Pari Passu Endgames
It was supposed to be a scheduling hearing, and I was supposed to be in New York for aconference. So I popped by Judge Griesa's courtroom on Friday to see about next steps in NML v. Argentina, and stumbled into a rave. Just about every analyst, journalist, and lawyer who has ever had anything to do with Argentina was on hand, along with the protagonists. They even set up an overflow courtroom, but the folks next to me preferred to get subway-cozy just to see it all in person.
The basic outcome is well-known by now: NML will file their brief by tomorrow on all the issues remanded to the District Court; Argentina and any third parties that care to intervene must respond by Friday; NML's reply is due by November 19. There will then be a hearing before Judge Griesa; he promised to rule before December 1 -- though perhaps even before -- with the goal of getting the Second Circuit's final chop in time for Argentina to make (or not make) the payments due to the Exchange Bondholders and NML on December 2. The stay on the injunction is in effect until the District Court rules ("until I have made my ruling"), but could be extended "until the Court of Appeals does further work" ("... but the Court of Appeals will not say nothing!").
Expect amicus briefs from the Bank of New York as trustee (present but quiet in the courtroom) and exchange bondholders. Watch for briefs from the U.S. Government, the New York Fed, the Clearing House, DTCC, international organizations, perhaps others. The expansive list of third-party targets in the plaintiffs' proposed order (Attachment B), and the Second Circuit's enigmatic reference to third parties beyond intermediary banks (p. 28), may have disturbed a hornet's nest. My view continues to be that the outcome depends heavily on the number and strength of third-party interventions. The trouble is that the biggies require quite a bit of process to come in, and would find it hard to turn on a dime in the few days allotted (less holidays and storm displacement). Conceivably the courts could even ask for briefs from the official actors later--so I am not sure what to read into any absences on Friday.
What follows is an attempt to fill in the color and the implications.
First, the color.
- Few thought it would get this far. The judge issued an injunction that piggybacks on the payment mechanism set up between Argentina and its bondholders, apparently without giving much thought to how the mechanism worked. The first few moments of the hearing passed spelling out how the money flows from Argentina to the Bank of New York in Buenos Aires, then to DTCC and Euroclear, then to their respective members, etc etc. Argentina's lawyers had to repeat and clarify quite a few times. Separately, Bank of New York showed up for the first time, and lawyers for the performing bond holders asked for "a seat at the table" --rather late in the program, as Ted Olson pointed out for Plaintiffs NML-- again, presumably because they never thought pari passu would be interpreted to implicate them.
- All love long gone for Argentina. The judge spent much of the hearing pummeling the Republic's lawyers for its politicians' press bluster, taking his talking points from the Plaintiffs' letter. In what must have been a feast for globalization nerds, the New York court took statements made for domestic political and global financial market consumption as targeted insults against itself. Bottom line: Argentina (not Cleary) must submit an affidafit by Friday to the effect that it is not trying to evade the court's injunctions. There has been some speculation about the Government refusing to do it, or clever phrasing -- but I just cannot see the lawyers walking into that courtroom again without a reasonably straightforward statement along the lines they were told to bring.
- This cannot last much longer. It is awkward to litigate a case before a court for a decade while refusing to pay that same court's judgments. The most poignant of the judge's many dramatic excursions is worth quoting at length: "The Republic as well as the Plaintiffs have had an enormous amount of service both from the District Court and the Court of Appeals ... The Republic was treated fairly and has won most of those litigated matters. In certain instances, where the Plaintiffs won in the District Court, it was reversed by the Appeals Court. The Republic has had the benefit of service of the District Court and the Court of Appeals, and has been treated with utmost fairness. Now the Republic did not prevail in this case. If the Court of Appeals ruling stands--and it stands now--the ruling adverse to the position of the Republic ... If--I emphasize if--there is any thought on the part of the Republic to defy and evade the current ruling, then that thought should be seriously reconsidered and set aside. I am repeating myself, but I want to repeat myself. ... The Republic should realize that its record of defiance of judgments already entered is beginning--perhaps too late--to be viewed very negatively, and that is certainly evidenced in the Court of Appeals discussion." A peek behind the curtain?
