sovereign debt restructuring: should we be worried about elliott?

8/10/2019 Sovereign Debt Restructuring: Should we be worried about Elliott?

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HARVARD LAW SCHOOL

International Finance Seminar

Professor Hal Scott and Professor Howell Jackson

SOVEREIGN DEBT RESTRUCTURING:

SHOULD WE BE WORRIED ABOUT ELLIOTT?

EDUARDO LUIS LOPEZ SANDOVAL

Cambridge - Massachussets

May 2002


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TABLE OF CONTENTS

I. INTRODUCTION...3

II. THE ELLIOTT CASE: FACTUAL BACKGROUND AND POST-JUDGEMENT

LEGAL STRATEGY...7

1. What exactly happened?..8

2. The Brussels Court of Appeals Decision...17

3. The Opinion of Professor Andreas F. Lowenfeld..20

III. INTERPRETING THE PARI PASSUCLAUSE...24

1. An Alternative Interpretation.24

2. Elements to be considered when interpreting thepari passuclause.36

2.1 Necessity to pay preferred creditors first....37

2.2 The role played by other clauses included in international loan

contracts..39

2.3 Variations on the conventional terms of the pari passu clause.44

2.4 International public policy issue: the holdout creditor problem...45

3. Rules for the Interpretation of International Loan Contracts.48

3.1 New York Rules49

3.2 English Rules...50

IV. FORMAL ASPECTS OF THE BRUSSELS DECISION.54

V. ADDITIONAL SUBSTANTIVE ISSUES58

1. Execution of NY decisions58

2. Property over funds transferred to Euroclear.61

VI. CONCLUSION..62


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I

INTRODUCTION

One of the most important cases of the last decade, in the sovereign debt arena,

was that involving the New York-based hedge fund named Elliott Associates, LP

(hereinafter referred to as Elliott) against the Republic of Peru1(hereinafter referred to as

Peru). After several years of litigation, the final decision favored Elliott and confirmed

various substantive issues relating to sovereign debt litigation. First, it was held that

buying distressed debt and suing the sovereign to make good on its obligations is not

against New York Champerty Law, therefore eliminating one of the few legal defenses

available to sovereigns against holdout creditors. Second, the Court clarified the

application of the US Foreign Sovereign Immunities Act with regard to which assets are

subject to being attached in execution of the Courts decision, stating clearly that all

assets, located in the jurisdiction where the suit is brought, are subject to attachment, if

they belong to an entity that (i) was somehow involved in the matter; (ii) is an agency or

instrumentality2of the defaulting sovereign; and (iii) is engaged in commercial activity in

the US.

1As it will be explained in more detail in the second part of this paper, Peru acted as a guarantor of the twodebtors involved in this case, namely Banco de la Nacion and Banco Popular del Peru.2Under 1610(b) of the US Foreign Sovereign Immunities Act, an agency or instrumentality of a state isdefined as an entity which is a separate legal person, corporate or otherwise; an organ of a foreign state orpolitical subdivision thereof; neither a citizen of a State of the United State, nor created under the laws ofany third country. See Farisa Zarin,How to Sue a Sovereign: The Case of Peru, Moodys Investors Service,Special Comment (Nov 2000). See also Farisa Zarin, Sovereign Debt, What happens if a Sovereign

Defaults, Moodys Investors Service, Special Comment (July 2000), available at


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Despite the favorable judicial decision obtained, Elliott was still faced with the

traditional problem of suing a sovereign, namely, the practical impossibility of attaching

the sovereigns assets in order to obtain payment. Neither Peru nor the Banco de la

Nacion (considered as an agency or instrumentality of Peru3) had property that could

be attached in the US. In response to this situation, Elliott Associates tried to intercept

and attach the Peruvian funds that were being transferred internationally for the payment

of those creditors who had agreed to the Brady Plan debt restructuring.

Elliotts first attempt involved a restraining order obtained against the New York

Fiscal Agent for the Peruvians Brady Bonds (The Chase Manhattan Bank). This bank

was ordered to retain any money that it received from Peru to be used for the interest

payment of the Brady bondholders. The argument was that Chase was merely the agent

of Peru and, therefore, the latter was still the owner of the funds that would be

transferred. However, such a transfer never took place because Peru became aware of the

restraining order. Continuing with the legal strategy, Elliott sought ex parte to obtain an

order from a Belgium Court restraining Euroclear from either accepting money from Peru

or paying it to the Brady creditors. The request was initially dismissed by the Brussels

Commercial Court, but the decision was rapidly revoked by the Court of Appeals,

granting the restraining order according to the terms requested by Elliott. Given the risk

of defaulting in the payment of interest to its Brady creditors, Peru was left with no other

http://www.moodys.com/moodys/cust/research/venus/Publication/Special%20Comment/noncategorized_number/57753.pdf(visited on December 31, 2001).3In this case, all parties agreed that Banco de la Nacion was an agency or instrumentality of Peru. SeeElliott Assocs., L.P. v. Banco de la Nacion. 2000 U.S. LEXIS 14169 (S.D.N.Y. Sept 29, 2000), at 8.


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alternative but to settle the controversy, so that the restraining order was not judicially

contended.

Elliotts victory in Brussels was fundamentally based on the argument that Peru

was attempting to make payments in violation of a principle of equal treatment (pari

passu clause) among foreign creditors, and was trying to use the Euroclear System to

achieve that objective. After analyzing the argument put forward by Elliott, the Court of

Appeals in Brussels expressly reached such a conclusion arguing that the pari passu

clause contained in the basic agreement that governs the repayment of the foreign debt of

Peru in effect provides that the debt must be repaidpro rataamong all creditors.

Such an interpretation was defended by Professor Andreas Lowenfeld, whose

opinion was submitted to the Courts in Belgium. According to Lowenfeld, the pari passu

clause means that, if there is not enough money to pay all creditors in full, the debtor

cannot discriminate amongst creditors, paying some of them in full and leaving others

unpaid; in such a situation, all creditors must be paidpro rata.

Although there is no clear idea about what the real effects of the Brussels decision

are and what its consequences will be in the sovereign debt context, it has been suggested

that it will definitely strengthen the position of holdout creditors. Holdout creditors have

been a major problem for sovereign debt restructuring since the beginning of the nineties,

when the international financial architecture for sovereign borrowing changed from

syndicated bank loans to sovereign bonds. The new bond-based structure led to the


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creation of a secondary market for such instruments and, consequently, to an exponential

growth in the number of bondholders. Due to the NY law applicable to most of them,

individual bondholders are not obliged to negotiate restructurings of the debt or to accept

the new terms of an exchange offer. It has been judicially recognized that those

bondholders are entitled to keep their original instruments and that the sovereign remains

beholden under the old terms. In practice, however, the possibility of holdout creditors

obtaining payment on their old instruments was very remote, because of the US Foreign

Sovereign Immunities Act restrictions. It is precisely in this area that the Brussels

decision will allegedly play a significant role.

Commentators have suggested that such a decision is one of the most important

weapons given to holdout creditors to defend against sovereigns and the majority of

creditors. It has been predicted4 that it will cause serious disruptions in sovereign debt

restructurings and, consequently, it will enhance global financial instability. If those

predictions turn out to be true, then it seems to be extremely urgent to implement an

international bankruptcy system for sovereign countries or any other legal mechanism

which can cause an orderly restructuring of the sovereign debts. However, such

predictions are based on the assumption that the Brussels decision represents a definite

and final conclusion of law, which will be used as a precedent in Belgium and will

probably influence the interpretation of the debated issue in other jurisdictions. It is

specifically this aspect of the controversy that this paper intends to address.

