will ‘need to flesh out when a good apple turns bad’.492
Nevertheless, GELPERN’s comment also shows that NML case proves an excellent feeding
ground for speculation, since the Court of Appeals did not provide any guidance as to what a
pari passu breach entails.493 It merely said:
[It] prohibits Argentina, as bond payor, from paying on other bonds without paying on the
FAA Bonds.494 We simply affirm the district court's conclusion that Argentina's
extraordinary behavior was a violation of the particular pari passu clause found in the
FAA.495
However, what does that mean? Does that preclude a ‘payment’ interpretation, or not? In fact,
all that NML v Argentina did, was create even more confusion in an already chaotic discussion
concerning the pari passu clause.
In sum, this decision may or may not disrupt future sovereign debt restructuring. It all
depends on the market’s reaction and each sovereign debt situation should best be approached
Zamour, ‘NML v. Argentina’ (n 473) 56.
Ibid 65.
490
Ibid 56.
491
H Weisburg H, A E Stolper and S Marzen, ‘Don’t Cry for Me Argentine Bondholders: the Second Circuit
Decides NML Capital v Argentina’ (Shearman & Sterling LLP Client Briefings, 29 October 2012)
<www.emta.org> accessed 26 September 2015; EMTA, ‘Second Circuit Adheres Strictly to the Rules of
Contract in Sovereign Debt Restructuring’ <www.emta.org> accessed 26 September 2015; H Weisburg H, A E
Stolper, S Marzen and Clancy P, ‘Don’t Cry for Me Argentine Bondholders: The Second Circuit Rules’
(Shearman & Sterling LLP Client Briefings, 27 August 2013) <www.emta.org> accessed 26 September 2015;
Day, ‘Market Failure’ (n 11) 246; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 403.
492
Gelpern, ‘Sovereign Damage Control’ (n 187) 12.
493
Zamour, ‘NML v. Argentina’ (n 473) 64; Day, ‘Market Failure’ (n 11) 245.
494
NML Capital, Ltd. v. Argentina, 699 F.3d 246, 259 (2d Cir. 2012).
495
NML Capital, Ltd. v. Argentina 727 F.3d 230, 247 (2d Cir. 2013).
488
489
73
Pari Passu Clauses: The Root of the Problem?
on a case-by-case basis.496 Besides, it should be noted that the ‘Exchange Bonds’ of 2005 and
2010 already included a new provision, namely a CAC. This type of clause ensures that
dissenting bondholders are also bound, if a sufficiently large number of bondholders agrees to
an offer. Supposedly, the inclusion of such a clause was intended to prevent any holdout
litigation from occurring under the Exchange Bonds.497 This seems to indicate that sovereign
debtors now think they can prevent holdout litigation by way of CACs. The Court of Appeals
also seemed to think so.498 The question therefore becomes: ‘Will CACs save the day?’. A
more detailed overview on this topic can be found below in Chapter 4 Drafting Is Key to the
Pari Passu-Holdout Issue.
3.3.2.4.
Conclusion
Under New York law, the ‘payment’ interpretation is now a fact. It appeared in Elliott, took a
step back in LNC, but was ‘revived’ in NML. Although it is purely fact-depended at the
moment that does not take away the fact that it is out there and that holdouts can rely on it.
However, can the same be said about the other dominant applicable law in a sovereign debt
context? Would English courts reach the same conclusion as their US counterparts?
3.3.3. English Law Litigation
So far, we have focussed on litigation under New York law. However, as stated before,
English law is also of paramount importance when discussing the governing law of debt
instruments. Therefore, the pari passu litigation before the English courts also merits some
attention. Would the English courts rule the same way as their American brethren? Would an
Argentinian ‘Lock Law’ scenario have the same result, or not?
Unfortunately, the answers are nowhere near crystal clear.499 As a matter of fact, there is only
one case with any pari passu relevance, namely Kensington International Ltd v. Republic of
The Congo.500 Other than that, legal doctrine is forced to rely on basic contract interpretation
Michael M Chamberlin, ‘Argentina–Implications for the Marketplace?’ (EMTA, November 2012),
<www.emta.org> accessed 26 September 2015.
497
NML Capital, Ltd. v. Argentina, 699 F.3d 246, 253 (2d Cir. 2012).
498
Ibid 264.
499
IMF, ‘Strengthening the Contractual Framework’ (n 279) 13.
500
Kensington International Ltd v. Republic of The Congo ComC (Bailii) [2003] EWHC 2331 (Comm). Upheld
on appeal in Kensington International Ltd. v. Republic of the Congo, [2003] EWCA Civ 709, A3/2003/1036.
(hereinafter: ‘Kensington Ltd v. Congo’).
496
74
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principles and –frankly– educated guesses. The whys and wherefores of this situation are
discussed below.
3.3.3.1.
Kensington International Ltd v. Republic of The Congo
RELEVANT FACTS
In 1984, a consortium of banks provided the Peoples Republic of Congo with a loan of US$
20 million. This loan, governed by English law, had to be fully repaid by the end of 1988.
However, Congo never managed to repay any principal and from 1985 onwards it did not
even pay any interest. Thus, Congo defaulted on its loan agreement and the creditors decided
to sell the debt. 501
Enter Kensington International Ltd (‘Kensington’). This fund, affiliated with Elliott, bought
the distressed debt at a steep discount and immediately sued Congo seeking a summary
judgement.502 Its claims were as follows: (i) order Congo to pay US$ 56.5 million of principal
and interest, (ii) restrain Congo or its agents from paying any other creditors, (iii) unless
Kensington is paid pro rata and (iv) prevent Congo from granting any other securities over its
assets. Congo, however, never showed up in court, nor did it ever acknowledge the existence
of the lawsuit. So, Judge CRESSWELL was forced to consider the claims without any
counterarguments from Congo.503
Unfortunately for Kensington, Judge CRESSWELL only granted a summary judgment on the
money claim.504 The remaining claims were left unanswered and were simply directed to a
speedy trial. However, was the assignee entitled to the injunctive relief it claimed, or not?
This question required the interpretation of the pari passu clause contained in the loan
agreement. Clause 9(d) read: ‘To procure that the claims of all other parties under this
agreement will rank as general obligations of the People’s Republic of the Congo, at least pari
passu in right and priority of payment with the claims of all other creditors of the People’s
Republic of the Congo […]’.505
Finally, it should be noted that the injunctive relief sought was completely novel and
unprecedented, especially in the light of the facts. Firstly, it concerned an assignee rather than
501
Ibid §1-2 and 4.
For more info on summary judgements see note 96.
503
Ibid §10, 11.
504
Ibid §15.
505
Ibid §15.
502
75
Pari Passu Clauses: The Root of the Problem?
an original party. Secondly, the relief was sought in 2002 for an event of default which dated
from 1984 and lastly, the claimant did not have any interest in the case until the assignment in
2000, whereas the loan should have been fully repaid by 1988.506 These facts do explain why
Judge CRESSWELL was unwilling to grant a full summary judgement.
RELEVANT ARGUMENTS
In essence, Kensington tried to convince the court to grant specific performance of both the
negative pledge clause and the pari passu clause. According to Kensington, Congo had
breached these clauses on multiple occasions and therefore, the enforcement of these clauses
by way of injunctive relief was both adequate and proportionate.507
In support of these allegations, Mr MCQUARTER, counsel for Kensington, produced the
following arguments. For a start, he asserted that Congo had a history of violating negative
pledge clauses and that this case was not any different, especially since the negative pledge
clause in question was clear and unambiguous.508 Furthermore, he admitted that the pari
passu clause had been the subject of considerable discussion and that English law lacked any
direct authority on this point. To clarify he pointed out that there were two rival
interpretations. One considered the pari passu clause to be more or less a sharing clause.509
The other said that it had to do with ‘ranking’, meaning an ‘agreement that the debtor will not
create a class of debt or unsecured debt that ranks ahead of the debt created by the particular
loan agreement’.510 Ultimately, he concluded that the pari passu clause could not be anything
else than a pro rata sharing clause511, because:
(i).
Pari passu literally means ‘by equal step’.512
(ii).
The decision in Bowen v Brecon Railway Company513’strongly suggests that the pari
passu clause means that money to be distributed should be distributed or paid on a pari
passu basis’.514
(iii).
506
The wording of the clause clearly puts emphasis on ‘payment’.515
Ibid §14.
Ibid §25-26.
508
Ibid §27-28.
509
A pro rata sharing clause guarantees that if one creditor receives a greater (i.e. disproportionate) payment, it
has to share it rateably with the others.
510
Kensington Ltd v. Congo (n 500) §53.
511
Ibid §54.
512
Ibid §56.
513
Bowen v Brecon Railway Company (1867) LR 3 Eq 541.
514
Kensington Ltd v. Congo (n 500) §57.
507
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(iv).
A ranking interpretation makes little sense in a sovereign context. In a corporate
context the pari passu clause might preserve a creditor’s ranking in an insolvency
situation. However, in a sovereign context there is no insolvency, so the clause must
have another meaning altogether. More specifically, extra creditor protection in the
form of a pro rata payment rule.516
(v).
Foreign authority may have some (indirect) bearing, because in Merchant Bills
Corporation Limited v Permanent Nominees Australia Limited517, Red Mountain
Finance v The Democratic Republic of Congo518 and Elliott v. Peru519 three separate
jurisdictions supported a ‘payment’ interpretation of the pari passu.
REASONING OF THE COURT
Judge TOMLINSON considered the claim for specific performance and came to the following
conclusions. The negative pledge clause had indeed been breached. The clause was clear and
unambiguous and Congo had become notorious for violating it in all its agreements. 520 The
pari passu clause arguments, however, did not convince the court. According to TOMLISON
‘little weight’ could be attached to the foreign authorities, because the state in question were
not part of the procedures or the decision itself lacked in reasoning.521 Besides, he also
doubted the legal correctness of the broader interpretation and cited the Encyclopaedia of
Banking Law to support his view:
It should also be observed that the pari passu clause has nothing to do with the time of
payment of unsecured indebtedness, since this depends upon contractual maturities. The
undertaking is not broken merely because one creditor is, in fact, paid before another. In
the case of a state borrower, the pari passu clause must bear a different construction, since
a government cannot be liquidated […] Hence, a statutorily enforced hierarchy on forced
dissolution is not in point. It is suggested that a pari passu clause in state creditors is
primarily intended to prevent the legislative ear-marking of revenues of the government,
or the legislative allocation of inadequate foreign currency reserves to a single creditor
and is generally directed against legal measures which have the effect of preferring one
515
Ibid §59.
Ibid § 60.
517
Bowen v Brecon Railway Company (1867) LR 3 Eq 541.
518
Red Mountain Finance v The Democratic Republic of Congo, Case No. CV 00-0164 R (C.D. Cal. 29th May,
2001).
519
Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
520
Kensington Ltd v. Congo (n 500) §30 and 43.
521
Ibid §62-63.