- The judge does not rule for the market. At least not the market in Argentine debt. Another highlight of Friday's hearing came when a lawyer for bondholders who participated in the exchange exclaimed that his clients were "being held hostage" and "suffering." Judge Griesa's response? Take it up with Argentina, because they can pay both. (This strikes me as a factual determination that depends on the pari passu formula, but we are on color, not fact.) "I don't sit here planning to affect the market. My job is not to affect the market, intentionally or not."
- The judge is ready to think outside the box. What might seem like protesting too much--"This court is not powerless ... steps can be taken to sanction ... I will not discuss ... means for dealing with that ..."--could also be read as readiness to throw caution to the winds. With the apparent blessing of the Second Circuit. (Here Plaintiffs' repeated suggestion that Argentina could post a bond bears watching.)
- Ted Olson is a soothing man. Whenever Judge Griesa showed the slightest bit of uncertainty or self-doubt (as in the pari passu formula or the duration of the stay), counsel for the Plaintiffs was there to tell him that he had been right and righteous all along, crystal-clear in every respect, and was therefore resoundingly affirmed. Argentina's response--"but this is really complicated"--is complicated by the fact that it is simply refusing to pay.
Next, the near-term implications. These are all about the three December payments due on the performing debt, and the potential triggering of Credit Default Swaps on Argentina.
- December payments are in limbo. I find it hard to believe that everything will be resolved in time for the first (small) payment to be made on December 2; however, I do not believe that Argentina will get a quick pass until March. Judge Griesa made no secret of his plan to keep up the pressure on Argentina; telling him that Argentine markets are tanking just confirms that his startegy is working. If he extends the stay, it will be in dribs and drabs. The biggest payment is on the GDP warrants on December 15; if the stay continues past then, March looks more likely.
- Payment workarounds are possible, but costly. The money belongs to the bondholders as soon as it hits BoNY in Argentina, but Argentina's payment obligation is not satisfied by the terms of the indenture until the payments "are received by the Holders of the Securities." This is an unusual formulation. Argentina can pay BoNY in Buenos Aires, though even that is contrary to the terms of the injunction. What happens next depends on what BoNY is willing or is allowed to do, and what bondholders are willing to accept. Without more from the courts, being clever is likely to be read as evading the injunction, and will cost both Argentina and BoNY in the litigation. If BoNY resigns, the question comes back for any successor that might be brave (or compensated) enough to step in its shoes.
- Formula magic is beguiling but unlikely. Some folks have suggested that the only equitable outcome on remand would be for Judge Griesa to order Argentina to pay NML the exchange terms, without extinguishing the underlying obligaiton. This would have the Federal District Court effectively simulate bankruptcy cramdown treatment, in line with the idea put forward by Marcus Miller and Dania Thomas some years ago. Courts do have the power to craft an equitable remedy within reasonable bounds of discretion. This court's repeated reference to "some" payment, as well as Plaintiffs' emphasis on "equal payment" as distinct from obligation ranking, seem to point to a payment remedy delinked from the terms of the bond. But most court specialists I bug scoff at the idea as just "making it up." You can bet lots of money that Elliott is not in this for the exchange terms, and would not take it lying down. Their letter to the court asks for full principal and past due interest.
- CDS could trigger. If there is a "failure to pay" on the part of Argentina, there is a "credit event" under the CDS contracts referencing Argentina. There is some question about whether there is a "failure to pay" if Argentina transfers funds to BoNY in Buenos Aires, but BoNY fails to pay the bondholders in New York. There is just barely enough fog in the indenture to give ISDA and its lawyers some room for interpretation (though the "received by Holders" language in the indenture cousels caution). The rumor mill has it that Elliott holds lots of CDS on Argentina;it is on the Determinations Committee charged with deciding whether there would be a credit event. If the rumor is true, this merits a separate post, since the incentives are not clear-cut here.
- Sympathetic retail holders may or may not benefit. German and Italian retirees are most likely to benefit from NML's victory if they have not reduced their contract claim to a judgment. If they hold judgments, they may no longer hold contracts with pari passu clauses under the merger doctrine. It bears emphasis that selling such risky investments to retail investors was and is wrong, not least because their enforcement hinges on highly specialized litigation strategies.