4See G. Mitu Gulati & Kenneth N. Klee, Sovereign Piracy, The Business Lawyer, Vol. 56, February 2001,at 636.


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The focus of this paper is on trying to determine what the real legal effects of the

Brussels decision are. The first part is aimed at analyzing the substantive part of the

Brussels decision. It has been held that it is not clear if Elliotts strategy would survive

legal challenge in future cases. So this part of the paper is intended to clarify such an

issue. The interpretation of the meaning of the pari passu clause in the sovereign debt

context is explored in depth. The paper tries to identify the legal meaning of such a clause

and to determine if there is any divergence when compared with the general

understanding of the clause in the market. Since the interpretation of the pari passu

clause has to be made in light of the laws governing the debt agreement wherein such a

clause is included, the analysis basically focuses on US law, with certain specific

references to English law.

In the second part of this paper, the controversy is explored from a formal

perspective; the paper tries to find answers to the following questions: Does the Brussels

decision represent a firm and definite conclusion of law? How important are the

conclusions stated in a decision on an ex parte motion? Did the Brussels Court really

arrive at a final conclusion of law on the issue under scrutiny? Will such a decision be

used as a precedent for mandatory observance in Belgium?

The outcome of this paper will help determine whether the Brussels decision

represents a real threat to the financial stability of the global sovereign debt market and

whether, therefore, it may be used as an argument to support the creation of an


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international bankruptcy procedure for sovereign debtors or the implementation of any

alternative proposal.

II

THE ELLIOTT CASE: FACTUAL BACKGROUND

AND POST-JUDGMENT LEGAL STRATEGY

1. What exactly happened?

In October 1995, Perus government publicly announced its Brady deal, after the

Bank Advisory Committee agreed to restructure Perus defaulted commercial bank loans,

in order to exchange such credits for Brady Bonds5. Three months after such an

announcement, Elliott, a New York-based vulture fund, began purchasing 1983 Letter

Agreements of Banco de la Nacion (hereinafter referred to as BN) and Banco

Popular del Peru, which had been guaranteed by Peru6. Between January and March of

1996, Elliott acquired a total of US$20.7 million (face value) of such commercial bank

loans. This debt was acquired at the distressed price of about US$11.4 million7. It is

5SeeMerrill Lynch Report,Debt Restructuring: Legal Consideration. Impact of Perus Legal Battle and

Ecuadors Restructuring on Nigeria and Other Potential Burden-Sharing Cases, October 30, 2000.Available at http://www.emta.org/keyper/linden1.pdf(visited on March 10, 2002).6See International Monetary Fund, Policy Development and Review and Legal Departments,Involving thePrivate Sector in the Resolution of Financial Crises Restructuring International Sovereign Bonds , at 12.Available at http://www.imf.org/external/pubs/ft/series/03/IPS.pdf(visited on March 10, 2002).7SeeAmbassador Philip S. Kaplan, Patton Boggs LLP,Memorandum prepared by Perus outside counseladdressed to Perus Minister of Economy, Mr. Carlos Bologna, about the Elliott Associates Settlement(hereinafter referred to as the Kaplan Memorandum), at 1. Available athttp://www.mef.gob.pe/Caso_E/frame_pdf.htm(visited on March 13, 2002). See also Ministry of Economyand Finance of Peru, Final Report about the Elliott Associates case, (hereinafter referred to as the MEF


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interesting to notice that Elliotts purchases occurred after the Brady deal was agreed and

only two weeks after another creditor, Pravin Banker, successfully litigated against Peru8.

The timing of such acquisitions allegedly suggested Elliotts intention to litigate9.

Immediately after completing its acquisition, and while Peru was still negotiating with

the Bank Advisory Committee the term sheet of its Brady deal, Elliott started making

demands for full payment.

In October 1996, Peru issued instructions to execute the Brady Exchange

Agreement. As expected, Elliott refrained from participating in the proposed Exchange

Agreement. Instead, on October 8th, 1996, Elliott filed a suit against Peru and BN and

also filed an ex parte motion for prejudgment attachment. It was clear that Elliotts

intention was to attach the collateral for the Brady closing, which would have caused a

serious impact in Perus ability to close the Brady deal10. However, the Court denied

Elliotts motion for attachment. The Court also denied a summary judgment motion

subsequently filed by Elliott.

With the collateral held in trust for the Brady bond holders and hence protected

from Elliotts attempts to attach such assets, the Brady Exchange Agreement closed on

March 7th, 1997. The closing was achieved upon Perus verbal promise not to provide

Final Report), at 1. Available at http://www.mef.gob.pe/Caso_E/frame_pdf.htm3 (visited on March 13,2002).8 See Memorandum prepared by Perus outside counsel, Mr. Mark A. Cymrot, from Baker & HostetlerLLP, addressed to Perus Minister of Economy, Mr. Carlos Bologna, about External Debt Litigation(hereinafter referred to as the Cymrot Memorandum), at 4. Document available athttp://www.mef.gob.pe/Caso_E/frame_pdf.htm(visited on March 10, 2002).9 See Merrill Lynch Report, supra note 5, at 2.


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any extra benefits to hold out creditors. Peru stood on its word and refused all Elliotts

continuous demands for full payment11. As a consequence, both parties became involved

in a lengthy pre-trial discovery process, trial finally held in March 1998, one year after

the Brady deals closing.

In August 1998, the District Court for the Southern District of New York adopted

a decision in Perus favor, after finding as a fact that Elliott purchased the Peruvian debt

with the intent and purpose to sue and did not seriously consider alternatives to

bringing an action

12

. Accordingly, the court held that Elliots assignment contracts --

whereby it acquired the Peruvian distressed debt-- violated 489 of the New York

Judiciary Law, which makes unlawful the acquisition of debt with the intent and for the

purpose of bringing an action or proceeding thereon. This decision represented the first

time a debtor succeeded in proving the champerty defense at trial13.

However, in September 1998, Elliott filed an appeal arguing that the champerty

doctrine did not apply14. The United States Court of Appeals for the Second Circuit

agreed and, therefore, reversed the judgment of the District Court. In its decision, dated

October 20th, 1999, the Court of Appeals held that 489 of the New York Judiciary Law

is not violated when the accused partys primary goal is found to be satisfaction of a

10Perus Brady restructuring program was made in the context of an IMF-supported program, wherebyIMF funds were used to help finance the acquisition of collateral for the new instruments. See InternationalMonetary Fund, supra note 6, at 12.11 See MEF Final Report, supra note 7, at 4 (Perus strategy was to frustrate Elliott in the litigation,demonstrate that it could not collect from Peru without an agreement, and eventually force Elliott to acceptsomething close to Brady terms, as had successfully been done in the Pravin Banker case).12Elliott Assocs. , L.P. v. Banco de la Nacion, 194 F.3d 363, 366 (2d. Cir. 1999)13See Cymrot Memorandum, supra note 8, at 4.14See Merrill Lynch Report, supranote 5, at 2.