516
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Pari Passu Clauses: The Root of the Problem?
set of creditors over the others or discriminating between creditors at a time when the
state is unable to pay its debts as they fall due.522
Whatever the case, TOMLISON decided that interpreting the pari passu clause was
unnecessary.523 In the end, he simply refused to grant injunctive relief because Kensington
could not tell the court what its considerations were when it acquired the debt, especially since
the breaches had been continuing for at least 18 years.524
IMPORTANCE OF THE CASE
Most authors consider Kensington a landmark case for pari passu interpretation under English
law.525 While the court did not choose one interpretation over the other, it clearly showed
reservations regarding the legal correctness of a ‘payment’ interpretation. In other words, the
court implicitly rejected the ‘payment’ interpretation set forth in Elliott v. Peru.526 Moreover,
these authors opine that this line of reasoning is complementary to the ‘ICS principles’ found
in Investors Compensation Scheme Ltd v West Bromwich Building Society (the ‘ICS case’).527
More specifically, they refer to the principle of ‘business common sense’ and the market
understanding of the word ‘rank’.528
In fact, when considering ambiguous contract clauses, the starting point under English law is
the so-called ‘five canons’ approach or the ‘ICS principles’ of Lord Hoffmann.529 In his
ground-breaking ICS judgement, he briefly summarized all contract interpretation rules in the
following five guidelines: 530
(i).
The Intention of the Parties Is Objective.
(ii).
The ‘Matrix of Facts’.
(iii).
The Exclusions From the ‘Matrix of Facts’.
522
Ibid §67 (emphasis added).
Ibid §91.
524
Ibid §92.
525
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 10; Olivares-Caminal,
‘Understanding the Pari Passu’ (n 7) 1229; Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n
27) 12. Andrew Shaw, however, does not see this case as a persuasive authority. (See Shaw, ’Ways to get paid in
a sovereign default’ (n 234) 631).
526
United States Court of Appeals_NML, p 45.
527
Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] AC 896.
528
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 9 and 12.
529
H Harris, ‘Contractual Interpretation: the "Five Canons"’ < http://www.crippslink.com/index.php?option=
com_content&view=article&id=1176:contractual-interpretation-the-qfive-canonsq&catid=88:commerciallaw&Itemid=626> accessed 21 February 2016; JW Carter, The Construction of Commercial Contracts (Hart
Publishing 2013); Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 267.
530
S Steiger, ‘Burning Question: Contract interpretation’ <http://www.lawcareers.net/Information/
BurningQuestion/Ince-Co-LLP-Contract-interpretation> accessed 21 February 2016.
523
78
Waves of Litigation and their Consequences
(iv).
The words used in a contract do not have to be taken literally.
(v).
Something Must Have Gone Wrong With the Language.
What these guidelines actually try to convey, is that English courts need to interpret contract
clauses in a purposive way, rather than a literal way.531 So, when a court is faced with an
ambiguous clause it has to consider the following question: What does the clause mean to a
reasonable person having access to all background knowledge that was available to the
parties? If the clause, read literally, leads to an absurdity in the light of the background
information, then the court should be able to assign a more appropriate meaning to it.
The latter is actually the principle of ‘business common sense’, which was first set forth by
the House of Lords in the Antaios532 case and was later endorsed by following case law533. At
the time, Lord DIPLOCK said ‘if detailed semantic and syntactical analysis of a written contract
lead to a conclusion that flouts business commonsense the contract must be made to yield to
business commonsense.’534 So, while the ‘payment’ interpretation might seem correct at first
glance, one cannot disregard the fact that the parties could never have intended it, especially
because of the far-reaching consequences such an interpretation entails.535 Besides, the legal
history of the clause is also relevant.536 Therefore, the ‘ranking’ interpretation is the correct
interpretation under English law.
This conclusion is held by reputable authorities. Chief among these is the Financial Markets
Law Committee (‘FMLC’). This independent committee, affiliated with the Bank of England,
identifies legal issues, uncertainties and misunderstandings on the financial market and it
opined that ‘the payment interpretation of the pari passu clause is unsupportable as a matter
of English law except where the clause is very clearly drafted to achieve this effect.’537
Also practitioners, such as renowned law firms Allen & Overy and Clifford Chance, opined
that the ‘ranking’ interpretation is the only correct one under English Law.538 In fact, lawyers
531
Ibid.
Antaios Compania Naviera S.A. v. Salen Rederierna A.B. 1 [1985] A.C. 191.
533
Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] AC 896, Rainy Sky SA and
others v Kookim Bank [2011] UKSC 50; BMA Special Opportunity Hub Fund Ltd and others v African
Minerals Finance Ltd (2013).
534
Ibid at 201.
535
See supra 3.3.2.2.6 Elliott Associates v. Banco de la Nacion.
536
Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 268.
537
FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 12; Allen & Overy Global
Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 12.
538
Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 13.
532
79
Pari Passu Clauses: The Root of the Problem?
at Allen & Overy go one step further and doubt that even a ‘Lock Law’ scenario (cf.
Argentina) would change an English Court’s view on the matter. Though it would be seen as a
breach of the (ranking) pari passu, it probably would not lead to pro rata payments as a
remedy.
539
It should be noted that Allen & Overy does not stand alone on this matter. Other
authors, such as SHAW and PETCH have voiced similar opinions.540
3.3.3.2.
Conclusion: The English Differ From the Americans
Although there is no direct (judicial) authority on the matter, it is safe to assume that under
English law the ‘payment’ interpretation of the pari passu would not fly, not even in a ‘Lock
Law’ scenario. The prime reason being that such an interpretation flouts basic contractual
interpretation principles under English law, namely the business common sense principle.
Indeed, the consequences of such an interpretation are simply to far-reaching and no
sovereign borrower would ever agree to such terms. Therefore, contractual mechanisms are
the only way –short of a statutory approach– to prevent future disputes with holdouts.
539
Ibid.
Shaw, ’Ways to get paid in a sovereign default’ (n 234) 63; Tolek N Petch, ‘NML v Argentina in an English
legal setting’ (2014) 9 (3) CMPLJ 266, 271.
540
80
Conclusion: Drafting is Key?
3.3.4. Conclusion: Where Did the Waves of Litigation Lead Us?
The presence of ‘payment’ language541 in certain pari passu clauses has resulted in quite a bit
of litigation in the sovereign debt context. Where once the ‘ranking’ interpretation was the
only interpretation, vulture funds now adhere to a second, ‘payment’, interpretation.
Although a literal read of some pari passu clauses might lead one to believe that the
‘payment’ interpretation is indeed valid, one cannot simply disregard all other possible
explanations. However, in the Elliott case, where the ‘payment’ interpretation made its debut,
the Belgian Court of Appeals did just that. It mindlessly followed a misguided declaration by
professor LOWENFIELD and plunged the sovereign debt sector into chaos.
Unfortunately, the NML case only added to that chaos and created a ‘new’ opening for vulture
funds. If the facts allow it, vulture funds can now request a ‘rateable payment’ remedy for a
breach of a pari passu clause. Although this is more of a remedy issue than an interpretation
issue, the result is more or less the same. Sovereign debtors are no longer be able to pay the
milk man. Instead, they are forced to settle.
However, it must be noted that this course of action is highly fact-based, so the significance of
NML is rather limited. Besides, the ‘payment’ interpretation only flies under New York law.
English courts (would) completely disregard it.
In essence, the ‘payment’ interpretation is the result of mindless copy paste behaviour and
complete disregard of the historical background of the pari passu clause. Obviously, the
advocates of the ‘payment’ interpretation choose to disregard this fact. Little wonder, since
this theory provides vulture funds with a lot of leverage over their sovereign debtor. The
consequences are simply not their problem. From their perspective, they have finally found a
way to force sovereign debtors to settle and get paid, even though it might take them a while
to obtain the desired judgement.
3.4.
CONCLUSION: DRAFTING IS KEY?
The analysis of the pari passu clause’s history and litigation has revealed one thing. There is a
distinct lack of judicial clarity and no real market understanding concerning the clause. In
fact, two interpretations are possible, though both are largely a matter of perspective.
541
E.g. rank at least pari passu in priority of payment.
81
Pari Passu Clauses: The Root of the Problem?
Historically, there is only one real interpretation, namely anything that has to do with legal
‘ranking’, meaning sovereign debtors should not create preference with regard to collateral,
nor earmark certain revenues, nor involuntary subordinate certain creditors by law. However,
ever since the Elliott case a new interpretation has surfaced. According to its advocates, the
‘payment’ interpretation precludes a sovereign debtor from paying any unsecured creditors,
without concurrently paying other unsecured creditors pro rata.
In addition, both these interpretations have their own sets of consequences. As mentioned
before the ‘ranking’ interpretation tries to uphold equality between creditors by preventing
any form of subordination. The ‘payment’ interpretation, on the other hand, has far-reaching
consequences. In a nutshell, it provides holdout creditors with leverage, but in doing so, it
creates all kinds of potential absurdities such as (i) being unable to prioritise payments, thus
jeopardizing the official sector’s preferential status, (ii) rendering real equality clauses useless
(i.e. sharing clauses, acceleration clauses…), (iii) destabilising sovereign debt restructuring
and (iv) affecting third parties which renders exchange bondholders hostages. Basically, it
would even make paying the milkman impossible.
Evidently, both the authors and parties involved argue back and forth about these
interpretations and their consequences. However, neither of them have any neutrality
regarding the meaning of the clause. In the end, it all boils down to a matter of perspective.
Sovereign debtors and exchange bondholders seek to block any payments to holdouts and try
to force them to participate in debt-restructuring, while holdouts endeavour to use the pari
passu as leverage to force sovereign states into settlements.
In any event, the cases referred to above have shown that litigation is definitely not an
efficient mechanism to address the sovereign immunity-bankruptcy standoff. Even though
holdouts always prevailed in the end by managing to force a sovereign state to settle, the time
and extreme effort it takes to obtain that goal hardly bodes well for an efficient approach.
One thing is for sure, BRATTON was right when he said that the ex post ‘payment’
interpretation highlighted the vulnerability of a purely contractual debt framework.542
However, lacking any statutory regime, the only other option is looking for the best way
mitigate the holdout issue or prevent it altogether. Therefore, construing the pari passu clause
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 867; Wong, ‘NML Capital, Ltd. v. Republic of
Argentina’ (n 287) 403.
542
82
Conclusion: Drafting is Key?
as clearly as possible and inserting certain other clauses such as CACs and exit consents,
might preclude or at least prevent holdouts from forcing a settlement via litigation.
Meanwhile, in the absence of clear contractual provisions, courts would do best to approach
each sovereign debt restructuring on a case-by-case basis.
83
DRAFTING IS KEY TO THE PARI PASSU-HOLDOUT ISSUE
Holdouts are faced with a sovereign immunity-bankruptcy situation. Lacking any other
recourse, they use whatever strategy available to achieve their goal of full repayment. As was
shown in the previous chapter, one of those tactics includes using the pari passu clause as an
enforcement device in sovereign debt litigation. Although its use is heavily debated and courts
do not give any crystal-clear indications on the matter, sovereigns still risk to encounter this
enforcement technique. Unfortunately, tackling the pari passu issue would merely be a
symptomatic solution. Holdouts, or more specially, the lack of creditor coordination, are the
root of the problem.
This chapter will therefore shed some light on the possible ways to mitigate the parri passu
conundrum and the holdout issue in general. First of all, this chapter will address the pari
passu clause. Secondly, it will discuss the legislative and contractual techniques to mitigate
the holdout issue –determining the pros and cons of each solution. Finally, it will provide a
possible approach to solve or at least mitigate the holdout issue.
However, it should be noted up front that these techniques are merely theoretical. No one
knows how the market or the courts will interpret them.543 Even the slightest hint of a
potentially profitable way to sue a sovereign debtor for full payment will entice creditors to
opt for litigation.544 As a result, introducing these measures creates ‘uncertainty’ costs.545
Besides, every issuance of bonds is unique and the terms differ accordingly. Consequently,
there is no all-round solution to the holdout issue.
