NML Capital Ltd et al v The Republic of Argentina

08 March 2013

Romano I. Peluso, CCTS, consultant and retired Senior Vice President and Corporate Trust Manager at Law Debenture Trust Company of New York, co-authored with Robert I. Landau the sixth edition of Corporate Trust Administration and Management, and holds an MBA from New York University. He has written articles on financial and business news for practically his entire career and for the American Bankers Association for more than 25 years.

The plaintiffs in this litigation are holders of sovereign debt issued pursuant to a Fiscal Agency Agreement between The Republic of Argentina and Bankers Trust Company, as Fiscal Agent dated as of October 19, 1994 (the “FAA”). Argentina defaulted in 2001 on over $81 billion of its debt. The plaintiffs’ bonds (the “FAA Bonds”) are in default and are subject to federal court judgments which are unsatisfied. No payments have been made on the FAA Bonds since 2001.

In 2005 and again in 2010, Argentina made exchange offers to holders of FAA Bonds, pursuant to which bondholders who tendered FAA Bonds received new bonds (the “Exchange Bonds”). As a result of the two exchange offers, approximately 91% of the FAA Bonds were tendered and the Exchange Bonds have been kept current by Argentina. 1

The Bank of New York Mellon is the Indenture Trustee for the Exchange Bonds under a Trust Indenture dated as of June 2, 2005 and the First Supplemental Indenture dated as of April 30, 2010. The plaintiffs’ FAA Bonds were not tendered into the exchange offers.2

Argentina has stated that it does not intend to make any further payments on the plaintiffs’ unexchanged FAA Bonds. Further, Argentina adopted legislation (the so-called “Lock Law”) that prohibited it from making any arrangement to pay the unexchanged FAA Bonds: “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].”3

District Court Proceedings
The plaintiffs applied to the United States District Court for the Southern District of New York for a determination that Argentina’s proposal to make full payment on the Exchange Bonds while making no payments on the FAA Bonds constituted a breach of the Pari Passu Clause in the FAA “by lower[ing] the rank of [the plaintiffs’] bonds in violation of [the Pari Passu Clause] of the FAA when it made payments currently due under the Exchange Bonds, while persisting in its refusal to satisfy its payment obligations currently due under the [plaintiffs’] Bonds” and through enactment of the Lock law.

Pari Passu is a Latin phrase generally understood to mean in equal steps or side by side. A Pari Passu Clause in a contract provides in broad terms, that one debt will be treated in the same way as another. A corporation, for example, can enter bankruptcy proceedings, which will require all its assets to be realized and the proceeds distributed to its creditors. If particular creditors share ratably, they are generally considered, as between each other, pari passu. If another creditor is entitled to be paid first, that creditor is preferred. If a further creditor only gets paid after others have been paid in full, that creditor is subordinated. Once all of a corporation’s assets have been sold and the proceeds distributed to creditors, the corporation will be dissolved.

What pari passu means for sovereigns is harder to work out because there is no applicable sovereign insolvency debt restructuring mechanism. The assets of a sovereign borrower cannot all be sold and the proceeds distributed to its creditors. A sovereign can raise more taxes and reduce expenditures, but attempts to do so raise questions as to the proper balance between citizens and creditors, not to mention of civil order. A sovereign cannot be dissolved.

In light of this, there have been two competing interpretations of Pari Passu Clauses in the sovereign debt market among lawyers and investment bankers:

  •  ranking interpretation – only requires debt to rank equally with other relevant debt. There can be no subordination of debt by the sovereign or enactment of laws to cause the same.
  • payment interpretation – not only must there be equal ranking of debt but the sovereign must also pay its creditors equally.

Not all Pari Passu Clauses are drafted in the same way. It is possible that the ranking interpretation is the right interpretation of some clauses, the payment interpretation for others. In that respect, the two interpretations do not necessarily compete.4

District Judge Thomas P. Griesa issued the following Injunction:

Whenever the Republic pays any amount due under terms of the bonds or other obligations issued pursuant to the Republic’s 2005 and 2010 Exchange Offers … the Republic shall concurrently or in advance make a “Ratable Payment” … to [Plaintiffs]

Such “Ratable Payment” … shall be an amount equal to the “Payment Percentage” … multiplied by the total amount currently due to [Plaintiffs] …
Such “Payment Percentage” shall be the fraction calculated by dividing the amount actually paid or which the Republic intends to pay under the terms of the Exchange Bonds by the total amount then due under the terms on the Exchange Bonds.