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valid debt and its intent is only to sue absent full performance15. It was found that

Elliotts primary goal was to satisfy a valid debt and not necessarily to litigate 16. The

Court of Appeals remanded the case to the trial court only for the purpose of calculating

damages.

Given the favorable decision obtained by Elliott from the Court of Appeals, on

November 2nd, 1999 the trial court granted Elliott, upon its request, an attachment and

restraining order over the commercial property of Peru and BN. Despite Elliotts success

in obtaining this post-judgment order, in practice it gained very little from that since there

was virtually no property held by Peru and/or BN in New York17. Elliott then requested

that such restraining orders were applicable to all foreign branches of New York banks

served by such orders. The trial court rejected such a petition on January 18, 2000 and,

therefore, Elliott was prevented from relying on one single order of attachment to catch

any transfers through branch offices18.

On June 22nd, 2000, the Court for the Southern District of New York finally

rejected Perus defenses and ordered judgment in favor of Elliott. In its decision, the

court authorized Elliott to recover from the defendants the sum of US$55,660,831.56,

15 Elliott Assocs. v. Banco de la Nacin, 194 F.3d 363 (2d Cir. 1999). Available atwww.tourolaw.edu/2ndCircuit/October 99/98-9268.html , visited on December 12, 2001. See also Samuel

E. Goldman, Mavericks in the Market: The Emerging Problem of Hold-Outs in Sovereign DebtRestructuring, 5 UCLA J. Intl L. & Foreign Aff. 159, at 15 (The court found that the decision to bringsuit was incidental and contingent to the decision to purchase the debt. It was incidental as the primarypurpose was to receive payment, and it was contingent since the decision to litigate came only after thedebtors decision not to pay).16See Merrill Lynch Report, supranote 5, at 2. See also Melissa I. Hoffman, Second Circuit Clarifies NewYork Law on Enforcement of Debt Instruments , Weil, Gotshal & Manges LLP - Bankruptcy Bulletin,February 2000, available at http://www.weil.com/weil/sitesearch_frames.html(visited on March 16, 2002).17See Cymrot Memorandum, supra note 8, at 5.


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representing the principal amount and past due interests up to such date, and authorized

the recovery of post judgment interest as well. The court also made it clear that such

amount did not include the costs and expenses incurred by Elliott in connection with the

enforcement of its rights. Additionally, the court authorized the execution of the decision

against any property of the defendants that is used for a commercial activity in the United

States19.

Under such circumstances, Peru was facing a very complicated situation by

September 2000. Both Peru and BNs commercial assets were subject to the attachment

order referred to above. Peru was faced with serious operational difficulties and, hence,

was forced to design a complete new strategy and procedure to channel and receive funds

derived from international loan agreements and other commercial transactions, as well as

to comply with the payment of international financial obligations. Thus, international

funds were received by and transferred from Peru through financial centers other than

New York20. The scenario was aggravated by Elliotts renewed efforts to attach

defendants property abroad, especially in Germany, Holland, Belgium, England,

Luxembourg and Canada. However, such strategy failed to find any significant property

to be attached.

Being aware that the first Peruvian Brady coupon following the June 22nddecision

would fall due on September 7th, 2000, Elliott sought to attach Perus interest payment to

18See Merrill Lynch Report, supranote 5, at 2.19See Elliott Associates, L.P., v. Banco de la Nacion, 2000 WL 1449862 S.D.N.Y. Sep 29, 2000.20See MEF Final Report, supra note 7, at 1.


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its Brady bondholders21. According to the terms of its Brady deal, in order to comply

with such payments, Peru was obliged to deliver US$80 million to the Chase Manhattan

Bank (hereinafter referred to as Chase), on September 6th, 2000. After receiving such

funds, Chase, acting as the fiscal agent for the Brady bonds, would proceed to make the

payment of the interests basically through three clearinghouses: Depository Trust

Company (DTC) of New York, Euroclear of Belgium and Clearstream of Luxemburg. As

part of Elliotts strategy to intercept such funds, it obtained ex parte restraining orders

against Chase, DTC, Morgan Guaranty Trust Company of New York (hereinafter

referred to as Morgan) and Bank of New York. The order was notified to the latter in its

role as cash custodian of Euroclear and to Morgan as operator of Euroclear.

Simultaneously, Elliott initiated legal proceeding in three different jurisdictions: England,

Belgium and Luxemburg, seeking to block the interest payment through the European

clearinghouses referred to above22. It was clear then that Elliots strategy was twofold:

first, trying to attach the funds at the level of the fiscal agent; second, capturing funds at

the level of the clearing houses.

However, the first part of Elliott strategy failed to achieve its objective when

Peru, presumably informed that a restraining order had been served upon Chase 23, did not

deliver the funds as agreed originally in the Brady plan. Notwithstanding having

frustrated Elliotts first plan, Peru failed to pay the corresponding interest to its Brady

bond holders on September 7th, 2000. Therefore, according to the terms of the agreement

governing the Brady instruments, Peru was granted a grace period of 30 days. So, if the

21See Cymrot Memorandum, supranote 8, at 5. See also Merrill Lynch Report, supra note 5, at 2.22See MEF Final Report, supra note 7, at 3. See alsoCymrot Memorandum, supranote 5, at 5.


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interest payment was not made before the end of the grace period, Peru would have

legally incurred in formal default and, hence, triggered the right of all its Brady

bondholders to demand full payments of their securities, which represented a total

exposure of up to US$3,837 million24.

Constrained by time pressure, Perus legal advisors25 devised a multi-level

strategy26 in order to have the Brady interests paid before October 7th, 2000. Initially,

they tried to find an alternative way to comply with the interest payments through a route

other than Chase, therefore avoiding Elliotts attachments attempts. This initiative was,

however, unsuccessful. As explained by Perus outside legal counsel, with DTC blocked

by Elliotts restraining order, and most of the international banks and clearinghouses

reluctant to cooperate due to fears of new lawsuits by Elliott27, the possibility of finding

an alternative route for the interest payments was quite complicated: Elliott was very

active in trying to block the Euroclear route, and the other natural alternative,

Clearstream, agreed to participate but only in return for an indemnity from Peru 28. In

spite of such difficulties, there were some rumors suggesting that Peru had seemingly

secured the backing of the Bank of International Settlements to go around Elliott. This

Switzerland-based institution is, as most international organizations, immune from

23

See Merrill Lynch Report, supra note 5, at 2.24See MEF Final Report, supra note 7, at 6.25 Perus legal advisory team in this particular matter was lead by Mr. Mark A. Cymot, from Baker &Hostetler LLP, and Mr. Roger Thomas, from Cleary, Gottlieb, Steen & Hamilton.26See Cymrot Memorandum, supranote 8, at 7.27See Id., at 7.28See Id., at 7. (Clearstream, the clearinghouse in Luxemburg, however, agreed to pay about 40 percent ofthe bondholders in return for an indemnity from Peru. Clearstream also held open the possibility that otherbondholders could transfer their accounts to Clearstream to receive payment. The indemnity involved somerisk of liability to Peru).


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lawsuits and attachments29. However, due to reasons that have not been publicly revealed

by Peru, this alternative route was never put in place. Presumably, the terms and

conditions of the Peruvian Brady bonds might have included a detailed mechanism for

the payment of interest and capital, whose non compliance would have been considered

as an event of default. This possibility, nonetheless, is merely speculative since it has not

been confirmed.