4.1.
TACKLING THE PARI PASSU ISSUE
Sovereign states have not been blind to the dangers a pari passu clause poses to potential
restructuring efforts.546 Cases such as Elliott v. Peru and NML v. Argentina have led to all
kinds of changes in the sovereign debt landscape, ranging from legislative to contractual
solutions.
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2501.
Broomfield, ‘Subduing the Vultures’ (n 204) 502.
545
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2501.
546
IMF, ‘Strengthening the Contractual Framework’ (n 279) 14.
543
544
85
Drafting is Key to the Pari Passu-Holdout Issue
As mentioned before, LNC Investment v. Nicaragua led to a change in Belgian law. In fact,
the Settlement Finality Law was amended in such a way that it would prevent any future
attempt to intercept payments at Euroclear via the pari passu clause. However, this action
only tackled the symptoms, not the root of the problem.
Apart from a legislative approach, some contractual modifications are possible that might
mitigate or solve the pari passu issue.
The most radical approach is probably the one hinted at by GULATI and SCOTT.547 They
implied that drafters could simply do away with the pari passu clause entirely. Since no one
really knows what this clause actually means, why bother to insert it in the debt instrument at
all? However, this idea completely disregards the fact that a pari passu clause prevents
involuntary subordination of the debt by the sovereign debtor. Thus, this approach is hardly a
viable option.
On the other hand, some sovereigns –e.g. Ecuador, Honduras and Mexico– adopted a less
radical approach. Instead of eliminating the pari passu clause entirely, they either changed the
language of the clause, clarified its meaning in the offering memorandum, or identified the
risk in the prospectus.548 Even though their methods differed, the end result was the same: a
specific exclusion of the ‘payment’ interpretation and the rateable payment remedy.549
The International Capital Markets Association (the ‘ICMA’) took note of this development
and proposed a model pari passu clause to facilitate any future sovereign debt restructurings.
It reads as follows:
The Notes are the direct, unconditional and unsecured obligations of the Issuer and rank
and will rank pari passu, without preference among themselves, with all other unsecured
External Indebtedness of the Issuer, from time to time outstanding, provided, however,
that the Issuer shall have no obligation to effect equal or rateable payment(s) at any time
with respect to any such other External Indebtedness and, in particular, shall have no
Gulati and Scott, The Three and a Half Minute Transaction (n 40) 157; (See also Mark L J Wright, ‘The Pari
Passu Clause in Sovereign Bond Contracts: Evolution or Intelligent Design?’ (2014) 40 Hofstra L. Rev. 103,
103-104).
548
IMF, ‘Strengthening the Contractual Framework’ (n 279) 14.
549
Ibid.
547
86
Holding the Holdouts
obligation to pay other External Indebtedness at the same time or as a condition of paying
sums due on the Notes and vice versa.550
This model has received wide support from both the IMF and practitioners. 551 Similarly to
Ecuador, this clause chose to directly exclude any ‘payment’ interpretation or rateable
payment remedy. However, perhaps the most important thing to note, is that there is no
evidence to suggest that inserting this clause in bond documentation causes ‘uncertainty
costs’.552 Apparently, the market thinks its meaning is quite straightforward.
Be that as it may, the ICMA’s approach targets only the (mis)use of the pari passu clause. As
shown by NML v Argentina, 553 some courts might allow the breach of a pari passu clause to
be remedied by a rateable payment –albeit under very specific circumstances. Therefore, to
prevent the use of yet another far-fetched remedy, it might be advisable to include a remedy
other than ‘acceleration’. For instance, a specific pool of assets that can be attached upon
breach. That, coupled with the ICMA’s model pari passu clause, might be enough to put an
end to the misuse of the pari passu once and for all.
All things considered, solving the pari passu issue itself is not that hard from a drafter’s
perspective. It only takes some diligent drafting and careful wording of the clause,
supplemented with clauses that remedy breaches of the pari passu. Conversely, solving the
actual problem –the holdout issue in general– is a whole other matter.
4.2.
HOLDING THE HOLDOUTS
Sovereign debt restructuring is voluntary by nature. As a result, bondholders are free to opt in
or opt out of an exchange offer. In addition, the increased atomisation of bondholders and the
resulting divergence of interests only enhance the creditor coordination issue. Hence, holdout
creditors are definitely the major stumbling block of a sovereign debt restructuring and
finding a solution to the holdout issue is paramount. Therefore, this section provides a brief
overview of (primarily) contractual techniques that address this participation issue. To
ICMA, ‘Standard Collective Actions Clauses, Pari Passu and Creditor Engagement Provisions for the Terms
and Conditions of Sovereign Notes’ <http://www.icmagroup.org/resources/Sovereign-Debt-Information/>
accessed 21 April 2016, (hereinafter: ICMA, ‘Standard Provisions’) (emphasis added).
551
IMF, ‘Strengthening the Contractual Framework’ (n 279) 15; Stephen Moverley QC Smith and Heather
Murphy, ‘Sovereign Bond Collective Action Clauses: Issues Arising’ [2015] 2 JIBFL 128A 2.
552
IMF, ‘Strengthening the Contractual Framework’ (n 279) 15.
553
See supra 3.3.2.3.8 NML Capital Ltd. v Argentina.
550
87
Drafting is Key to the Pari Passu-Holdout Issue
conclude, this section will also provide a possible approach to solve or at least mitigate the
holdout issue.
4.2.1. Three Approaches to Curb Holdout Power
Generally speaking, there are three ways to tackle the holdout issue: (i) a statutory approach,
which proffers a sovereign insolvency regime (e.g. the SDRM) or limits vulture funds’
activities, (ii) a market-based approach, which uses corporate restructuring techniques such as
CACs and exit consents to emulate features of bankruptcy, and (iii) a contractual approach,
which focuses on contractual provisions that facilitate a restructuring.554
4.2.2. The Statutory Approach
As mentioned before, a statutory approach is politically impossible. The IMF tried, but failed
to implement the SDRM due to the tremendous amount of criticism it received. Moreover,
there is even evidence to suggest that the market intentionally came up with contractual
alternatives to block the SDRM initiative.555 However, this raises another question entirely:
What if that was the IMF’s intention all along –getting the market to address the holdout issue
itself?556
In addition to the SDRM failure, some countries have adopted legislation that curbs vulture
fund activity.557 Pioneering this initiative, was Belgium.558 In 2007 the Belgian market was
flooded with vulture fund litigation.559 For instance, Kensington International Ltd. managed to
seize money earmarked by the Belgian government for development aid projects in the
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1094; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;
Warren and Avery, ‘Investors of Prey’ (n 204) 225-226.
554
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1643, 1649 and 1674; Gelpern, ’Contract Hope’ (n 20) 143.
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1650.
557
Broomfield, ‘Subduing the Vultures’ (n 204) 503; Sookun, Stop Vulture Fund Lawsuits (n 191) 87-91;
Warren and Avery, ‘Investors of Prey’ (n 204) 225-226; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507.
558
Patrick Wautelet, ‘Vulture funds, creditors and sovereign debtors: how to find a balance?’ (2011) 20
<https://orbi.ulg.ac.be/bitstream/2268/87549/1/Vulture%20funds%20and%20sovereign%20debtors%20Wautelet
.pdf> accessed 24 April 2016, (hereinafter: Wautelet,’Vulture Funds’); Human Rights Council Advisory
Committee, ‘Draft progress report on the activities of vulture funds and the impact on human rights’ (OHCHR
2015) 14 <http://www.ohchr.org/Documents/HRBodies/HRCouncil/AdvisoryCom/Session15/A_HRC_AC_15_
CRP_1.doc> accessed 24 April 2016, (hereinafter: OHCHR,’Draft Progress Report’).
559
Warren and Avery, ‘Investors of Prey’ (n 204) 225.
555
556
88
Holding the Holdouts
Democratic Republic of the Congo.560 Consequently, a new law561 was passed to keep future
development aid money out of the clutches of vulture funds.562
However, the scope of the Belgian law is rather limited.563 It reads: ‘[T]he funds and assets
which are earmarked for international cooperation as well as the funds and assets earmarked
for public development aid, other than those of the international cooperation, cannot be
attached nor assigned.’564 The law specifically safeguards money intended for development
and international cooperation, but it does not provide a general prohibition on vulture funds
activity in Belgium.
In 2014, another attempt was made to curtail vulture funds in Belgium.565 This time, the law
proposal provided a detailed legal framework and included indicative criteria to identify
vulture funds.566 The aim of the law was to help the judges determine if a creditor’s actions
were contrary to public interest and ‘immoral’.567 Unfortunately, the law proposal was
retracted in May 2015.568
Following Belgium’s example, the United Kingdom enacted the ‘Debt Relief (Developing
Countries) Act in 2010.569 However, its approach was a little more aggressive vis-à-vis
vulture funds than the Belgian initiative. In essence, the act sought to clip the wings of
vulture funds by (i) putting a cap on vulture fund repayment, (ii) demanding disclosure of
secret vulture fund activity when bringing a lawsuit, (iii) imposing transparency rules and (iv)
banning corrupt payments.570 Be that as it may, its scope was still limited since it only
Sookun, Stop Vulture Fund Lawsuits (n 191) 88; OHCHR,’Draft Progress Report’ (n 558) 14.
Wet van 6 maart 2008 die ertoe strekt de inbeslagneming of de overdracht te verhinderen van overheidsgeld
besteed voor de internationale samenwerking, met name via de techniek van de aasgierfondsen. In fact, this law
inserted a new provision in the law of 25 May 1999. (Art. 11bis Wet van 25 mei 1999 betreffende de Belgische
internationale samenwerking).
562
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507; OHCHR,’Draft Progress Report’ (n 558) 14.
563
Broomfield, ‘Subduing the Vultures’ (n 204) 503; Warren and Avery, ‘Investors of Prey’ (n 204) 225.
564
Unofficial translation of art. 11bis Wet van 25 mei 1999 betreffende de Belgische internationale
samenwerking by Patrick Wautelet (See Wautelet,’Vulture Funds’ (n 558) 21).
565
OHCHR,’Draft Progress Report’ (n 558) 15.
566
Ibid.
567
Ibid.
568
<https://www.dekamer.be/kvvcr/showpage.cfm?section=/flwb&language=nl&cfm=flwbn.cfm?lang=N&legisl
at=54&dossierID=0394> accessed 26 April 2016.
569
Broomfield, ‘Subduing the Vultures’ (n 204) 507; Warren and Avery, ‘Investors of Prey’ (n 204) 226; Ryan,
‘Sovereign Bankruptcy’ (n 3) 2507.
570
Sookun, Stop Vulture Fund Lawsuits (n 191) 89; OHCHR,’Draft Progress Report’ (n 558) 14.
560
561
89
Drafting is Key to the Pari Passu-Holdout Issue
protected so-called ‘Heavily Indebted Poor Countries’ (‘HIPCs’) countries from vulture fund
activity in the UK.571
Similarly, the United States of America attempted to aggressively curtail vulture fund
activity.572 The bill was known as the Stop Vulture Funds Bill and it imposed a maximum
recoverable amount for vulture funds, namely the purchase price plus 6% interest. 573 Under
this bill, a limited number of countries, qualifying as poor countries574, would have been
protected from vulture fund activity. Unfortunately, this bill never made it into law.575
On the whole, several states do take steps to enact legislation that curtails vulture fund
activity. Nevertheless, their initiatives lack the power to address the holdout situation
effectively.576 It is quite clear that more (aggressive) legislation is necessary. 577 Unfortunately,
political traction for a more aggressive stance –genre SDRM– is absent.