The District Court also prohibited Argentina from “altering or amending the processes or specific transfer mechanisms by which it makes payments on the Exchange Bonds …” The District Court also ordered Argentina to provide copies of its injunction to all parties involved, in advising upon, preparing, processing or facilitating any payment on the Exchange Bonds, and further provided that all such [parties] shall be bound by the terms of the injunction.

Argentina appealed, and the District Court suspended the effectiveness of its Injunction pending the disposition of the United States Court of Appeals for the Second Circuit.5

Proceedings on Appeal
The Pari Passu Clause considered by both the District Court and Second Circuit  in the NML v Argentina litigation reads as follows “[t]he Securities will constitute…direct, unconditional, unsecured and subordinated obligations of the Republic and shall at all times rank pari passu without preference amongst 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…”

Regarding the Pari Passu Clause of the FAA, the United States Court of Appeals for the Second Circuit referred to the second sentence as the “Equal Treatment Provision.”6

The Second Circuit in its decision of October 26, 2012 concluded that the language of the Clause (1) prohibits Argentina, as bond issuer, from formally subordinating the FAA Bonds by issuing superior debt, and (2) prohibits Argentina, as bond payor, from paying on other bonds without paying on the FAA Bonds.

The Second Circuit also said that the Pari Passu Clause was important to sovereign bonds because when sovereigns default they do not enter bankruptcy proceedings where the legal rank of debt determines the order in which creditors will be paid. Sovereigns can choose for themselves the order in which creditors will be paid. Thus, the Pari Passu Clause prevents Argentina as payor from discriminating against FAA Bonds in favor of other unsubordinated, foreign bonds.

The Second Circuit went on to say that as a result of Argentina’s refusal to pay the FAA Bonds, its announcements that it would not pay those bonds, and the enactment of legislation prohibiting making payment, “we have little difficulty concluding that Argentina breached the Pari Passu Clause of the FAA.”

Regarding the Injunction, Argentina advanced many arguments against the terms and scope of the Injunction, all of which the Circuit Court held to be “unpersuasive.”  Argentina for example proposed that the Injunction violated the Foreign Sovereign Immunities Act of 1976 that establishes the limitations as to whether a foreign sovereign nation (or its political subdivisions, agencies, or instrumentalities) may be sued in U.S. courts—federal or state.

The Circuit Court, however, was concerned about two aspects of the Injunction:

  • the “ratable payment” mechanism contained in the injunction was unclear and appeared to be ambiguous.
  • the application of the Injunction to “pure intermediaries” potentially violated the protections in favor of intermediaries provided for in UCC Article 4-A.

The Circuit Court remanded the case back to the District Court for additional proceedings with respect to the terms of the injunction.7

Orders of District Court Regarding Remanded Issues
On November 21, District Judge Griesa issued orders resolving the issues remanded to him. In what appears to be a total victory for the plaintiffs, Judge Griesa ruled:

  • that the plaintiffs were entitled to a “ratable payment” from Argentina equivalent to “100% of what is currently due plaintiffs” if Argentina pays 100% of what is due to the Exchange Bondholders.
  • that the Paying Agent on the Exchange Bonds (which are not in default), is subject to his injunctions – meaning that funds paid  to the Paying Agent  for payment to the Exchange Bondholders are potentially available for payment instead to the plaintiffs, and
  • that the stays of his injunctions previously in place are lifted.8

Argentina has sought new stays from the Second Circuit. On November 28, 2012, the Second Circuit issued a stay of all three of District Judge Griesa’s November 21 orders.9

The court decisions have created an uproar in the sovereign debt restructuring arena, but whether the success means that the holdout bondholders will recover anything depends upon the next phase of the litigation and, in particular, the remedies that the courts grant. Whether the rulings have wider implications on sovereigns’ ability to restructure their debts also turns on the next stage of the litigation. 10

The three judges of the Second Circuit will need to decide the following major issues:

  • does the Injunction violate the Foreign Sovereign Immunities Act?
  • is the Injunction unconstitutional? 
  • does the Injunction abridge important public policies?
  • are the terms of the Injunction inequitable?