In addition, Perus advisors also considered the filing of motions challenging

Elliotts restraining orders and, most specifically, the possibility of posting with the court

a security bond equal to the amount of the judgments in order to have such orders

withdrawn30. Notwithstanding its appeal, this course of action was not followed because

it was considered that giving Elliott a security bond would have reduced Perus leverage

at the negotiation table31.

On September 21stand 22nd, 2000, two Courts from New York granted Elliott ex

parte restraining orders whereby, if a deposit or transfer occurred, Elliott would have the

right to serve additional restraining orders on Chase, DTC, Morgan and the Bank of New

York. Such orders were specifically aimed at avoiding the payment of the Brady

interests. Arguing that the orders appeared to reach beyond the US in violation of the

29See Carol S. Remond, Peru Settles Creditor Dispute with Elliott for US$58M,Dow Jones Newswires.Available at http://www.emta.org/ndevelop/djnews.html(visited on March 21st, 2002).30This is the same approach taken by Peru in the Pravin Banker case.31See Cymrot Memorandum, supra note 8, at 7. See alsoKaplan Memorandum, supra note 7, at 1.


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restrictions imposed by the decision of June 22nd, 2000, Peru, as well as Morgan and

Chase, challenged the referred orders32.

Also on September 22nd, Elliott filed an ex partemotion before the Commercial

Court of Brussels, Belgium, in order to prevent Euroclear from accepting or paying out

cash from Peru, intended to pay interest on the Brady bonds33. Elliotts petition was

aimed at enjoining Morgan, for reasons of absolute necessity, to instruct its Cash

Correspondents not to have any amounts credited to their accounts that originate from

the Republic of Peru or Banco de la Nacion, including amounts designed to pay interest

under the Brady bonds and, in case such funds had already been received, to instruct

such Cash Correspondents to block such funds and also not to take any action that

would result in such funds being distributed in any manner within the Euroclear

system34. Elliotts motion was denied because the Court considered that the tests of

absolute necessity and extremely urgent had not been fully met35. Not satisfied with

the decision, Elliott appealed in September 25th.

On September 26th, 2000, one day after Elliotts request for appeal was filed, the

8thChamber of the Brussels Court of Appeals reversed the Commercial Courts decision

and, hence, ordered the restraining order according to the terms requested by Elliott. As

mentioned before, the key argument presented by Elliott, and recognized as such by the

32See MEF Final Report, supra note 7, at 6.33See Merrill Lynch Report, supra note 5, at 2.34See Elliott Assocs. L.P., General Docket No. 2000/QR/92 (Court of Appeals of Brussels, 8 thChambers,Sept. 26, 2000) Unofficial translation (hereinafter referred to as Brussels Decision UnofficialTranslation), at 1.35See Id., at 2.


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Brussels Court of Appeals, was that Peru was trying to use Euroclear to violate the

principle of equal treatment of creditors, allegedly derived from the pari passu clause

contained in the original loan agreements held by Elliott36.

Under the pressure of having been put in a position where it might be forced to

default in its interest payments, Peru settled the controversy with Elliott on September

29th. Peru did no even wait until after the hearing that had been set to consider a request

made by Peru and Morgan to throw out the restraining orders affecting Morgan, Chase,

DTC and Bank of New York37

. The practical effect of the Brussels decision was

determinant. Although the Brussels Court of Appeals decision could have been legally

attacked, default in the payment of the Brady interest was imminent. In consequence,

Peru was left with no other alternative but to negotiate a settlement with Elliott. Peru paid

US$58.45 million in total to Elliott and had all restraining orders lifted38. Thus, Peru was

able to comply with the payment of its Brady interest on October 5th, 2000.

2. The Brussels Court of Appeals Decision

As mentioned before, the 8thChamber of the Brussels Court of Appeals issued the

decision under analysis (hereinafter referred to as the Brussels decision) on September

36See International Monetary Fund, Involving the Private Sector in the Resolution of Financial Crises

Restructuring International Sovereign Bonds, supra note 6, at 12.37See Reuters Banking-Financial Services Report, Peru Settles With Hedge Fund For More Than US$58M,available at http://www.mediaislandgroup.com/~financial/pilots/banking/STORIES/bank17.htm (visitedon March 21, 2002).38See MEF Final Report, supra note 7, at 6.


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26th, 2000, reversing the Commercial Court decision which denied Elliotts request for a

restraining order against Euroclear.

According to the terms of the Brussels decision, Elliott challenged the

Commercial Court ruling by invoking the following arguments: (i) it has a claim of

more than US$55 million against the Republic of Peru and has obtained two enforceable

judgments from a New York judge; (ii) the Peruvian Republic attempts to make

payments in violation of a principle of equal treatment (pari passu clause) among foreign

creditors, whereby Elliott Associates is excluded, and tries to use the Euroclear system to

achieve that objective; and (iii) the requested measures are necessary to achieve that

objective and this is only possible by bringing an ex parte motion39.

In sum, the Court of Appeals understood Elliotts motion as one intended to

prevent that Peru would resort to using the possibilities offered by the Euroclear System

in order to make discriminatory payments in a legal environment that avoids the effect of

the American judgments40. The court concluded that Elliott had an enforceable claim

against Peru and that the latter was trying to escape the enforcement thereof by making

an interest payment () via Euroclear41. Obviously, this rationale was based on the

premise that Peru was contractually barred from paying one group of creditors before

paying Elliott42.

39Brussels Decision Unofficial Translation, supra note 34, at 2.40Id.41Id.42SeeGulati & Klee, supra note 4, at 636.


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To reach that conclusion, the Court of Appeal had to analyze and interpret what

was the real and effective content and meaning of section 11(c), the pari passu clause, of

the Guaranty dated as of May 31, 1983, whereby Peru had guaranteed the 1983 Letter

Agreements of BN and Banco Popular del Peru. The clause under scrutiny reads

literally as follows43:

Representations and Warranties. - The Guarantor [i.e., theRepublic of Peru] represents and warrants as follows: ()(b) This Guaranty is the legal, valid and binding

obligation of the Guarantor, enforceable against the

Guarantor in accordance with its terms.(c)

The obligations of the Guarantor hereunder do rankand will rank at least pari passu in priority ofpayment with all other External Indebtedness of theGuarantor, and interest thereon.

The interpretation given by the Court of Appeals to the clause in question

concurred with the argument put forward by Elliott. The court expressly held that it

appears from the basic agreement that governs the repayment of the foreign debt of Peru

that the various creditors benefit from apari passu clause that in effect provides that the

debt must be repaid pro rata among all creditors. This seems to lead to the conclusion

that, upon an interest payment, no creditor can be deprived of its proportionate share44.

The ruling is very straightforward on this point and does not analyze the legal

matter in greater detail. It seems that the Court of Appeals just took for granted the

argument presented by Elliott and did not worry about exploring other possible meanings

43 See Declaration of Professor Andreas F. Lowenfeld, before the Southern District Court of New York(hereinafter referred to as the Lowenfeld Declaration), page 8.


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of the referred clause. The court assumed that the pari passu clause represents no more

than apro rata rule and, therefore, that Elliot had a legal right to be protected against a

serious and real threat, namely, the payment of interest to other creditors. However, the

Court of Appeals never mentioned nor explained the legal argument upon which such an

assumption is based. It was totally convinced by Elliotts arguments, which in turn, were

vividly explained by the New York University Professor, Andreas F. Lowenfeld, in his

declaration before the Southern District Court of New York45.

