On October 26, 2012, the U.S. Second Circuit Court of Appeals ruled that Argentina had breached its contracts with hedge fund "holdout" creditors that held bonds issued in 1994 and were not tendered back to Argentina in bond exchanges in 2005 and 2010.
The central basis of the court's decision was its interpretation of the pari passu clause in the holdout creditors' contracts. A pari passu clause gives a creditor equal rights as other creditors when it comes to legal ranking or actual payment rights. A typical sovereign debt pari passu clause is drafted as follows:
These Notes rank, and will rank, equally (or Pari Passu) in right of payment with all other present and future unsecured and unsubordinated External Indebtedness of the issuer.
Although several commentators seemed surprised by the court's decision, the opinion was consistent with how the specific pari passu clause in question should have been expected to be interpreted.
A 2011 working paper by Mark Weidemaier, Robert Scott and Mitu Gulati examined three different ways pari passu clauses in sovereign debt agreements may be drafted. The authors rank each type of pari passu clause with respect how likely a court would be to interpret the clause to require equal payments to bondholders. They rank that likelihood in the following order, from least-to-most likely:
- “the bonds rank pari passu with all External Indebtedness;”
- “the bonds will rank at least pari passu in priority of payment and in rank of security;”
- “the bonds will rank at least pari passu in priority of payment and in rank of security and shall be paid as such.”
Unlike any of the above examples, the pari passu clause of Argentina's holdout creditors was drafted using two sentences:
The Securities will constitute . . . direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu 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 . . . .
In a separate blog post on Credit Slips, Mark Weidemaier interprets the holdout creditors' two-sentence pari passu clause to fall under the second category of pari passu--the category with a medium likelihood of being interpreted as granting equal payment rights--because it only "arguably impl[ied] an equal payment obligation." But that conclusion seems wrong.
Although the hold out creditors' pari passu clause does not include "shall be paid as such" language, the fact that the clause is split up into two sentences very strongly implies that the clause promises an equality of payment priority by Argentina, and not just an equal ranking. Indeed, the two-sentence formulation was the basis for the court's interpretation of the second sentence as worthy of its own designations as the Equal Treatment Provision.
Since the Argentine holdout creditors' pari passu clause seems to be of the category most likely to be interpreted as requiring equal payment rights, we shouldn't be too surprised that the court went along with that interpretation.