4.2.3. The Market-Based Approach: Exit Consents and Collective Action Clauses
Lacking an effective legislative solution, some authors proclaim a market-based approach as
the way forward.578 According to them, the solution to the holdout issue might be found in
corporate restructuring techniques such as collective action clauses (‘CACs’) and exit
consents.
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507.
Broomfield, ‘Subduing the Vultures’ (n 204) 507; Warren and Avery, ‘Investors of Prey’ (n 204) 226-227.
573
Ibid; Sookun, Stop Vulture Fund Lawsuits (n 191) 90-91.
574
I.e. those countries that can borrow from the International Development Association (see Broomfield,
‘Subduing the Vultures’ (n 204) 507).
575
Sookun, Stop Vulture Fund Lawsuits (n 191) 90-91; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507.
576
Wautelet,’Vulture Funds’ (n Wautelet,’Vulture Funds’) 22; OHCHR,’Draft Progress Report’ (n 558) 16.
577
Ibid.
578
See in general Barry Eichengreen and Richard Portes, Crisis, What Crisis? Orderly Workouts for Sovereign
Debtors (Center for Economic Policy Research, 1995); Lee C Buchheit and G Mitu Gulati, ‘Exit Consents in
Sovereign Bond Echanges’ (2000) 48 UCLA L. Rev. 59, (hereinafter: Buchheit and Gulati, ‘Exit Consents’); Lee
C Buchheit and G Mitu Gulati, ’Sovereign Bonds and the Collective Will’ (2002) 51 Emory L J 1318
(hereinafter: Buchheit and Gulati, ‘Sovereign Bonds’); Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639;
Olivares-Caminal, ‘Is There a Need’ (n 2) 21; Gelpern, ’Contract Hope’ (n 20) 132; W Mark C Weidemaier and
G Mitu Gulati, ‘A People’s History of Collective Action Clauses’ (2013) 54 Va. J. Int'l L. 52, (hereinafter:
Weidemaier and Gulati, ‘A People’s History’); Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt
Instruments’ (n 25) 121; Naoki Ishikawa, ‘Towards the Holy Grail of Orderly Sovereign Debt Restructuring Part
I: The Use of CACs in Sovereign Debt Financing’ (2007) 6 JIBFL 333, (hereinafter: Ishikawa ‘Towards the
Holy Grail Part I’); Naoki Ishikawa ‘Towards the Holy Grail of Orderly Sovereign Debt Restructuring Part II:
Optimum Architecture of Collective Action Clauses’ (2007) 7 JIBFL 404, (hereinafter: Ishikawa ‘Towards the
Holy Grail Part II’).
571
572
90
Holding the Holdouts
4.2.3.1.
Collective Action Clauses or CACs
Sovereign debt restructuring is voluntary by nature. As a result, individual bondholders can
choose to holdout rather than participate, even though it might be in the creditors’ collective
best interests to do so.579 Moreover, the shift from bank lending to bond issuance led to an
increased atomisation of bondholders, which only strengthened the coordination issue.580 In a
corporate context such creditor coordination issues are resolved via the bankruptcy regime.581
Unfortunately, no such framework exists for sovereigns. Therefore, CACs can be used to fix
this problem in a sovereign debt context.582
4.2.3.1.1. What Are Collective Action Clauses?
In the broad sense of the word, CACs are clauses specifically designed to remedy bondholder
coordination issues.583 However, CACs can take on many forms. For instance, (i) majority
action clauses or modification clauses enable a defined percentage of bondholders –usually
75 per cent in principal amount– to amend any of the terms and conditions of the bonds in a
vote that is binding for all holders of that bond, (ii) aggregation clauses enable cross-border
bond-modification votes, (iii) collective representation or engagement clauses coordinate the
representation of the bondholders as a group by appointing a representative or a committee to
negotiate on their behalf upon default, (iv) majority enforcement or acceleration clauses
prevent an individual creditor from demanding full payment or suing the sovereign debtor
after a default, unless a predetermined percentage of bondholders approves it and (v) sharing
clauses force creditors who obtain (litigation) proceeds from the sovereign debtor to share
them among all creditors on a pro rata basis.584
Within this myriad assortment of CACs there are two types of clauses that form the
centrepiece of the CAC discourse.585 The first is a majority action clause, the second a
IMF, ‘Strengthening the Contractual Framework’ (n 279) 16.
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1320; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84)
43.
581
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639.
582
Gelpern, ’Contract Hope’ (n 20) 143.
583
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639; Weidemaier and Gulati, ‘A People’s History’ (n 578) 64;
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502; Samples, ‘Rogue Trends’ (n 13) 83; Turchi, ‘Restructuring a
Sovereign Bond Pari Passu Work Around’ (n 25) 2183.
584
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1641; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43;
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 46; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;
Weidemaier and Gulati, ‘A People’s History’ (n 578) 53.
585
International Monetary Fund, ‘The Design and Effectiveness of Collective Action Clauses’ (2002) 2
<https://www.imf.org/external/np/psi/2002/eng/060602.pdf> accessed 30 April 2016, (hereinafter: IMF, ‘The
579
580
91
Drafting is Key to the Pari Passu-Holdout Issue
majority enforcement clause. In fact, the other types of CACs586 merely have a supportive
role.587
It is generally understood that modification of (payment) terms and the ability to curtail
individual enforcement rights, could facilitate sovereign debt restructuring significantly.588
Indeed, bonds can be restructured via CACs despite the objections of the minority
bondholders.589 However, if that is truly the case, why did it take until 2003 for CACs to
become widespread in bonds issued under New York law? Besides, are these clauses even
legal?
4.2.3.1.2. The History of CACs
CACs are not something new or innovative. On the contrary, they have been around for more
than a century –just not in sovereign debt instruments issued under New York law.590 In fact,
the origin of CACs can be traced back to 1879.591 Ever since, they have been a ‘regular
feature’ of English bonds.592
In the early nineteenth century, English corporate bonds were characterised by unanimous
action clauses or ‘UACs’.593 This meant that the terms could not be changed without the
consent of all bondholders.594 In addition, English law lacked a US Chapter 11 bankruptcy
regime that allowed debtors to reorganise debt in order to avoid liquidation. 595 As a result, a
minority of creditors, unwilling to cooperate in voluntary debt restructurings, could force
distressed corporate debtors into bankruptcy and subsequently liquidation.596 Needless to say,
Design’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43; Olivares-Caminal, ‘Is There a Need’ (n 2)
30; Gelpern, ’Contract Hope’ (n 20) 143; Weidemaier and Gulati, ‘A People’s History’ (n 578) 53.
586
Such as trustee clauses, information provision clauses, representation clauses…
587
Ishikawa ‘Towards the Holy Grail Part II’ (n 578).
588
International Monetary Fund, ’Collective Action Clauses in Sovereign Bond Contracts—Encouraging Greater
Use’ (2002) 3 <https://www.imf.org/external/np/psi/2002/eng/060602a.htm> accessed 30 April 2016,
(hereinafter: IMF, ‘Collective Action Clauses’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 44;
Ishikawa ‘Towards the Holy Grail Part I’ (n 578); Olivares-Caminal, ‘Is There a Need’ (n 2) 33; Weidemaier and
Gulati, ‘A People’s History’ (n 578) 53.
589
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1097.
590
Ibid. Das and others, ‘Sovereign Debt Restructurings’ (n 25) 44.
591
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;
592
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1321, IMF, ‘Collective Action Clauses’ (n 588) 3; Fisch and
Gentile, ‘Vultures or Vanguards’ (n 42) 1097; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work
Around’ (n 25) 2183.
593
IMF, ‘Collective Action Clauses’ (n 588) 3.
594
Ibid. Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324.
595
IMF, ‘Collective Action Clauses’ (n 588) 3; Olivares-Caminal, ‘Is There a Need’ (n 2) 30.
596
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324.
92
Holding the Holdouts
some creditors (i.e. holdouts) used this ‘threat of liquidation’ to obtain preferential
treatment.597
After years of enduring this structural flaw in corporate debt, the London market reacted and
introduced CACs to fix the issue.598 The father of this new clause was Sir Francis B.
Palmer.599 In his opus Company Precedents, he briefly explained the use of CACs:
It is by no means uncommon [anno1881] to insert [majority action clauses] in a debenture
trust deed, enabling the majority to bind the minority in respect of various matters. […]
Now it sometimes happens that a company which has raised a large sum on debentures
[i.e. bonds] falls into temporary difficulties, and, though a large majority of its debenture
holders may be willing to give time or make some reasonable arrangement, a minority
decline to concur, and, in the result, the company is forced into liquidation. The insertion
of [majority action] provisions […] meets this inconvenience, and may save the majority
from the tyranny of the minority.600
Apparently, CACs were the London market’s reaction to the so-called ‘tyranny of the
minority’.601 Ever since they have been present in both sovereign and corporate bonds issued
under English Law.602 Oddly enough, prior to 2003 CACs were absent from the New York
market.603 This raises the question: why?
In the late nineteenth century, US bond issuers were plagued by the same issues as their
English brethren.604 When a US debtor had troubles servicing his debt, he was also faced with
the ‘threat of liquidation’.605 Indeed, it was not until 1934 that a ‘US Chapter 11
reorganisation’ became possible.606 Meanwhile, creditors had to endure the ‘tyranny of the
minority’ in the event of restructuring negotiations. Surprisingly, the US market did not react
with CACs to resolve this issue, instead they opted for equity receivership, UACs and exit
597
Ibid.
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324; IMF, ‘Collective Action Clauses’ (n 588) 3.
599
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325.
600
Francis B Palmer, Company Precedents 271 (2nd ed., Stevens and Sons, 1881), (emphasis added).
601
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325.
602
Ibid.
603
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43; Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639;
Broomfield, ‘Subduing the Vultures’ (n 204) 498; Gelpern, ’Contract Hope’ (n 20) 143; Turchi, ‘Restructuring a
Sovereign Bond Pari Passu Work Around’ (n 25) 2183.
604
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1326.
605
Ibid.
606
Ibid.
598
93
Drafting is Key to the Pari Passu-Holdout Issue
consents.607 Needless to say, this makes one wonder why two similar situations were solved
differently.
The origin of the market’s reluctance lay in the Negotiable Instruments Law (‘NIL’).608
Apparently, the market feared that the use of CACs would damage a bond’s status as
negotiable instrument.609 The NIL regarded negotiable instruments as unconditional promises
or orders to pay at a fixed or determinable time.610 The ability to modify terms via CACs
would undermine that. Therefore, the market had to come up with another solution: ‘equity
receivership’.611
In essence, equity receivership constituted a court-supervised restructuring.612 However, it
was soon replaced by a Chapter 11-style reorganisation in 1934.613 Although some voices
cried out for the use of CACs, the –newly created– Securities and Exchange Commission
(‘SEC’) was not a fan.614 The SEC’s research had shown that CACs did mitigate the ‘tyranny
of the minority’, but at the cost of creating a ‘tyranny of the majority’.615 Besides, the SEC
feared corporate insiders might abuse the CACs for their personal gain. For instance, equity
owners could buy up distressed debt of their company, only to reduce or forgive the debt
through the use of CACs.616
Since this practice was completely contrary to normal bankruptcy proceedings, the United
states inserted a new section in the Trust Indenture Act of 1939 (‘TIA’).617 Under section
316(b) of the TIA –the so-called ‘voting prohibition’– the use of CACs to modify payment
terms of publicly traded corporate bonds was expressly prohibited.618 It should be noted that
modification of payment terms was still possible, but it required the consent of every
bondholder (i.e. UAC).619 Oddly enough, almost all bond issuances followed the TIA-driven
607
See infra 4.2.3.2 Exit Consents.