Strategically speaking, the Brussels Court of Appeal decision (hereinafter referred

to as the Brussels decision) played a crucial role in the final outcome of the Elliott case.

It could be argued that this decision was the one which finally forced Peru to accept the

terms requested by Elliott at the negotiation table. Once the Brussels Court of Appeals

issued the restraining order against Euroclear, there was, apparently, no legal remedy that

could have allowed Peru to pay its Brady interests before the end of the grace period.

Consequently, Peru settled the case and the referred order was not appealed.

3. The Opinion of Professor Andreas F. Lowenfeld

In his declaration, Lowenfeld explained that Elliott claims that it is entitled, under

section 11(c) of the 1983 Guaranty, to be treated with respect to payment of principal

and interest at least on equal terms with all other External Indebtedness46, and therefore,

44Brussels Decision Unofficial Translation, supra note 34, at 3.45 As mentioned by Gulati and Klee, Professor Lowenfelds opinion was also submitted in the Brusselscase.See Gulati & Klee, supra note 4, at footnote 12.46Lowenfeld Declaration, supra note 43, at 6.


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any payment to the Brady bondholders and not to Elliott would constitute a preferential

arrangement contrary to the terms of section 11(c)47. After analyzing Elliott request,

Lowenfeld concluded thus:

my conclusion is that the pari passu clause in theGuaranty entitles each Lender to share equally and ratablywith any other holder of External Indebtedness as defined. Ihave no doubt that the Brady Bonds described aboveconstitute External Indebtedness of the Republic of Peru.Accordingly, if the Republic pays principal or interest toholders of the Brady Bonds or some of them, it is obligatedto make payment of a proportionate amount to all holders

of Affected Debt incurred in the Letter Agreements,including Plaintiff Elliott Associates, L.P., and thatobligation is enforceable in this court if necessary by aninjunction48.

Lowenfeld explains that there is no difficulty in understanding the literal meaning

of the term pari passu. He refers that such a term comes from the Latin noun

passus, which means step, pace, stride, and from the Latin adjective

par, meaning

equal or like. His conclusion is also based on the Websters New International

Dictionary49, which defines the term in question as with or at an equal pace; in or to an

equal proportion, degree, place, rank, or title, as well as on the Blacks Law

Dictionary50, which defines pari passu as By an equal progress; equably, ratably;

without preference. Used specially of creditors who, in marshalling assets, are entitled to

receive out of the same fund without any precedence over each other. Accordingly,

under this literal approach to the meaning of the aforementioned clause, Lowenfeld

47Id.48Id., at 7.49See Websters New International Dictionary. Second Edition, unabridged, 1951.


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concludes that any debt under the Letter Agreements is to have at least equal rank with

all other Peruvian External Indebtedness51.

Continuing with his explanation, Lowenfeld argues that the fact that sovereigns

do not go bankrupt and cannot be liquidated does not mean that thepari passu clause has

no sense or direct effect when applicable to sovereigns. Based on the opinion of an

English commentator, William Tudor John, Lowenfeld concludes that the pari passu

clause is of the greatest importance in governmental loan agreements because it is

primarily intended to prevent the earmarking of revenues of the government towards a

single creditor, the allocation of foreign currency reserves, and generally against legal

measures which have the effect of preferring one set of creditors against the others or

which discriminate between creditors52.

Additionally, Lowenfeld expresses his disagreement with all those academic

articles53which suggest that the pari passu clause --in the sovereign debt context-- does

not exactly mean what it literally says, or that it cannot be relied on by lenders if

disregarded or violated by borrowers. In Lowenfelds opinion, the pari passuclause does

50See Blacks Law Dictionary, Sixth Edition, 1990.51It has not been possible to verify the textual definition of the term External Indebtedness in the LetterAgreements mentioned above, but according to what Professor Lowenfeld mentions in his Declaration, itseems that such a definition was included in Section 1 of the Letter Agreements, covering any other portion

of the debt issued under said Letter Agreements and also any bonds or other evidence of debt issued orguaranteed by Peru, including the Brady bonds.52See William Tudor John. Sovereign Risk and Immunity under English Law and Practice, inRobert S.Rendell, ed., International Financial Law, Vol 1, p. 71 at 95 (2d ed. 1983). See also LowenfeldDeclaration, supra note 43, at 10.53Lowenfeld makes express reference to an article written by Lee C. Buchheit, The Pari Passu Clause subspecie aeternitatis, 10 Intl Financial L. Rev. No. 12, p. 11 (Dec. 1991), where the author mentions thatThe fact that no one seems quite sure what the pari passu clause really means, at least in a loan to asovereign borrower, has not stunted its popularity among drafters of loan agreements and debt restructuringagreements.


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really mean what it says: a given debt will rank equally with other debt of the borrower,

whether that borrower is an individual, a company, or a sovereign state54. The logical

and legal basis for this conclusion is clearly explained by Lowenfeld as follows:

A borrower from Tom, Dick and Harry cant say I willpay Tom and Dick in full, and if there is anything left overIll pay Harry. If there is not enough money to go around,the borrower faced with apari passuprovision must pay allthree of them on the same basis:Suppose, for example, the total debt is $50,000 and theborrower has only $30,000 available. Tom lent $20,000 andDick and Harry lent $15,000 each. The borrower must pay

three fifths of the amount owed to each one i.e., $12,000to Tom, and $9,000 each to Dick and Harry. Of course theremaining sums would remain as obligations of theborrower. But if the borrower proposed to pay Tom$20,000 in full satisfaction, Dick $10,000 and Harrynothing, a court could and should issue an injunction at thebehest of Harry. The injunction would run in the firstinstance against the borrower, but I believe (puttingjurisdictional considerations aside) to Tom and Dick aswell55.

The final argument put forward by Lowenfeld notes that the same District Court

and the Court of Appeals have already decided on the issue under analysis when

resolving a closely analogous case, namely Alliance Bond Fund, Inc. v. Grupo Mexicano

de Desarrollo, S.A.56. In this case, the Mexican borrower and its guarantors were enjoined

from making payments to some creditors while the plaintiffs, who were the beneficiaries

of apari passuclause, were going to be left out. Despite the fact that this case was finally

reversed by the U.S. Supreme Court --on the ground that prejudgment injunctions

54See Lowenfeld Declaration, supra note 43, at 11.55Id., at 12.56143 F.3d 688 (2d Cir. 1998)


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preventing the payment of money were not authorized in the Federal Rules of Civil

Procedures and were inconsistent with traditional equity jurisprudence-- Lowenfeld

argues that its rationale may still be applicable to the Elliott case, for there being a final

judgment favoring the plaintiff already57.

Based on the aforementioned arguments, Lowenfeld concludes that Section 11(c)

of the 1983 Guaranty creates a binding and continuing obligation to treat all covered

borrowers equally without discrimination, including Elliott.

