Don’t Cry for Me Argentina: Part I
An overview of Argentina’s sovereign debt holdout hurdles in NML Capital Ltd v. Republic of Argentina  UKSC 31 and its wider implications.
The unresolved decade-long dispute between NML Capital Ltd and the Republic of Argentina in the US Courts has been referred to as the ‘trial of the century’ in sovereign debt restructuring due to the complicated and perhaps precedent-setting legal issues it poses. Before engaging in a discussion on those issues, it is important to set out the background of the dispute and identify the key stakeholders involved.
In the midst of a crippling economic depression, in late 2001, Argentina defaulted on part of its foreign debt worth 90 billion US dollars. Sovereign bond issuance is the means by which countries raise capital. Bonds are bought by various parties, such as pension funds, hedge funds, foreign governments and the International Monetary Fund (IMF). A sovereign default occurs when a country fails to repay its debt within the timeframe agreed between the parties. It has great implications on the defaulting country such as a freeze in foreign capital and investment, which are needed to fund essential state projects. The need for foreign capital acts as an incentive for states to voluntarily renegotiate their defaulted debt with bondholders under guidelines issued by the IMF. A consensual agreement between the parties would take the form of a debt restructuring where typically new bonds are issued at some loss to the bondholders or alternatively, a later maturity date is agreed.
With its economy in dire condition, its currency steeply depreciating and capital moving out of the country, in 2002 Argentina began its restructuring by taking a hard position towards bondholders. After prolonged and complicated negotiations, Argentina made a unilateral offer to the creditors, offering new bonds with substantial ‘haircuts’ in comparison to the original ones. In addition, it introduced a ‘Lock Law’ (Loj Cerroj) prohibiting the state from repaying any holdouts creditors: ‘The national State shall be prohibited from conducting any type of in-court, out-of-court or private settlement with respect to [unexchanged FAA Bonds].’
This measure was incorporated in order to encourage participation in the restructuring by ensuring that holdouts would not receive a more favourable offer at a later date to that of the exchanged bondholders. Finally in 2005, Argentina restructured 76% of its debt going up to 93% in its second restructuring in 2010. Given the substantial losses offered by Argentina to the defaulted bondholders, the initial 76% participation was considered a great success.
The remaining holdout creditors have sought litigation as means of recouping payment from Argentina pursuant to the original bonds. In fact, some of the defaulted debt was bought by hedge funds, including NML Capital Ltd, a part of Elliot Management, on the secondary market. Referred to as ‘vulture funds’ for their aggressive strategy of buying cheap distressed debt and then suing the defaulting country, the holdout hedge funds took the matter to the US courts.
Why New York?
The bonds were issued under a Fiscal Agency Agreement (FAA) in 1994 specifying the jurisdiction of the New York courts and New York governing law. Therefore, the holdout creditors applied to the United States District Court for the Southern District of New York for full repayment of the original bonds on the basis of a breach of the pari passu clause in the FAA.
The pari passu clause
NML Ltd argues that Argentina violated the pari passu provision in its FAA by paying exchanged debt-holders without also paying holdout creditors. The FAA provision states:
“[t]he 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…”
The pari passu, translated from Latin as ‘equal footing,’ is a clause widely used in sovereign and corporate debt contracts. It has a particular application in the context of a corporate bankruptcy or a sovereign default. Its goal is to ensure that all creditors are treated equally. Although ubiquitous, pari passu has no uniform meaning as Lee Buchheit, one of the most prominent sovereign debt restructuring experts, has suggested. He also notes that a clear distinction should be made between pari passu in the corporate debt and sovereign debt contexts. In 2005, litigation in Belgium by NML Capital’s associate, Elliot Management, encouraged the Bank of England’s Financial Markets Law Committee to issue an analysis of the role, use and meaning of the clause in English law. However, the New York courts have never interpreted the pari passu clause within a sovereign context until the present dispute between NML Capital Ltd v Republic of Argentina. Therefore, its interpretation could set a precedent for the meaning of pari passu under New York law.
Judge Griesa from the District Court held that Argentina’s declaration of non-payment, its payments to exchanged bondholders and its introduction of the Lock Law violated the pari passu clause in the FAA rendering the holdout creditors as de facto subordinated creditors. The Second Circuit Court further supported this through its own judgement:
Instead, we conclude that in pairing the two sentences of its Pari Passu Clause, the FAA manifested an intention to protect bondholders from more than just formal subordination. The first sentence … prohibits Argentina, as bond issuer, from formally subordinating the bonds by issuing superior debt. The second sentence … prohibits Argentina, as bond payor, from paying on other bonds without paying on the FAA bonds, Thus, the two sentences of the Pari Passu Clause protect against different forms of discrimination: the issuance of other superior debt (first sentence) and the giving of priority to other payment obligations (second sentence)
The Second Circuit Court also dismissed Argentina’s claim that those measures were purely legal subordination and that the meaning of pari passu has been established by custom in the past 50 years:
that there was “de facto” subordination because Argentina reduced the rank of plaintiffs’bonds to a permanent non-performing status by passing legislation barring payments on them while continuing to pay on the restructured debt and by repeatedly asserting that it has no intention of making payments on plaintiffs’ bonds
Part II will discuss the implications of the Second Circuit’s interpretation of pari passu, the unprecedented injunction and Argentina’s sovereign immunity.