- If Argentina pays NML disproportionately, one interesting move would be for all the other defaulted holders with pari passu clauses to go after NML the same way as NML has gone after the exchange bondholders. Pari passu would then become all for one, one for all. More on this in another post.
Last, the big picture. I am coming around to the view that this is the end of sovereign debt restructuring as we know it. This may be good, bad, or medium -- but it is surely big.
- Ending the immunity-bankruptcy standoff. Sovereigns did not need bankruptcy protection because their debt was effectively unenforceable. Holdouts could create enough of a nuisance to force settlements, but that path was for the select few. The result was surely perverse -- countries could not be made to pay, but they could not get debt discharge either -- and they had no clue where the next wild enforcement attempt would come from. Argentina and Elliott show what happens when you take this "nonsystem" to the limit. It is unattractive. Now it might turn out that sovereign debt is enforceable after all ... against third parties. Bankruptcy time?
- No incentive to participate. Imagine a country running out of money. It wants to exchange its old bonds for new ones the old fashioned way. Until now, would-be participants weighed the risk of protracted limbo, against the risk of getting paid a little while a fiew holdouts got paid a lot. Holdouts ran the risk of chasing a government around the world for years. The few that did kept the system in balance. Now would-be participants, fiscal agents, trustees, ... closing dinner caterers ... are signing up to be defendants in holdout litigation. No, CACs make no difference. See Greece. (But see more on aggregation below.)
- Preferred Creditor Status on the table. By its terms, the District Court and Second Circuit interpretaiton of pari passu covers payments to international organizations, which have enjoyed informal preferred creditor status for decades. The Second Circuit repeats the Plaintiffs' contention that "commercial creditors never were nor could be on equal footing with the multilateral organizations"--but that one comes straight out of thin air. The institutions havescrupulously avoided claiming formal preference, and have even gotten into a bit of a tiff with the EU over Europe's attempt to formalize preference in a treaty. Reckoning time has come.
- No backup system. In the words of Judge Griesa, "I repeat myself--but I want to repeat myself"--this decision caught a lot of folks by surprise. There is no Plan B.
- The official sector has rejected a treaty regime that might have helped address the holdout dilemma, though it was far from comprehensive in coverage.
- The official sector's preferred solution -- prompting contract change for pari passu on the model of the CAC initiative in 2002-2003 -- would face opposition on impunity/creditor rights grounds, would take years, and is unlikely to approach anything like comprehensive coverage. Even so, I would not be surprised to see a sell-side outfit marketing liability management strategies to reform pari passu and introduce heretofore rare aggregated CACs to help reduce (not eliminate) NML-type risks. Where single-series CACs make no difference, aggregation might help on the margins. Even then, an issue could drop out of an aggregated restructuring, or a holdout could find a stand-alone instrument (a loan?) with a pari passu clause, and proceed to enforce against all the sheep that agreed to be shorn.
- Regulatory intervention, for example, requiring narrowly-worded pari passu clauses as a condition of accessing payment systems such as Fedwire, seems like a remote possibility at this stage.
- The last option is a national statutory fix to insulate payment and clearing systems, and maybe a broader set of third parties. Again, this is likely to face opposition, take time, and leave big holes.
- Off to London? It is tempting to think that with New York law in limbo, sovereign issuers will just decamp to London, where the policy establishment seems more likely to favor a narrow interpretation of pari passu. I am skeptical for two reasons.
- First, there are investors disposed to see the broad interpretation as long-overdue debtor discipline; these may flock to New York and drag some governments with them. There were plenty of folks who thought mutual assured destruction was a stable way of running the world -- and it was for a while. Put differently, I am not at all convinced that sovereign debt prices will tank across the board with this decision. For some, it is a positive.
- Second, it is far from settled that English courts will go narrow after New York went broad. There is a reason people worried about Brussels in 2000. Pari passu has long gone global.
All this to say we live in interesting times, and will be smarter in a couple of weeks.
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