III

INTERPRETING THEPARI PASSUCLAUSE

1. An Alternative Interpretation?

On the basis of its historically well recognized literal meaning, commentators

have claimed that the essence of the pari passu provision is that it is an undertaking of

the borrower to maintain parity between its creditors58. In the same line of thought, it

has been said that the very purpose of this clause () is to ensure equal treatment for all

unsecured creditors59. In other words, the primary objective of the clause is to ensure

57See Lowenfeld Declaration, supranote 43, at 13.58Ibrahim F. I. Shihata, The World Bank Legal Papers, Chapter 12 (2000), at 303.59 Esin Taboglu, The International Debt Problem: Legal Problems of Restructuring Sovereign Private

Debt. Paper submitted to professor Phillip Wellons in satisfaction of LLM Written Work Requirement.Harvard (1990), at 42.


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that the borrower has not conferred priority to any other unsecured creditor60. Parity or

equal treatment between creditors is clearly the main principle upon which the legal

significance of thepari passu clause is conceived. However, equality seems to be a very

broad and abstract concept that has been differently understood and interpreted by

practitioners and academics when trying to elaborate a precise definition of the clause

under analysis.

As a result, there is not a general consensus on the definition of the pari passu

clause. It has been held that the pari passu clause in a loan agreement is a covenant

under which the borrower agrees that all of its payment obligations under the agreement,

currently and in the future, will rank at least equally with all of its other existing and

future unsecured debts61. Under this definition, the main focus of attention must be in

determining what the phrase will rank at least equally exactly means.

In a more comprehensive definition, the clause under consideration has been

defined as a covenant whereby it is agreed that the payment obligations of the borrower

under the agreement constitute unconditional general obligations of the borrower and will

rank at leastpari passu in priority of payment with all other external indebtedness of the

borrower62. This definition makes it clear that the equal ranking amongst creditors is

exclusively in relation to priority of payment. Nonetheless, the term in reference is still

60Ravi C. Tennekoon, The Law & Regulation of International Finance, Butterworth (1991), at 89.61 See UNITAR Online Resource Center, Training and Capacity Building Programmes in the LegalAspects of Debt, Financial Management ad Negotiation, Glossaries. Available athttp://www.unitar.org/dfm/Resource_Center/TrainingPackage/TP10/GlossaryP.htm (visited on March 17,2002).62Ibrahim F. I. Shihata, supra note 58, at 303.


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highly confusing given the various and different interpretations that can be put forward

with regard to the phrase to rank at leastpari passu in priority of payment.

Equality in priority of payment is evidently the key term in order to understand

the practical application and effects of the pari passu clause. But, what does priority of

payment effectively mean? It is precisely in answering this question where the final

divergence in the Elliott case arose: was such a term related or not to apro ratapayment?

As seen above, the interpretation suggested by Lowenfeld is straightforward and

compelling:pari passumeans that all payments must be made on apro ratabasis, that is,

that such a clause entitles its beneficiary to share equally and ratably with any other

external indebtedness. And Lowenfeld arrives at such a conclusion without making any

distinction as to whether the borrower is an individual, a company, or a sovereign. Thus,

any beneficiary of the pari passu clause has the right to share equally and ratably63

with any other external indebtedness. Hence, if the borrower makes payments to just one

or some of its creditors, the beneficiaries of the referred clause have the right to be paid a

proportionate amount64, meaning, on a pro rata basis.

It has been difficult to find commentators backing expressly what Lowenfeld

suggested. Following Tudor Johns opinion --in the context of governmental loan

agreements (quoted above)--, Vinok K. Agarwal seems to agree with such a particular

interpretation as well. After mentioning that the pari passu clause requires that the

63Lowenfeld Declaration, supra note 43, at 7.64Id.


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borrower shall treat all the unsecured lenders equally, the latter argues that the borrower

will not give preference to any particular lender in the matter of recovery of loan

amount65. The same author also states that, as a direct effect of thepari passu provision

and in connection with external debt only, the lender shall not be discriminated in the

matter of availability of assets66.

Also in the same line of thought, Brian Semkow argues that, in the context of

sovereign borrowing, the pari passu provision will prevent sovereign borrowers from

discrimination against the lending banks in the payment of creditors out of general

revenues or foreign currency reserves67. Similarly, Philip Wood agrees with this idea

when related to the sovereign context. The author argues that the referred clause bears a

different construction in the case of a sovereign state. Since the latter cannot go bankrupt

nor can be liquidated --notes Wood-- the hierarchy on force dissolution is not the point68.

The commentator then concludes, following what was previously mentioned by Tudor

John, as follows:

The clause is primarily intended to prevent the earmarkingof revenues of the government or the allocation of itsforeign currency reserves to a single creditor and generallyis directed against legal measures which have the effect of

65 Vinod K. Agarwal, Negotiation of Specific Clauses of Loan Agreements, available athttp://www.unitar.org/dfm/Resource_Center/Document_Series/Document10/15Covenants.htm (visited onMarch 9, 2002)66Id.67Brian W. Semkow, Syndicating and Rescheduling International Financial Transactions: A Survey of the

Legal Issues Encountered by Commercial Banks, 18 Intl Law. 869, 899 (1984).68See Philip Wood,Law and Practice of International Finance, volume 2, International Business & LawSeries, 1984, at 6-23.


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preferring one set of creditors over the others ordiscriminating between creditors69

That also seems to be what Derek Asiedu-Akrofi suggests. This author analyzes

the effects of a sovereign debt repurchase transaction in the light of a pari passu

provision and concludes as follows:

[T]he sale of the debt at a discount of the true marketvalue arguably does not confer any special benefit on thecreditor banks, as sale at discount entails considerablelosses. Whether or not such an argument can withstandlegal challenge, however, remains doubtful. Once a creditoragrees to accept a lesser sum in substitution for the full

value of the original debt, it is unlikely that it maysuccessfully plead that it has not received adisproportionate payment while the other creditors have notbeen paid pro rata. Such payment inevitably conferspreferential treatment on the creditor(s) engaging in thattransaction, thus infringing the mandatory prepayment andpari passuclauses.70

Notwithstanding the natural appeal of the Lowenfeld interpretation of the pari

passu clause, there are a number of commentators that believe that the real meaning of

the clause in the sovereign context is not so clear. Also, international organizations have

made public their skepticism about the legality of the argument put forward by Elliott.

The International Monetary Fund, for instance, has opined that [t]he legal bases upon

69 Id. But see Philip Wood, Project Finance, Subordinated Debt and State Loans, Sweet & Maxwell,London 1995, at 165 (the same author mentions that [i]n the state context, the meaning of the clause is

uncertain because there is no hierarchy of payment which is legally enforced under a bankruptcy regime.Probably the clause means that on a de facto inability to pay external debt as it falls due, one creditor willnot be preferred by virtue of an allocation of international monetary assets achieved by a method goingbeyond contract.70 Derek Asiedu-Akrofi, Sustaining Lender Commitment to Sovereign Debtors, Columbia Journal ofTransnational Law, 1992. The author continues referring that [i]n order to ensure that such breaches donot occur, it is necessary for the debtor country/buyer to extend participation in the transaction to all thecreditors. The debtor government also should seek and obtain waivers of the mandatory prepayment, pari

passuand sharing clauses in existing loan agreements. In this way, banks that refuse to participate in the


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which Elliott litigated its case --particularly its reliance on the pari passu clause-- are

somewhat controversial71.