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1326.
609
Ibid.
610
Ibid.
611
Ibid.
612
Ibid 1327; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 71; Olivares-Caminal, ‘Is There a Need’ (n 2)
29.
613
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1327.
614
Ibid.
615
Ibid 1328.
616
Ibid.
617
Ibid; Gelpern and Gulati, ‘Public Symbol’ (n 90) 1705; Weidemaier and Gulati, ‘A People’s History’ (n 578)
59.
618
Ibid; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 53; Olivares-Caminal, ‘Is There a Need’ (n 2) 30.
619
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1705; Olivares-Caminal, ‘Is There a Need’ (n 2) 30.
608
94
Holding the Holdouts
approach of UACs, even though the TIA contained an exception and was not applicable to
foreign sovereign bonds issued in the US. 620
In 2003 the ‘CAC shift’ occurred.621 After years of promoting by the IMF, G7 and the US
Treasury, Mexico was the first to adopt CACs in its issue of New York bonds. 622 This
breakthrough led to a rapid shift from UACs to CACs and ever since, CACs have been a
‘regular feature’ in bonds issued under New York law.623
In sum, CACs have been around for more than a century, especially in the UK. Most authors
agree that the absence of CACs in the US prior to 2003 was ‘market convention’ rather than
legal requirement.624 However, some authors claim that the ‘pro-CAC movement’ focuses too
much on the history of majority action clauses and dismisses every scrap of contrary evidence
that suggests that other types of CACs were present in the US prior to 2003.625
4.2.3.1.3. Legal Actions Against CACs
As mentioned before, CACs can be used to address the so-called ‘tyranny of the minority’.
However, what about the tyranny of majority? Is there nothing an individual bondholder can
do against the collusion of a sovereign debtor and the majority of creditors?626 In other words,
is there something akin to ‘good faith’ or ‘intercreditor’ duties in sovereign debt instruments?
In the US, good faith duty operates as a ‘gap filler’.627 If parties do not specifically prohibit an
action such as debtor-creditor collusion, then good faith can be called upon to prohibit it.
However, in order to do so, the action must be unforeseeable, meaning, had parties known
they would have prohibited it.628 Besides, even if this condition is met, US judges often
refrain from intervening because that will force parties to draft better contracts.629
Consequently, good faith duties are therefore virtually non-existent in the corporate bond
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1097; Olivares-Caminal, ‘Is There a Need’ (n 2) 30-31.
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1641; Gelpern, ’Contract Hope’ (n 20) 142.
622
IMF, ‘Collective Action Clauses’ (n 588) 3; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 45.
623
Gelpern, ’Contract Hope’ (n 20) 142-143; Weidemaier and Gulati, ‘A People’s History’ (n 578) 57; Samples,
‘Rogue Trends’ (n 13) 83; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2183.
624
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 45.
625
See Weidemaier and Gulati, ‘A People’s History’ (n 578) and Bratton and Gulati, ‘Sovereign Debt Reform’ (n
84) for a deeper analysis on the rise of CACs.
626
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 62.
627
Ibid.
628
Ibid.
629
Ibid.
620
621
95
Drafting is Key to the Pari Passu-Holdout Issue
context, let alone in a sovereign bond context.630 Luckily, in case of corporate bonds
individual creditors can still rely on Chapter 11 to offer some protection.631 Sovereign
creditors, however, do not have that luxury.
In sum, ‘judicial policing of the opportunistic use of CACs in restructurings’ is highly
unlikely in the US, even though it would help to prevent a tyranny of the majority. 632 Hence,
there is little an individual bondholder can do against misuse of a CAC.
Under English law, however, intercreditor duties do exist.633 For instance, in Redwood Master
Fund Ltd. v. TD Bank Europe Ltd, the High Court specifically stated that CACs should be
exercised in good faith.634 Although, it must be noted that the court did not extend this duty so
far that it amounted to a minority veto right.635 In any event, contrary to their American
brethren, English courts will scrutinize the use of CACs.636
4.2.3.1.4. The Value of CACs and Their Limitations
Most agree that –in theory– the value of CACs lies in solving creditor coordination
problems.637 Indeed, the ability to modify key (financial) terms and limit individual
enforcement rights can prevent or reduce the risk of holdouts.638 In that sense, CACs actually
emulate US bankruptcy features such as a ‘cramdown’ and an ‘automatic stay’. 639 A
cramdown mimics a majority action clause, since it entails a reorganisation plan that binds a
dissenting class of creditors, whereas an automatic stay mirrors a majority enforcement clause
given that it prevents individual creditors from undertaking legal actions against the sovereign
debtor.640 Hence, it is generally understood that CACs could significantly facilitate sovereign
debt restructuring.
Nevertheless, there are some downsides to using ‘plain vanilla’ majority action or
enforcement CACs in sovereign debt workouts.641 For instance, without any additional
630
Ibid 64.
Ibid 70.
632
Ibid 65.
633
Ibid 72; IMF, ‘Strengthening the Contractual Framework’ (n 279) 29.
634
[2002] EWHC 2703 (Ch) English High Court.
635
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 63.
636
Ibid 74.
637
Ibid 48; IMF, ‘Strengthening the Contractual Framework’ (n 279) 29.
638
IMF, ‘Collective Action Clauses’ (n 588) 3.
639
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1345 and 1347; Gelpern, ’Contract Hope’ (n 20) 143.
640
Ibid.
641
Ibid 1344.
631
96
Holding the Holdouts
features CACs only operate within individual bond series.642 This results in a coordination
problem across bonds, especially when a sovereign debtor is trying to restructure dozens of
bond issues involving different currencies and governing laws.643
Closely related to this issue are so-called ‘blocking stakes’.644 Voting thresholds might be the
core of collective action decision-making, but they also show holdouts how much bonds they
need to acquire in order to effectively block any decision.645 For instance, in 2012 holdouts
managed to block a restructuring in Greece despite the presence of CACs.646 Luckily,
aggregation clauses647 might mitigate both the cross-issuance issue and the risk of blocking
stakes.648
Finally, sovereign debtors might abuse the CAC mechanism by buying up or controlling the
distressed debt. Therefore, an additional feature called ‘disenfranchisement’ is required to
exclude those bonds from the bondholder votes.649
Nowadays, aggregation features are heavily promoted or obligatory in bond issuances. For
instance, the ICMA model CAC includes such a clause and all Eurobonds650 are required to
use a standardised aggregation provision.651
It must be noted, however, that an aggregation feature poses problems of its own. In some
instances, such clauses rely on a double majority or ‘two limb’ voting structure. 652 This means
that a minimum threshold of support is required in both the individual series and across all
Ibid; Gelpern, ’Contract Hope’ (n 20) 143; Samples, ‘Rogue Trends’ (n 13) 83; Wong, ‘NML Capital, Ltd. v.
Republic of Argentina’ (n 287) 421.
643
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1098.
644
Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421.
645
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1344; IMF, ‘Strengthening the Contractual Framework’ (n
279) 18; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287)
421.
646
IMF, ‘Strengthening the Contractual Framework’ (n 279) 18; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502;
Samples, ‘Rogue Trends’ (n 13) 83.
647
Aggregation clauses enable cross-border bond-modification votes, where multiple series of bonds can be
amended with a double majority threshold. (See Gelpern, ’Contract Hope’ (n 20) 143).
648
IMF, ‘Strengthening the Contractual Framework’ (n 279) 18; Gelpern, ’Contract Hope’ (n 20) 143; Samples,
‘Rogue Trends’ (n 13) 83; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421.
649
Gelpern, ’Contract Hope’ (n 20) 143.
650
i.e. Domestic and foreign bonds in the euro area (See IMF, ‘Strengthening the Contractual Framework’ (n
279) 19).
651
ICMA, ‘Standard Provisions’ (n 550) 4; IMF, ‘Strengthening the Contractual Framework’ (n 279) 19;
Gelpern, ’Contract Hope’ (n 20) 143;
652
IMF, ‘Strengthening the Contractual Framework’ (n 279) 19; Gelpern, ’Contract Hope’ (n 20) 143; Wong,
‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421.
642
97
Drafting is Key to the Pari Passu-Holdout Issue
series as a whole.653 When an individual series fails to back a modification, it drops out and
the other bond series go forward.654 Usually the voting threshold is lower for individual series
than the minimum level of support required across all bonds (e.g. 66 ⅔ versus 75 per cent).655
The lower threshold makes it more difficult for holdouts to acquire a blocking stake, but not
impossible.656 That is why the ICMA model CAC provides a feature called ‘single limb’
voting, which essentially calculates the vote on aggregated basis across all affected bond
series.657
Moreover, aggregation clauses do not help ‘non-bond debt’, nor does it solve broader
information-sharing issues.658 Again, these problems can be resolved by inserting additional
clauses, but it does show that simply including an aggregation feature is not enough.659
In sum, CACs essentially eliminate holdout activity and in doing so, facilitate sovereign debt
restructuring. There is more to it than merely inserting a majority action/enforcement clause.
Some meticulous drafting is required to make the CAC mechanism effective. This includes
adding features such as aggregation or disenfranchisement. That is why some authors argue
that CACs were inserted not because of their –theoretical– value, but rather as an attempt to
pre-empt the IMF’s SDRM proposal.660
4.2.3.2.
Exit Consents
CACs are not the only contractual technique to address creditor coordination issues.661 As
mentioned before, prior to 2003 bonds issued under New York law were subject to unanimous
action clauses (‘UACs’) rather than CACs.662 Due to the TIA-driven drafting approach, the
only way to amend payment terms was the consent of all bondholders.663 Given the dispersed
ownership of sovereign bonds, this was well-nigh impossible.664 Therefore, the market
IMF, ‘Strengthening the Contractual Framework’ (n 279) 19.
Gelpern, ’Contract Hope’ (n 20) 143.
655
IMF, ‘Strengthening the Contractual Framework’ (n 279) 19.
656
Ibid.
657
ICMA, ‘Standard Provisions’ (n 550) 1; IMF, ‘Strengthening the Contractual Framework’ (n 279) 20.
658
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503.
659
Ishikawa ‘Towards the Holy Grail Part II’ (n 578).
660
Gelpern and Gulati, ‘Public Symbol’ (n 90) 1643, 1649 and 1674; Fisch and Gentile, ‘Vultures or Vanguards’
(n 42) 1097; Gelpern, ’Contract Hope’ (n 20) 143; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502.
661
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503.
662
See supra 4.2.3.1.2 The History of CACs.
663
Ibid.
664
Olivares-Caminal, ‘Is There a Need’ (n 2) 33.