The final round of appellate filings by all parties ended the beginning of February.  Oral argument before the Second Circuit was heard on  February 27, 2013.11

Worries grew that Argentina was inching closer to another default after remarks made by Argentina’s lawyer during oral argument suggesting the government would choose to default if ordered to pay creditors who had not agreed to new terms for their debt resulting from the country’s 2001 default.  After the oral argument hearing, Argentina Vice President Amado Boudou said “It’s not that Argentina won’t pay. Argentina will always pay those who entered into the exchange. What Argentina won’t do is break its own laws.”12

During oral argument, the three judge panel of the Second Circuit expressed interest in whether an alternative ratable payment formula might be appropriate – one that would provide for equitable payments to the plaintiffs over time but would not amount to a 100% one-time payment. Discussion on the topic was vague. On March 1, 2013, the panel of judges ordered Argentina’s counsel to state in writing, on or before March 29, 2013, the precise terms of any alternative payment formula and schedule to which it is prepared to commit. The order directs that Argentina indicate:

  • how and when it proposes to make current those debt obligations on the original bonds that have gone unpaid over the last 11 years,
  • the rate at which it proposes to repay debt obligations on the original bonds going forward, and
  • what assurances, if any, it can provide that the official government action necessary to implement its proposal will be taken, and the timetable for such action.13

Argentina President Cristina Kirchner indicated she may make an offer to creditors who had refused to negotiate terms of their debt. The move could pave the way to a resolution of the country’s decade long fight over its 2001 default. Lawyers and analysts warned that a resolution is still a long way off and much depends on the details of Mrs. Kirchner’s offer to the holdouts and the terms of the alternative payment formula submitted to the Second Circuit.14

A decision by the Second Circuit is likely in April.15

1.    Shearman & Sterling LLP, Client Publication, “Don’t Cry for Me Argentine Bondholders: the Second Circuit Court Decides NML Capital v Argentina,” October 29, 2012.
2.    Declaration of Bank of New York Mellon regarding payment processes for Exchange Bonds, November 16, 2012.
3.    Endnote 1.
4.    Clifford Chance LLP, Briefing Note, “Sovereign pari passu clauses: don’t cry for Argentina – yet, December 2012.
5.    Endnote 1.
6.    Endnote 4.
7.    Endnote 1.
8.    Shearman & Sterling LLP, Client Publication, “Don’t Cry for Me Argentine Bondholders: Judge Griesa Gives Plaintiffs TOTAL Victory,” November 23, 2012.
9.    Shearman & Sterling LLP, Client Publication, “Don’t Cry for me Argentine Bondholders: The Second Circuit Stays Everything,” November 29, 2012.
10.    Endnote 4.
11.    Shearman & Sterling LLP, Client Publication, “Don’t Cry for Me Argentine Bondholders: Second Circuit Briefing Concludes,” February 8, 2013.
12.    Parks, Ken and Katy Burne, “Default Fears Hit Argentina,” The Wall Street Journal, March 1, 2013 and Webber, Jude “Debt dispute hearing rekindles fears of Argentina default,” Financial Times, March 1, 2013.
13.    Shearman & Sterling LLP, Client Publication, “Don’t Cry for Me Argentine Bondholders: Second Circuit Requests a Payment Proposal,” March 1, 2013.
14.    Romig, Shane and Ken Parks, “Argentina Eases on Holdouts,” The Wall Street Journal, March 2-3, 2013.
15.    Endnote 12.


Written by
Romano I. Peluso, CCTS

Romano I. Peluso served on the Subcommittee to review the Annotated Trust Indenture Act Report prepared by American Bar Association. The Report cites the case law for each provision of the Trust Indenture Act of 1939, as amended. The Report was published in The Business Lawyer, Section of Business Law, American Bar Association, August 2012, Volume 67, Issue 4, pages 977 - 1192.

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