This is Adam Levitin posting for Anna Gelpern. Only the awful illiterative post title is mine. Here's Anna:
Argentina and its most intransigent creditors are duking it out again (or still) in the Second Circuit, reviving the crazy battle over the meaning and import of the pari passu (equal treatment) clause in sovereign debt contracts. For the small but committed contingent of pari passu pointy heads, this is WorldCupOlympicMarchMadnessSuperBowl. For everyone else, this bears watching because an obscure turn in the Argentina story could open the door to enforcement against sovereign debtors in general. (Nope, this is not a closet Eupdate. Pay no attention to the man behind the blue-striped curtain.)
Recap: Argentina defaulted on roughly $100 billion in debt in 2001, then restructured about three-quarters of it in 2005 with a 60%++ haircut, depending on how you count. In 2010, it mopped up most of the rest. However, a small subset of expert holdouts keeps on suing, lobbying, and trying to collect by any means necessary. Last December, the long-suffering SDNY Judge Griesa ruled that the Republic breached the pari passu covenant in its debt contracts by (a) paying the holders of its restructured bonds but not the holdouts, and (b) passing a "Lock Law" that bars the government from paying the holdouts. On February 23, the judge issued an injunction, telling Argentina to pay the holdouts pro rata whenever it pays the holders of its restructured bonds. Argentina has appealed, pointing out among other things that paying people who took a massive haircut on par with those who took none was an odd reading of equal treatment. This week, the U.S. Government filed a Statement of Interest, joining the New York Fed and the New York Clearing House at a friend-filled party.
For those who care about neither Argentina nor pari passu, this matters because a broad reading of the February 23 SDNY order would subject countries who pay some creditors, but not others, to injunctions of the sort just slapped on Argentina. Creditors who get paid while the holdouts are not, or even intermediaries routing payments for Argentina, might be exposed as well. Since successful sovereign debt exchanges so far have all relied on a credible threat of stiffing non-participants, upholding the order could spell the end of the prevailing restructuring regime.
A narrow reading of the order would tie the injunctive remedy much more closely to Argentina's "Lock Law." The law can be read as a formal subordination of the holdouts (as distinct from selective payment)—a breach of the pari passu covenant under a reasonably conservative reading of the clause. Because this law is unusual, this would at least limit the effect of the order on the foreign sovereign debt market. But even a narrow reading would not solve the problem raised most forcefully in the U.S. Government brief—that the injunction would give creditors a worldwide remedy beyond the scope of the Foreign Sovereign Immunities Act.
Now some might say that upholding the SDNY order, even broadly, would not be a bad thing: it would jolt a screwed-up legal regime, and might prompt sensible reform. The alternative appears to be effective impunity for sovereigns that, like Argentina, can afford to pay the nuisance tax of never-ending enforcement litigation, and bear what reputational cost it does in the markets. The argument obviously loses force with poor countries that cannot afford to stay out of the markets and live in court for a decade, and must choose between clean water and holdout creditors. Yet others might say that the persistence of Argentina and the revival of pari passu as an enforcement device show again the cost to the international system of having no sovereign bankruptcy regime.
I would not go so far. But even if the SDNY order were totally wrong (and I think it is), there is something quite dysfunctional about a market where the contracts do not map onto the background legal regime. Normal-looking clauses turn into arrant nonsense when you stick them in sovereign IOUs. This is because private debt contracts are presumptively enforceable (even if not always enforced), and can be restructured in bankruptcy. Substituting immunity for bankruptcy in the sovereign context destabilizes, and occasionally eviscerates, the meaning of the contract text.
Pari passu is the reigning poster child for this proposition: because sovereigns cannot file for bankruptcy, there is never a moment of agreed insolvency or a waterfall of asset distribution. Instead, creditors owed on Monday might get paid, but those owed on Thursday might not. Is that subordination, or luck of the draw? The one agreed way to breach the covenant is to shout out "I subordinate"—but who does that?? (OK, maybe Argentina … I don't think the Greek "Retro-CAC" Law is comparable.)
The bigger mystery, given such apparent dysfunction, is why the brilliant lawyers who draft these contracts don't just fix the provision once and for all, so that it would make sense. Smart people have offered thoughtful explanations. I suspect the answer has something to do with the weirdness of writing a totally, utterly, certainly unenforceable debt contract. That’s just not what upstanding lawyers do—or is it?
Finally, there is a weird political/PR dynamic at play here. Argentina and Greece, represented by the same law firm and threatened by the same holdout creditors, have polar opposite PR strategies. For Argentina, they key is to hitch its case to the European caravan, to demonstrate that ruling against Argentina would bring on global financial apocalypse. Hence the reference to Greece, Portugal, Spain, and Ireland as potential victims in the Argentina brief. In contrast, the last thing Greece wants is to have the spectre of Argentina hover over its still-pending debt exchange. The holdouts want some combination of both — they want Greece to feel threatened by the potential outcome in Argentina, but not so threatened that the US and EU establishment get scared too and join the battle full force on Argentina's side.
All this for pari passu? Stay tuned for geek party of the century.