653
654
98
Holding the Holdouts
devised a new technique called ‘exit consents’ to coerce (potential) holdouts into participating
in a sovereign debt swap.665
4.2.3.2.1. What Are Exit Consents?
Exit consents or exit amendments are a legal technique that makes the acceptance of an
exchange offer conditional on a bondholders’ consent to amend certain non-payment terms of
the old bonds.666 Upon acquiring a predetermined threshold, the targeted non-payment terms
are amended and as a result, the value of the bonds is reduced.667 More specifically, these
amendments include the removal of key (financial) covenants668
such as a sovereign
immunity waiver, listing requirements or even the pari passu clause.669 By stripping away the
bonds’ favourable features670, the bonds become less attractive or illiquid.671 In other words,
the consenting bondholders are ‘poisoning the well behind them’ and forcing other
bondholders to participate in the exchange offer.672 If not, holdouts are left with impaired or
useless bonds.673 Small wonder that Bratton refers to this as a ‘starvation tactic’.674
Over the course of years, exit consents have evolved. They were first used in 2000 after
Ecuador defaulted on its bonds in 1999.675 At that time, the exchange offer constituted a ‘takeit-or-leave-it’ strategy.676 Only by consenting to a list of amendments were bondholders able
to participate. The stripped out features of the bond included a cross-default clause, a negative
pledge covenant and the rescission of acceleration of the bonds.677 A few years later, Uruguay
followed Ecuador’s lead and made use of the exit consent technique.678 However, as opposed
to Ecuador, Uruguay opted for ‘consensual exit consents’, meaning bondholders willing to
Goldman, ‘Mavericks in the Market’ (n 130) 175; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1095.
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;
Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122; Turchi, ‘Restructuring a
Sovereign Bond Pari Passu Work Around’ (n 25) 2183.
667
Ibid.
668
E.g. Cross-default clauses, negative pledge clauses, acceleration clauses, governing law clauses…
669
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46; Bratton, ‘Pari Passu and a Distressed Sovereign’
(n 75) 830; Olivares-Caminal, ‘Is There a Need’ (n 2) 30; Wheeler and Attaran, ‘Declawing the Vulture Funds’
(n 133) 265.
670
Including those securing seniority.
671
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46.
672
Ibid; Olivares-Caminal, ‘Is There a Need’ (n 2) 30.
673
Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122.
674
Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 830-831.
675
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331; Das and others, ‘Sovereign Debt Restructurings’ (n 25)
46; Olivares-Caminal, ‘Is There a Need’ (n 2) 31; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504.
676
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 47.
677
Olivares-Caminal, ‘Is There a Need’ (n 2) 31-32.
678
Ibid 32; Broomfield, ‘Subduing the Vultures’ (n 204) 497; Turchi, ‘Restructuring a Sovereign Bond Pari
Passu Work Around’ (n 25) 2183.
665
666
99
Drafting is Key to the Pari Passu-Holdout Issue
participate in the exchange offer could choose to grant their exit consent or not.679 Moreover,
Uruguay’s exit amendments were the first to include a waiver immunity clause.680 In sum, exit
consents have evolved from a ‘take-it-or-leave-it’ tactic to a ‘consensual’ approach instead.
Prior to 2003, three categories of bond terms could be distinguished: (i) terms that were
subject to a UAC (i.e. ‘unanimous consent matters’), for instance payment terms; (ii) terms
that, if amended, had an effect on unanimous consent matters; and (iii) all other provisions,
including pari passu clauses, negative pledges and immunity waivers.681 Consequently, only
terms of the third category were available for exit amendments, as long as the required
majority of 66 ⅔ was reached and the issuer consented.682
Nowadays, however, CACs are allowed in sovereign bonds issued under New York law.
Consequently, all terms can be amended with the consent of a specified majority of
bondholders.
4.2.3.2.2. Legal Actions Against Exit Consents
Exit consents try to coerce dissenting creditors into participating in an exchange offer. As
such, they are an effective tool to address the so-called ‘tyranny of the minority’ (cf.
CACs).683 However, some authors and market participants argue that the coercion of nonparticipating bondholders constitutes a ‘tyranny on the minority’.684 Nevertheless, the cases
on the subject of intercreditor duties are rather limited in number. In fact, there are but a few
cases in the corporate context and none with regard to sovereign debt.685
In the late nineteenth century, majority action clauses were first introduced as an alternative to
the holdout’s ‘threat of liquidation’.686 At that time, the creditors were subject to some kind of
fiduciary duty, namely a duty to act in the best interest of all bondholders.687 This was
confirmed in Hackettstown National Bank v. D.G. Yuengling Brewing Co688, when an attempt
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 47; Olivares-Caminal, ‘Is There a Need’ (n 2) 32.
Olivares-Caminal, ‘Is There a Need’ (n 2) 32.
681
Buchheit and Gulati, ‘Exit Consents’ (n 578) 79-80.
682
Ibid 82; Olivares-Caminal, ‘Is There a Need’ (n 2) 33.
683
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1336.
684
Goldman, ‘Mavericks in the Market’ (n 130) 175; Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1335.
685
Buchheit and Gulati, ‘Exit Consents’ (n 578) 78-82.
686
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1336.
687
Ibid.
688
74 F. 110 (2d Cir. 1896) <https://law.resource.org/pub/us/case/reporter/F/0074/0074.f1.0110.pdf> accessed 6
May 2016.
679
680
100
Holding the Holdouts
to use a majority action clause was deemed ‘a corrupt and unwarranted exercise of the power
of the majority’.689 Consequently, later cases were subject to scrutiny by US courts.690
As mentioned above, majority actions did not ‘take hold’ in the US market.691 Besides, with
the enactment of Chapter 11 and the TIA’s ‘voting prohibition’, majority actions soon
disappeared along with the fiduciary duties.692 Instead, US law turned and became quite
hostile towards the notion of implied intercreditor duties.693
However, in the landmark case of Katz v. Oak Industries Inc694 the door was opened to more
judicial discretion.695 In that case the plaintiff asserted that the removal of all financial
covenants binding the issuer constituted a breach of the issuer’s obligation to act in good
faith.696 Although Chancellor Allen ultimately rejected the plaintiff’s reasoning, he did
introduce a ‘test’ to determine if there was a breach of an implied contractual obligation (i.e. a
duty to act in good faith):
Because it is an implied contractual obligation that is asserted […] the appropriate legal
test is […] this: is it clear from what was expressly agreed upon that the parties who
negotiated the express terms of the contract would have agreed to proscribe the act later
complained of as a breach of the implied covenant of good faith – had they thought to
negotiate with respect to that matter. If […] yes, then […] such [an] act constitutes a
breach of the implied covenant of good faith.697
In other words, this test determines that if drafters had foreseen the (mis)conduct in question,
they would have barred it via contract, meaning they would have increased the number of the
‘unanimous consent matters’.698
Furthermore, in Federated Strategic Income Fund v. Mechala Group Jamaica, Ltd.699 a New
York court did rule in favour of a bondholder minority and blocked the use of an exit
689
Ibid at 114.
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1337.
691
See supra 4.2.3.1.2 The History of CACs.
692
Ibid.
693
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1339.
694
508 A.2d 873 (Del.Ch. 1986).
695
Buchheit and Gulati, ‘Exit Consents’ (n 578) 80; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1095.
696
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504.
697
Katz v. Oak Industries Inc 508 A.2d 873, 880 (Del.Ch. 1986), (emphasis added).
698
Buchheit and Gulati, ‘Exit Consents’ (n 578) 80.
699
No. 99 CIV 105 1 7 HB, 1999 WL 993648 (S.D.N.Y. Nov. 2, 1999).
690
101
Drafting is Key to the Pari Passu-Holdout Issue
amendment.700 In casu, the amendment would have completely impaired the minority
bondholders’ enforcement rights, given that the issuer would have been left without any assets
to attach.701 Hence, the court found that the exit consent went too far.702
In addition, in Assénagon Asset Management S.A. v. Irish Bank Resolution Corp.703 an
English court rejected the validity of an exit consent, reasoning that ‘the only function [of the
exit consent] is the intimidation of a potential minority, based upon the fear […] that, by
rejecting the exchange and voting against the resolution, he (or it) will be left out in the
cold.’704
In sum, unlike CACs, exit consents are scrutinized by US courts as well as by their English
counterparts. Consequently, depending on the circumstances, minority bondholders will be
able to do something about the abuse of this technique. Nevertheless, this fact must not be
overrated, because exit consents have been deployed successfully in quite a number of cases
(e.g. Ecuador in 2000, Uruguay in 2003 and Belize in 2004).705
4.2.3.2.3. Benefits and Downsides of Using Exit Consents
The objective of an exit consent is to encourage a minority of bondholders to accept an
exchange offer once the majority has accepted the offer. In other words, this technique tries to
address the holdout issue. So far, there have been quite a few cases in which this technique
has been successfully deployed, with participation rates ranging from 72% in Dominica to
98% in Belize.706 Besides, compared to CACs, the average threshold of an exit amendment is
lower, which makes it easier to use.707 Consequently, this ‘starvation tactic’ does seem to have
its merits with regard to mitigating the holdout issue.
Despite these advantages it is unlikely that this approach will be viable in all circumstances.708
First of all, an exchange offer might not always be economically feasible.709 Sometimes the
changes required are of such a magnitude that none of the bondholders will be willing to
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 68; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504.
Buchheit and Gulati, ‘Exit Consents’ (n 578) 73.
702
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504.
703
[2012] EWHC 2090 (Ch).
704
Ibid at 84.
705
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503.
706
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 49.
707
Olivares-Caminal, ‘Is There a Need’ (n 2) 34.
708
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096
709
Ibid; Broomfield, ‘Subduing the Vultures’ (n 204) 497; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505.
700
701
102
Holding the Holdouts
accept them.710 Secondly, sovereign debtors always run the risk of a ruling against the use of
exit consents.711 Depending on the circumstances, a court can always find that the use of exit
consents constitutes a ‘tyranny of the majority’. Finally, when using exit consents one must
beware of the so-called ‘buoying-up’ effect.712 While it is so that exit consents initially reduce
the value of bonds, there is also an increase in value following the completion of the
restructuring.713 Consequently, it is possible that the ‘buoying-up’ effect outweighs the
negative effects of exit consents.714
In sum, similarly to CACs, exit consents essentially eliminate holdout activity and in doing
so, they facilitate sovereign debt restructuring. Their major downside, however, is their
inability to amend every bond term. Nevertheless, sometimes their lower thresholds make
them more convenient than CACs. Consequently, it rather depends on the circumstances
which of the two approaches is best.
4.2.4. The Contractual Approach: A Trust Structure, MDV and Restructuring Triggers
Other than the corporate restructuring techniques mentioned above, there are contractual
techniques –proclaimed by several authors– that might facilitate sovereign restructuring and in
doing so, prevent or mitigate holdouts. Amongst others, these provisions include a trust
structure, an MDV and restructuring ‘triggers’. This section will give a basic overview of
these techniques and highlight their merits in the sovereign debt context.
4.2.4.1.
A Trust Structure
When sovereigns issue debt, they either choose to use a fiscal agent structure or a trust
structure.715 Generally speaking, bonds issued under New York law will take the form of a
fiscal agency agreement, while bonds issued under English law will take the form of a trust
deed.716 However, what is the significance of that choice, especially in the light of the holdout
issue?
710
Ibid.
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096.
712
Ibid. Broomfield, ‘Subduing the Vultures’ (n 204) 498; Wheeler and Attaran, ‘Declawing the Vulture Funds’
(n 133) 265; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505.