Moreover, it has even been held that, indeed, the Lowenfeld interpretation is

precisely what the clause does not mean72. According to Gulati & Klee, the main

objective of thepari passuclause is to ensure that the borrower does not have, nor it will

subsequently create, a class of creditors whose claims will rank senior in priority to the

lending claims of the current creditors73. The referred authors explain that the meaning

of such a clause in the corporate debt context is that no other lender will enjoy a priority

in a liquidation distribution of the borrowers assets74.

The argument put forward by the aforementioned authors --regarding the

interpretation of the provision in the corporate context-- finds support in Wood. He

expressly mentions that the undertaking is to be construed as a commitment or a

warranty that on an insolvent liquidation or a forced distribution of assets unsecured

creditors will be entitled to pro rata payment and also that, on the occasion of judicial

compromises or agreed debt settlements, the bondholder will be not discriminated

against75. Also supporting this restrictive construction is Lee C. Buchheit, who explains

that the interest of the lenders in including apari passuprovision in their contracts is that,

transaction may be stopped from making claims on the proceeds accruing to those banks engaging in thedebt repurchase transaction.71See International Monetary Fund, supra note 6, at 12. See also Anne Krueger, International Financial

Architecture for 2002: A New Approach to Sovereign Debt Restructuring, available athttp://www.imf.org/external/np/speeches/2001/112601.htm(visited on March 9, 2002). (It is not clear ifElliotts strategy would survive legal challenge in future cases).72Gulati & Klee, supra note 4, at 639.73Id.74Id.


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in case of a bankruptcy or compulsory distribution of the borrowers assets, the lenders

do not wish to be surprised by the appearance of other creditors holding claims against

the debtors state that rank senior to their own76.

This restrictive interpretation of the clause under analysis does not leave room for

Lowenfelds pro rata theory in the corporate context. The upshot is that corporate

borrowers subject to apari passuprovision can feel free to deal with and discharge their

indebtedness as they may deem more convenient to their interests. This outcome is made

clear by Wood, who expressly points out that the pari passu clause has nothing to do

with the time of payment of unsecured indebtedness since this depend upon contractual

maturity. The pari passuundertaking is not broken because one creditor is paid before

another77. Buchheit is even more explicit when explaining his position in the following

terms:

A lender who remains unpaid at a time when othercreditors are current on their loans may articulate hisgrievance in terms of liberty, equality or fraternity, but heshould not invoke hispari passucovenant as the legal basisfor his disappointment. This provision assures the creditorthat its loan will not be subordinated to the claims of othercreditors in the event of the borrowers bankruptcy, but itdoes not force the solvent borrower to make pro ratapayments to all its creditors78.

75Philip Wood, supra note 68, at 6-23.76Lee C. Buchheit, The Pari Passu Clause Sub Specie Aeternitatis, 10 International Financial Law ReviewNo.12 (December 1991), at 11.77SeePhilip Wood, supra note 68, at 6-23 . See alsoPhilip Wood, supra note 69, at 165 (It does not meanthat one debt cannot be paid before another in time).78Lee C. Buchheit,How to Negotiate Eurocurrency Loan Agreements(2nded. 2000), at 83.


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This idea of the pari passuprovision being directly effective only in case of the

distribution of the borrowers assets due to insolvency or bankruptcy (in the corporate

context) has also received support from Joseph J. Norton. This author argues that the

provision in question has been designed to ensure the equal ranking of unsecured claims

on liquidation of assets to unsecured creditors on the borrowers insolvency79. He goes

even further explaining that thepari passuclause does not require concurrent or equal

payment prior to that time [borrowers insolvency], and does not restrict guaranteed loan

or setoffs80.

The main conclusion arrived at by the referred commentators, although referring

to the corporate context only, is of the greatest importance. Contrary to what Lowenfeld

argued in his Declaration, these authors make it clear that the pro rata argument cannot

be accepted out of the context of an insolvency or bankruptcy situation. But this rationale

does not seem to be that convincing when applied in the sovereign context. As it is

generally known, a sovereign country cannot legally go into bankruptcy, nor declare itself

insolvent81. This is clearly explained by Buchheit, who argues that [s]overeigns are not

subject to domestic bankruptcy regimes nor is it likely that a sovereigns assets can be

marshaled and distributed to creditors without the sovereigns consent82. In consequence

--concludes the author-- "when a sovereign promises in a loan agreement that the loan

79Joseph J. Norton, International Syndicated Lending and Economic Development in Latin America: The

Legal Context, in Essays in International Finance & Economic Law No.9 (1997), at 43.80 Id. (The author mentions that the pari passu clause prevents the borrower from assuming new debtswhich subordinates the interests of the syndicated members).81SeePhilip Wood, supra note 68, at 6-23.82Lee C. Buchheit, supra note 76, at 11.


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will rankpari passuwith all of the sovereigns other external indebtedness, the lender is

not being told anything about where it will stand in a queue of bankruptcy creditors83.

Assuming the validity of the argument referred to above, what would then be the

purpose and exact meaning of thepari passu provision in the sovereign arena? Gulati &

Klee, after recognizing that there is no liquidation in the sovereign debt context84, explain

the significance of thepari passu clause in the sovereign context thus:

The pari passu clause works as a covenant by theborrower that it will not bestow a legally senior prioritystatus on certain lenders. This protects against thetemptation for the sovereign to enact laws affecting thelegal ranking of creditors. Rankingpari passutherefore isabout insolvency payouts (in the corporate context) orabout the alteration of payment priorities by law (in thesovereign context). It is an equal ranking, but it applies tospecific contexts85.

In accordance with the explanation provided by the referred authors, Buchheit is

also explicit in recognizing that the only function of the clause in the sovereign context is

to restrain the sovereign borrower from passing laws aimed at distorting the position of

equality given to the beneficiaries of the clause. He explains his argument as follows:

If a sovereign borrower intends as a practical matter todiscriminate among its creditors in terms of payments, the

83Id.84The same premise is also put forward by Wood, who mentions that in the case of a sovereign state, the

pari passu clause bears a different construction. A government cannot be liquidated (at least not in thatsense) nor of course are there procedures for the ranking of governmental debt on sovereign bankruptcyequivalent to those pertaining in private bankruptcy. SeePhilip Wood, supranote 68, at 6-23.85Gulati & Klee, supra note 4, at 640.


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pari passu undertaking will at least prevent the sovereignfrom attempting to legitimize the discrimination byenacting laws or decrees which purport to bestow a seniorstatus on certain indebtedness or give a legal preference tocertain creditors over others86.

Apparently, the great concern here is related to the possibility of subordination. In

general, a regular corporate borrower cannot legally subordinate a lender without its

express consent87. Accordingly, Gooch & Klein argue that the pari passu clause88 in

effect states that there are no legal provisions which would cause the loans to be

subordinated to other indebtedness of the borrower89. However, in the case of a

sovereign, it could simply alter the law to subordinate the disfavored lender90. That is a

matter that is under the sovereigns control. In this regard, Buchheit mentions that

sovereign borrowers, because they have it within their power to enact laws affecting the

legal ranking of creditors, are thought to be appropriate objects of a pari passu

covenant91.

