Present at the creation, pari passu edition | FT Alphaville

Present at the creation, pari passu edition

Holdouts’ opposition papers in the Argentine pari passu saga had just landed at pixel time on Friday. Here’s the one from NML itself, and here’s the one from other holdouts including Aurelius Capital.

We’ll try to do a proper take later on what the briefs say, but first, we thought we’d devote this post to some context on where the litigation is going as well.

It’s going by fast. The holdout filing means the clock’s ticking down to February 27, when the Second Circuit hears oral arguments on whether Argentina and its restructured bondholders should succeed in opposing terms of an order to pay the holdouts alongside other bond payments. (For more on the case and its context, by the way, it’s well worth reading these new draft papers by Anna Gelpern, Theresa Monteleone, and Mark Weidemaier, alongside the briefs and counter-briefs that have been spewing forth.)

But also, reading the holdout papers should now confirm just how far this litigation has moved beyond the pari passu clause itself.

The actual initial shock of the Second Circuit approval of the order in October — pari passu means rateable payment! United States courts should apparently have “little difficulty” in concluding that! — is pretty much status quo by now.

So, while NML, Aurelius, and co do have to reply to a paper mountain of briefs filed since January, they really don’t have to refight the meaning of pari passu. Efforts to refight the meaning elsewhere keep bouncing off. What the holdouts do have to do is try and destroy, in detail, the third-party arguments that the order’s provisions are attaching assets which they shouldn’t, and are therefore unjustly broad or threatening to the payments system as a whole.

“No one in this case is attaching anything,” the Aurelius-led brief says at one point. The whole thing argues (in pretty pungent language) that the courts are simply using their injunctive power to get Argentina to pay, and the parties appealing the order are just confusing this with creditors’ powers to seize assets.

Well for now we’d just note one part. Supreme confidence that rateable payment is now a settled issue – but still, actually, the core issue – certainly comes across in this rhetorical flourish from the Aurelius brief:

Indeed, the briefs filed by Argentina and its supporters are most telling for what they don’t say. For instance, Appellants and amici protest that the injunction will unfairly restrain nonparties that are merely honoring their lawful obligations on the exchange bonds. What they fail to mention is that payment on the exchange bonds is not always “lawful.” Here, in the absence of a ratable payment to Appellees, such a payment would violate the injunction that this Court already affirmed. Nor do Appellants and amici acknowledge the irony of heralding the sacredness of other contracts to justify ignoring the court-ordered remedy for breaches of this one.

Well there’s still some very complex stuff here — clearing houses; funds transfers; indenture trust law. That appears to be the nub now, the nuts and bolts of enforceable remedy. And in so far as the appellants can wave around federal statute – the Foreign Sovereign Immunities Act – here, this might be the main kind of substance which makes the case cert. worthy.

You could already tell what’s changed from the way the best pro-holdout amicus briefs filed earlier this month threw the big guns at the third parties. EM Ltd drafted in an expert on the funds transfer system to say that this won’t be held hostage. They also directly took on the arguments of one restructured bondholder, Fintech, that the order attaches property which properly belongs to them, countering that this “rests on an erroneous factual premise—that it is the beneficiary of a funds transfer originated by Argentina.” Meanwhile, Montreux Partners and Wilton Capital got Jack Goldsmith (he of the Bush torture memos affair) to pen a brief going after BNY Mellon’s attempts at self-extrication from the injunction.

But… we still want to talk about pari passu and rateable payment.

This is because it’s a) fun b) the history’s cool c) actually, it still does undergird all these pro-holdout claims about how the system should accommodate creditor rights.

If the pari passu clause is a rateable payments clause, then that makes it inherently an intercreditor clause. If Tom the debtor must pay Dick and Harry equal amounts each if he can’t pay them both in full, Dick could maybe sue Harry if Tom pays Harry what he’s owed and nothing to Dick.

That’s a problem if Tom’s constant dereliction over paying his debts generally requires Harry to shut up and swallow a write-down of his claim now and then, in return for getting something back. Harry might not want to play nicely any more, even if Dick’s pursuit of Tom is as inherently risky as ever. This last point gets rammed home in Gelpern’s new draft paper: “The choice on the table is not between 30 cents now and maybe 100 cents later. It is between 30 cents now plus being served with injunction papers – and maybe 100 cents later.”

Now, if that’s the possible future… it’s worth looking again at the primordial slime of pari passu.

So it was pretty interesting to read this Dealbook column last week by Harry Tether in support of the Second Circuit’s interpretation. As a JPMorgan Chase banker, Tether was closely involved in the “Brady” restructuring negotiations of the 1980s — he drafted these clauses:

During the Latin American debt crisis of the 1980s, when sovereign borrowers sought concessions from private creditors, the equal treatment provision became a vitally important affirmative covenant to international banks. Our direct negotiations, often long and arduous, led to mutually satisfactory restructurings of debtors’ financial obligations, in part because they required debtors to include strong legal protections in the new borrowing contracts. The sovereign debtor’s interest was to regain access to international capital markets, while the creditors’ interest was to receive a predictable and sustainable repayment flow. As a diverse group of creditors, we left our competitive instincts at the door. The pari passu clause served as a common denominator that assured equal priority of payment to all creditors of a similar debt class…

The pari passu clause and the fundamental principle of equal payment were understood then and have now been reaffirmed again to mean that debtors cannot discriminate in priority of payment to creditors holding comparable classes of debt.

This is rateable payment.

It’s worth remembering that at the time, sovereign debt (at least the stuff that had blown up in the 198os) would quite usually be in the form of syndicated bank loans. (It’s difficult to imagine now, exactly because Brady bonds were the prototype of the idea that sovereign debt works best as tradeable bonds.)

The story being told is that smaller banks were worried about getting squished by larger banks when it came to a future restructuring, and so they made sure that this precise version of pari passu language would go into the new bonds. The bonds became a prototype, the legal language was easily transferred, and the rest is history.

This is not the ‘origin’ story for pari passu clauses in sovereign debt. It can’t be. There are loads of these stories — that’s why pari passu is such a mystery! In Mitu Gulati and Robert Scott’s excellent new book The Three and a Half Minute Transaction, for example, they find what could be the first ever sovereign pari passu clause within a Bolivian loan of 1870. (And we really need to write a post on that story some time.) Gulati and Scott also note the Brady-era origin story, but they question whether it could be the whole story of why this damn piece of boilerplate keeps get chucked into sovereign bonds. Quite a few bonds with such contracts were already in issue by the 1980s.

But Gulati and Scott do note that pari passu clauses started using ‘riskier’ references to payment soon after the Brady era, so it could be an origin story for the modern pari passu clause. Chart via their book, click to enlarge:

So, Tether’s account firms up the idea that this era was a turning point which is still being played out today, in the Argentine litigation. The first implication is that ever since then, governments should have known what they were getting themselves and their potential restructured creditors into by using this or that pari passu language. One of Argentina’s arguments against rateable payment has been that “no sovereign debtor or creditor would ever agree to such a prohibition” (emphasis ours), after all.

The second implication though — this origin story puts the intercreditor rationale for the pari passu clause front and centre. Banks vs banks. Of course, at the same time it’s also nuanced: Tether is talking about payments only within a class of debt, which is interesting when many are worried that it could now be easier for holdouts to challenge official creditors’ preferential debt service.

In any event, there’s a sense of going back to the future here.