713
Broomfield, ‘Subduing the Vultures’ (n 204) 497-498.
714
Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505.
715
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221.
716
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1332; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506.
711
103
Drafting is Key to the Pari Passu-Holdout Issue
Under a fiscal agency agreement, the issuer appoints a ‘fiscal’ agent, meaning someone who
will handle matters such as the redeeming of bonds and coupons upon maturity.717 Moreover,
said agent will act as representative of the issuer and funds held by the fiscal agent will remain
the sovereign’s funds until they are deposited in each creditor’s account. 718 Besides, since the
agent does not act for the bondholders, each bondholder typically retains individual
enforcement rights, including the right to call for acceleration.719
On the other hand, a trust structure differs in three ways. First of all, under a trust structure, a
trustee is appointed as a fiduciary representative of the bondholders who takes on a
monitoring role to ensure that the issuer meets all the terms and conditions of the issuance.720
Secondly, any payments done through a trustee cannot be attached.721 From the moment the
funds are deposited on the trustee’s account they are no longer the sovereign’s property.722 In
fact, the trustee merely holds on to them on behalf of the creditors. 723 Finally, a trust structure
entails that the enforcement powers are centralised on the trustee.724 Consequently, there are
no individual enforcement rights for the bondholders.725 The only way726 to sue a sovereign
debtor is via the trustee acting upon instructions given by a specific percentage of
bondholders.727 Besides, any recoveries made by the trustee must be shared pro rata among
the bondholders.728
In sum, a trust structure essentially eliminates individual bondholder litigation and prevents
funds from being seized by recalcitrant creditors. As such, it is a great way to address the
holdout issue, but it requires a sovereign to issue bonds pursuant to such a structure.
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221; Fisch and Gentile, ‘Vultures or Vanguards’ (n
42) 1106.
718
Ibid; Broomfield, ‘Subduing the Vultures’ (n 204) 499.
719
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1332; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42)
1106; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506.
720
Ishikawa ‘Towards the Holy Grail Part II’ (n 578).
721
Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221.
722
Ibid. Broomfield, ‘Subduing the Vultures’ (n 204) 500.
723
Ibid.
724
Ishikawa ‘Towards the Holy Grail Part II’ (n 578).
725
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331.
726
It should be noted that a bondholder can act individually, if only when a trustee fails to follow the instructions
of the bondholders. (See Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331).
727
Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331; Broomfield, ‘Subduing the Vultures’ (n 204) 499.
728
Ibid.
717
104
Holding the Holdouts
4.2.4.2.
MDV: Minimum Default Value
GREGORY DAY has come up with an innovative idea to solve the sovereign debt issue. He
argues that a solution can be found in a technique similar to that of a ‘crop lien’, namely in a
‘minimal default value’ or ‘MDV’.729
During the nineteenth century, farmers were unable to obtain a loan because they lacked the
property to secure it.730 Luckily, this issue was solved in many countries by farmers who
pledged a portion of the next seasons’ harvest as security, hence a ‘crop lien’.731
Consequently, banks obtained a mechanism that enabled them to remedy a default, while
farmers were incentivized to make regular payments.732
DAY argues that a similar solution is possible in a sovereign debt context.733 If all parties
agreed ex ante to include an MDV in the debt instrument, it could provide them with a more
efficient way to remedy a default. In essence an MDV constitutes a provision clause that when
a default event or material breach occurs, a creditor may claim a predetermined percentage of
the original investment.734 An example clarifies:
[I]f a sovereign bond listed an MDV as 20% of a $1 million loan, then, upon a
nonpayment, the creditor could demand $200,000 from the bond's fiscal agent to be
drawn from the debtor nation's foreign central bank account, immediately terminating the
contract.735
Ostensibly, such a mechanism would entail certain advantages.736 First of all, an MDV
constitutes a termination clause of sorts.737 However, and MDV would not be a creditor’s
preferred route, because it would only allow him to mitigate losses and avoid lengthy
restructuring negotiations or litigation. In other words, an MDV merely provides a
prearranged settlement.738 Secondly, an MDV would neutralize vulture funds.739 It increases
the bonds’ minimal value, thereby reducing profits for vulture funds and making their
Day, ‘Market Failure’ (n 11) 256.
Ibid 255.
731
Ibid 256.
732
Ibid.
733
Ibid.
734
Ibid 257.
735
Ibid 258.
736
Ibid 258-261.
737
Ibid 258.
738
Ibid.
739
Ibid 259.
729
730
105
Drafting is Key to the Pari Passu-Holdout Issue
business strategy less attractive. Moreover, creditors will be less inclined to dump bonds with
vulture funds, since their prices might be lower than the prearranged settlement.740 Thirdly,
this system would be more equitable than the current ‘winner-takes-all’ framework.741
Nowadays only reputation precludes sovereign debtors from an opportunistic default. An
MDV might prevent it altogether, since it raises the minimum costs of a default. Finally, DAY
is convinced that MDVs would work, because they bypass courts.742 Consequently, they
provide creditors with a self-executing remedy and succeed in solving the holdout issue.
However, the MDV system is not without its flaws. From a business perspective, borrowing
money only to block a percentage of it on a bank account is far from an attractive a plan. In
fact, it is weird, to say the least. Moreover, to effectively block vulture funds activity, the
MDV would have to constitute a very large prearranged settlement. Otherwise it might not be
that much of a disincentive to vulture funds or creditors. DAY, however, claims that creditors
will opt for a 20% settlement rather than risk being faced with a debt swap at 2 cents on the
dollar.743 While I can agree with that logic, his example is a bit extreme. For instance,
Argentina’s debt swap included an exchange of 25 cents on the dollar.744 How would a 20%
MDV then stop creditors from engaging in vulture fund activity?
On the whole, MDVs are certainly an innovative approach, yet theoretical at best. Given their
disadvantages, they will never see the light of day.
4.2.4.3.
Restructuring Triggers
Inherent to restructuring negotiations are a wide array of costs, including reputational costs,
lawyer fees, administrative costs and so on.745 Moreover there is evidence to suggest that
restructurings destabilise a country’s economy, while the outcome of the negotiations is
always uncertain.746 Consequently, sovereign debtors are often reluctant to start restructuring
negotiations, even though it might be in their best interests to do so early on.747
740
Ibid.
Ibid.
742
Ibid 260.
743
Ibid 259.
744
See supra 3.3.2.3.8. NML capital Ltd v Argentina.
745
Das and others, ‘Sovereign Debt Restructurings’ (n 25) 65-66; Crispi, ‘Not Just the Luck of the Irish’ (n 1)
1873.
746
A. Mechele Dickerson, ‘A Politically Viable Approach to Sovereign Debt Restructuring’ (2004) 53 EMORY
L.J. 997, 1007, (hereinafter: Dickerson, ‘A Politically Viable Approach’); Das and others, ‘Sovereign Debt
Restructurings’ (n 25) 65-66.
747
Dickerson, ‘A Politically Viable Approach’ (n 746) 1006-1007.
741
106
Holding the Holdouts
According to KATHERINE CRISPI, sovereign debt instruments should therefore dictate when a
restructuring will begin.748 More specifically, contracts should include a provision that
identifies an economic indicator to automatically triggers restructuring negotiations.749 As a
result, such a ‘trigger’ would make the whole restructuring scenario a well-organised, efficient
process and allow sovereigns to regain access to capital markets more easily.750
Furthermore, CRISPI asserts that such a trigger will entail certain benefits for the restructuring
process.751 First of all, she claims it would tackle holdouts, because the provision would also
include a time limit during which restructurings need to take place.752 In other words, if
creditors refuse to cooperate, they lose their right of repayment. Consequently, any holdout
behaviour would result in a loss of legal right of repayment.753 Secondly, she claims that a
predetermined economic trigger will reduce the risk of an opportunistic default. 754 If the
trigger event occurs, a sovereign will have to initiate restructuring negotiations. Indeed,
economic indicators such as the GDP, export-to-import ratio and debt-to-equity ratio are
objective.755 Hence, they will do away with the discretionary element that characterises
restructurings today. Finally, she argues that including triggers will reduce costs of
negotiations and preclude drawn-out negotiations.756 All of that will expedite and facilitate
future access to the market.
At first glance, triggers appear to be a great mechanism to ensure that sovereign debtors do
not wait too long to restructure their debt. In that sense, they might indeed prevent some
reputational damage and quicken the restructuring process. However, claiming that a trigger
would reduce costs in general is overly optimistic. Though triggers might prevent drawn out
negotiations, lawyer fees might reflect the rushing of the process. Indeed, it is not because
negotiations are instigated automatically and constrained by a time limit that they will be any
less
complicated.
Triggers
do
not
help
with
regard
to
Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889.
Ibid.
750
Ibid.
751
Ibid 1889-1891.
752
Ibid 1889-1890.
753
Ibid.
754
Ibid 1890.
755
Ibid.
756
Ibid 1891.
748
749
107
Drafting is Key to the Pari Passu-Holdout Issue
finding ‘balanced’ terms and conditions. So, they might prove to be more time efficient, but at
the risk of increasing legal costs.
Besides, triggers only postpone the issue of debtor moral hazard. For instance, to strengthen
his bargaining position, a sovereign debtor could play hardball during the negotiations.
Consequently, when time runs out, the creditors would be left with no legal rights to
repayment, while the sovereign will have eliminated the risk of litigation. Thus, it might be
prudent to take note of this possibility and rule it out via another provision.
On the whole, there might be some merit to triggers, but they certainly raise another set of
questions as well. If one chose to use them, it would be advisable to include complementary
provisions to address issues such as (postponed) debtor moral hazard. Triggers as such are
insufficient to effectively create a flawless restructuring.
4.3.
CONCLUSION: A POSSIBLE APPROACH TO ADDRESS THE ISSUE
Lacking a sovereign insolvency regime and given the limited scope of legislation to curtail
excessive holdout behaviour, creditors and sovereign debtors are left with the contractual tools
to solve the pari passu-holdout issue. However, while designing the new clauses is quite easy,
the hard part is getting the debtors and creditors to accept them.757 Besides, all contract tools
have their limitations.758 This raises the question: Which drafting solution is best?
For starters, adjusting the pari passu clause is a must. There is no judicial clarity nor any real
market understanding regarding pari passu interpretation.759 The clause is simply too big a
litigation risk to escape a contractual reform unscathed. Therefore, it would be advisable to
change the language of the clause in such a way that it precludes both the payment
interpretation and the rateable payment remedy. Moreover, the new clause should also be
accompanied by a new remedy. As shown in NML v Argentina, the current acceleration
remedy simply does not cut it.760
Secondly, the holdout issue in general should be addressed in an effective way. CACs are an
excellent tool to address the holdout issue. However, their voting thresholds can be quite
difficult to achieve. Exit consents, on the other hand, are easier to deploy, but they lack the
Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 46.
Broomfield, ‘Subduing the Vultures’ (n 204) 496-497.
759
See supra 3 Pari Passu Clauses: The Root of the Problem?
760
See supra 3.3.2.3 The Third Wave: The Return of the Pari Passu?
757
758
108
Conclusion: A Possible Approach to Address the Issue
ability to amend payment terms. In brief, none of the contractual mechanisms mentioned
above will solve the holdout issue on its own. Therefore, it would be advisable to use a
combination of a few techniques instead.
The combination of contractual tools should include a trust structure, CACs and exit consents.
A trust structure is needed, given that it provides multiple benefits at once: (i) it provides
representation by a fiduciary trustee of the bondholders who will take on a monitoring role
and make any restructuring easier to coordinate, (ii) any payments done through a trustee
cannot be attached, which will definitely hamper holdouts and (iii) a trustee structure does not
provide individual enforcement rights for bondholders, which will hamper holdout activity
even more. Furthermore, CACs should be included to facilitate any restructuring. Similar to
the ICMA model, the CACs should be drafted with all the bells and whistles. More
specifically, they should include a modification clause with an aggregation feature,
supplemented with a disenfranchisement feature and a provision on the sharing of information
to mitigate any coordination issues. Lastly, the contractual tools also encompass exit consents.
As OLIVARES put it, there might be instances where the supermajority of a CAC cannot be
achieved. Then, it might be convenient to use an exit consent –with a lower threshold– to
persuade recalcitrant creditors.
Finally, even though it might not be a ‘contractual’ approach, it would be beneficial to
promote legislation that curtails excessive vulture fund activity. Indeed, current legislative
approaches are too feeble. The scope of the Belgian law does not encompass a lot of vulture
fund activity and the United Kingdoms’ law is limited to HIPCs. Therefore, it would be
beneficial to the market if major actors such as the IMF, the G-10 or the World Bank decided
to promote the enactment of similar –though more elaborate– legislation.
In Sum, GELPERN was right when she proposed a contractual approach in tandem with a
statutory one.761 However, given that a sovereign insolvency regime is currently politically
impossible, national legislation to curtail excessive vulture fund activity is the next best thing.
So, the holdout issue can definitely be mitigated by way of contract, but it should be noted
that the larger issue of over-borrowing still remains.762
761
762
Gelpern, ’Contract Hope’ (n 20) 148.
Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506-2507.
109
GENERAL CONCLUSION: WHAT TO EXPECT IN THE FUTURE?
From the outset, this thesis has tried to shed some light on the pari passu-holdout issue in a
sovereign debt restructuring. It started with some essential background information on the
subject and determined that in a sovereign default scenario creditors are faced with a so-called
‘sovereign immunity-bankruptcy standoff’.
Lacking a sovereign insolvency regime, creditors are forced to restructure their debt by way of
negotiations. Usually this leads to a debt swap or an exchange offer, whereby creditors have
the opportunity to exchange their old debt for new debt at inferior terms. However, due to the
voluntary nature of those restructurings, some recalcitrant creditors might refuse to
participate. Instead, these ‘holdouts’ try to achieve better terms or even sue the sovereign
debtor for full repayment of the debt. To their dismay, they are often faced with sovereign
immunity and find themselves in a veritable hunt for sovereign assets to attach. Hence, they
look for creative ways to pierce or circumvent a sovereign’s defences, but that approach is
both costly and time consuming.
Enter vulture funds. These investment funds buy up distressed debt of countries at a steep
discount with the sole intention of suing the sovereign debtors for repayment at par value.
Unlike regular holdout creditors they have the time and money to do so. Needless to say, are
often criticised for being the major stumbling block in a sovereign debt restructuring, because
they disrupt negotiations and cause lengthy sovereign debt litigation.
Still, it must be noted that vulture funds are not always a bad thing. Sometimes they provide
liquidity to the market or keep sovereign debtors from engaging in opportunistic defaults.
Nevertheless, in most cases, they are purely intent on high returns and merely bleed a country
dry.
Furthermore, this thesis examined landmark sovereign debt cases and showed how vultures
make use of a pari passu clause to force a sovereign debtor to settle.
Ever since the Elliott v. Peru case vulture funds have been proclaiming the ‘payment’
interpretation of the pari passu clause as the correct one, meaning that sovereign debtors
cannot pay exchange bondholders without paying the holdouts pro rata. In other words, only
paying the exchange bondholders constitutes a breach of the pari passu clause. Thus, this
tactic forces sovereign debtors to choose between defaulting on exchanged bonds or paying
111
General Conclusion: What to Expect in the Future?
the holdouts. In essence, it completely bypasses the issue of ‘asset hunting’ and therefore, it
has been a favourite of vulture funds ever since its first appearance.
By way of contrast, the historical analysis of the pari passu has shown that another
interpretation prevails, namely anything that has to do with legal ‘ranking’. Sovereign debtors
should not create preference with regard to collateral, nor earmark certain revenues, nor
involuntary subordinate certain creditors by law. In other words, the ‘ranking’ interpretation
tries to uphold equality between creditors by preventing any form of subordination.
Besides, the ‘ranking’ interpretation deserves support because of the extreme consequences
the ‘payment’ interpretation entails. In a nutshell, those potential absurdities include (i) being
unable to prioritise payments, thus jeopardizing the official sector’s preferential status, (ii)
rendering real equality clauses useless, (iii) destabilising sovereign debt restructuring and (iv)
affecting third parties which renders exchange bondholders hostages. Basically, it would even
make paying the milkman impossible.
To make matters worse, NML Catpital Ltd –a vulture fund affiliated with Elliott– has devised
yet another use for the pari passu clause. When Argentina subordinated debt by enacting the
‘Lock Law’, NML proposed ‘rateable payment’ as remedy for the breach of the pari passu
clause. Although it must be noted that Argentina’s behaviour in court played a big role in this
case, that does not take away the fact that this new pari passu approach is out there and poses
a risk to orderly sovereign debt restructuring.
Oddly enough, English Courts do not agree with their American brethren when it comes to
pari passu interpretations. Instead, they claim that the ‘payment’ interpretation flouts basic
contractual interpretation principles under English law, namely the business common sense
principle. Indeed, given the absurd consequences of the ‘payment’ interpretation sovereign
borrowers would never agree to such terms.
In sum, both English and American litigation has shown that there is no judicial clarity, nor
any real market understanding regarding the pari passu clause. Therefore, it would be
advisable for debtors and creditors alike to prevent or mitigate the holdout issue ex ante in the
debt instrument. In the absence of clear contractual provisions, courts would do well to
approach each sovereign debt restructuring on a case-by-case basis.
Finally, this thesis discussed some legislative and contractual techniques to prevent or at least
mitigate the pari passu-holdout issue and it suggested which approach should be endorsed.
112
General Conclusion: What to Expect in the Future?
Apparently, there are various techniques to address the pari passu-holdout issue. For instance,
changing the language of the pari passu clause. However, pari passu clauses are only part of
the problem in a distressed sovereign debt scenario. Limiting behaviour of holdouts,
especially vulture funds, is the actual issue. They will use whatever strategy available to
prevent a restructuring from ever taking place or force a sovereign debtor into a settlement.
Unfortunately, a sovereign insolvency regime remains politically impossible and legislative
attempts at ‘curtailing’ vulture fund activity are too limited to be effective. Consequently, the
contractual approach should –for now– be the main focus of issuers and creditors alike.
Meticulously drafting a combination of anti-holdout techniques could at least mitigate the
issue.
Given that contractual tools are never air-tight, this thesis suggested that sovereign debt
instruments should take on the form of a trust structure and insert both CACs and exit
consents. This, combined with legislation –promoted by actors such as the IMF or the G-10–
that curtails excessive vulture fund activity, should enable sovereign debtors to minimise
holdout litigation.
As a final note, it should be pointed out that the larger issue of over-borrowing and tardy
restructuring will still remain. Moreover, the contractual solutions mentioned above are purely
theoretical. Only time will tell if they are effective in a default scenario. In any event, one
thing is for certain. As long as there is even the slightest hint of a potentially profitable way to
sue a sovereign debtor for full repayment, holdouts will try and obtain settlements. Therefore,
further research on these subjects and on the prospect of an SDRM 2.0 might be interesting.
113
REFERENCES
TABLE OF CASES
Australia
Merchant Bills Corporation Limited v Permanent Nominees Australia Limited (1972-73)
Australian Law Reports 565.
Belgium
Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.
Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en NV
Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831.
United Kingdom
Assénagon Asset Management S.A. v. Irish Bank Resolution Corp [2012] EWHC 2090 (Ch).
Antaios Compania Naviera S.A. v. Salen Rederierna A.B. [1985] 1 A.C. 191.
Bowen v Brecon Railway Company (1867) LR 3 Eq 541.
Kensington International Ltd. v. Republic of the Congo [2003] EWHC 2331 (Comm).
Kensington International, Ltd. v. Republic of the Congo, [2003] EWCA Civ 709,
A3/2003/1036.
Kensington International Ltd. v Republic of the Congo [2005] EWHC 2684 Queen’s Bench
Division (Commercial Court).
Redwood Master Fund Ltd & Others v TD Bank Europe Limited & Others [2002] EWHC
2703 (Ch) English High Court.
United States of America
Bluebird Partners, L.P. v. First Fidelity Bank, N.A., 94 N.Y.2d 726 (2000).
Connecticut Bank of Commerce v. Republic of Congo 309 F.3d 240.
Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363 (2d. Cir. 1999).
115
References
Federated Strategic Income Fund v. Mechala Group Jamaica, Ltd. No. 99 CIV 105 1 7 HB,
1999 WL 993648 (S.D.N.Y. Nov. 2, 1999).
Hackettstown National Bank v. D.G. Yuengling Brewing Co 74 F. 110 (2d Cir. 1896).
Katz v. Oak Industries Inc. 508 A.2d 873 (Del.Ch. 1986).
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Dec. 7, 2011).
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Feb. 23, 2012).
NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012).
NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).
NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013).
MHR Capital Partners LP v. Presstek, Inc., 912 N.E.2d 43 (N.Y. 2009).
Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997).
Red Mountain Finance v. The Democratic Republic of Congo, Case No. CV 00-0164 R (C.D.
Cal. 29th May, 2001).
Republic of Argentina v. Weltover 504 U.S. 607 (1992).
Republic of Argentina v. NML Capital Ltd, 573 U. S. (2014).
Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F2d 1039 (2d Cir. 1982).
Case Documents
— —, ‘Unofficial translation of Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92’
<www.emta.org.> accessed 26 September 2015.
Affidavit in support of motion for permission to file letter brief as amicus curiae, NML
Capital Ltd. v. Republic of Argentina, No. 12-105 (2d Cir. 2012).
Brief of amici curiae Argentine law professors in support of affirmance, NML Capital Ltd. v.
Republic of Argentina, No. 12-105 (2d Cir. 2012).
116
References
Brief for the United States of America as Amicus Curiae in Support of Argentina’s Petition
for Panel Rehearing and Rehearing En Banc, NML Capital, Ltd. v. Republic of Argentina,
No. 12-105 (2d Cir. Dec. 28, 2012).
Transcript of Court Hearing, NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978
(S.D.N.Y. Feb. 23, 2012).
Transcript of Court Hearing, NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978
(S.D.N.Y. Nov. 21, 2012).
TABLE OF LEGISLATION
Australia
Section 11 Foreign States Immunities Act 1985 (the FSI Act).
Argentina
Ley 26.017 de fecha 9 de febrero de 2005 [30.590] B.O.
Belgium
Art. 1165 BW.
Art. 584 and 1412quinquies Ger. W.
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Art. 11bis Wet van 25 mei 1999 betreffende de Belgische internationale samenwerking.
Wet van 6 maart 2008 die ertoe strekt de inbeslagneming of de overdracht te verhinderen van
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United Kingdom
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11 U.S.C.
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