Therefore, it is held that lenders normally request the inclusion of this provision in

their contracts to ensure that their credits will not automatically be subordinated to other

existing senior indebtedness of the borrower92and, specially in the case of sovereigns, to

86Lee C. Buchheit, supra note 76, at 11.87See Gulati & Klee, supra note 4, at 640. See alsoLee C. Buchheit, supra note 76, at 11.88

The idea put forward by these commentators is referred to the pari passuclause included in a contract asa representation and warranty, not as a covenant. That explains the using of present tense by the authors.89Anthony C. Gooch & Linda B. Klein,Annotated Sample Loan Agreement, in International Borrowing:Negotiating and Structuring International Debt Transactions, Second Edition, Daniel D. Bradlow, Editor(1986), at 332.90Id.91Lee C. Buchheit, supra note 78, at 84.92 Lee C. Buchheit & Ralph Reisner, Inter-Creditor Issues in Debt Restructuring, in InternationalBorrowing: Negotiating and Structuring International Debt Transactions, Third Edition, Daniel D.Bradlow, Editor (1994), at 438.


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bar the borrower from attempting to create a class of senior indebtedness in preference

to that outstanding under the loan agreement in which the clause appears93. Blocking

contractually the ability of sovereign borrower to affect the status of its lenders seems to

be the main (if not the only) function of thepari passu clause in the sovereign context.

This is clearly suggested by Walker & Buchheit when holding that thepari passu clause

will restrict the [sovereign] borrower from subordinating in a formal way the debt being

incurred (or restructured) pursuant to the agreement containing this clause in favor of

some other external obligation94.

Subordination, however, can occur in a legal/formal sense e.g. when a sovereign

enacts a statute altering the priority status of its creditors, or it can also occur in practice,

namely when a sovereign just treats some creditors more favorably than others, in what

could be referred to as de factosubordination. This type of subordination, nonetheless, is

allegedly not restricted by the pari passu clause in the sovereign context. This is the

argument put forward by Buchheit & Reisner, who expressly state that [t]he borrower

does not violate this clause by electing as a matter of practice to pay certain indebtedness

in preference to the obligations outstanding under the agreement in which this clause

appears95. Exploring this idea much further, Buchheit explains that:

The existence of a conventional pari passu undertaking ina loan agreement will have no effect on the sovereign

93Id.94 Mark Walker & Lee C. Buchheit, Legal Issues in the Restructuring of Commercial Bank Loans toSovereign Borrowers, in International Borrowing: Negotiating and Structuring International DebtTransactions, Second Edition, Daniel D. Bradlow, Editor (1986), at 464. See also Esin Taboglu, supranote 59, at 42.95Buchheit & Reisner, supra note 92, at 438.


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borrowers legal ability to pay one creditor even if it is thenin default on its payment obligations to other creditors, toprepay one lender or group of lenders ahead of some othersor to pledge assets to secure the borrowers obligationsunder one loan without giving equal security in respect of

its other indebtedness. If a lender wants these protections, itmust search for them in other clauses of the loan agreementor restructuring agreement96.

In sum, what can be concluded so far is that there are several and divergent

interpretations of thepari passuprovision, apart from the one presented by Lowenfeld. In

fact, his broad suggestion that thepari passu provision implies that all payments must be

made on apro rata basis without considering the context in which the clause is applied,

does not find much support amongst commentators. Most of the academic writings

consulted analyze the issue in question from a double perspective, that is, differentiating

expressly between the two dissimilar contexts where the clause plays its role, namely the

corporate and the sovereign contexts97. Certainly, there is a uniform position with regard

to the meaning of the clause in the corporate context: It does not mean what Lowenfeld

suggested. However, when referring to the sovereign context, commentators opinions

are divided. The two extremes of the spectrum can clearly be observed. On the one hand,

Lowenfelds theory, on the other, Buchheits argument. The question then becomes: How

to decide which is the right one? This is exactly the question that the next part of this

paper will address and try to answer.

96Lee C. Buchheit, supranote 76, at 11.97 See Guillermo Soliven, Some Issues in the Negotiation of Commercial Foreign Exchange Loans in

Developing Countries, in Issues in Negotiating International Loan Agreements with Transnational Banks,United Nations Centre on Transnational Corporations, New York 1983, at 17. (It has been expresslyrecognized that this is one of the areas where there are marked differences in the clauses applicable to


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2. Elements to be taken into account when deciding for the right

interpretation of thepari passu clause

As can be concluded from what has been explained above, academics have not

arrived at a uniform position with regard to the correct interpretation of the pari passu

rule. Academic opinions based on abstract rationales, however, are not always in line

with what normally happens in real life. Accordingly, probably the best way of

determining which of the interpretations presented is the more coherent is to contrast

them against the market understanding of the clause under consideration. Understanding

what would be the reaction of lenders, borrowers, and the market, when facing the pari

passu provision under its different interpretations, is of the utmost importance for the

goal of this paper. After going through the analysis suggested, Gulati & Klee conclude

that if Lowenfelds opinion were the correct one, [d]ebtors, and especially sovereign

debtors, would be crazy to agree to such a term with all of their creditors 98. These

authors suggest that if debtors agreed to give creditors pari passu rights under

Lowenfelds terms, this would then result in a lower interest coupon for the creditors

who receive it, to be granted only after hard negotiations, and to be given to only a few

creditors99. In order to test this conclusion, the next few paragraphs will focus on

determining the general market understanding of thepari passuclause.

2.1 Necessity to pay preferred creditors first

private and public sector borrowers, arising as a result of the differences in the debt obligations of these twotypes of entities).98Gulati & Klee, supra note 4, at 639.99Id.


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It is expressly mentioned in Lowenfelds Declaration that a clause such as Section

11(c), the pari passu clause, is standard in virtually all loan or debt restructuring

agreements and sovereign guaranties100. It is therefore reasonable to assume that most --if

not all-- of the external indebtedness of sovereign creditors is subject to the same

provision: ranks, and will rank, pari passu. Thus, under Lowenfelds interpretation of

the clause, there cannot be preferred creditors and it would be impossible for a sovereign

to pay one creditor before another. This author expressly states that [w]hen the borrower

(or guarantor) is a sovereign state, there are no super-priority unsecured creditors and the

pari passuclause is a general non-discrimination clause.

This assumption clearly contrasts with what can be observed in practice, where

International Financial Institutions have effectively assumed a status of preferred

creditors. About this particular issue, Ibrahim F.I. Shihata states that [n]othwithstanding

the pari passu clause, borrowing governments have, in practice, generally accorded

preferred creditors status to international financial institutions such as the World Bank

and the IMF101. The author concludes mentioning that [t]he preferred creditor status is

a practical arrangement accepted by borrowers and other lenders102. Gulati & Klee

explain the gravamen of such a conclusion in the following terms:

A sovereign that is short of cash will not wish to makepayments pro rata, thereby defaulting on all its debts andbringing upon itself the ire of every creditor. Instead, a

100See Lowenfeld Declaration, supra note 43, at 9.101See Ibrahim F.I. Shihata, supra note 58, at 303.102Id.


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sovereign will want to be able to pay the importantcreditors first so that they continue to provide support103.

In addition, there are other categories of creditors that also assume a de facto

status as preferred creditors due to their strategic significance for the welfare of the

sovereign borrower. Thus, any attempt to restructure or default on the payment of these

types of credit will trigger adverse consequences for the debtor country. Amongst this

class of preferred creditors can be found, for instance, those derived from short-term

trade and also suppliers credits. Default in the payment on such type of credits will

inevitably jeopardize the sovereigns ability to participate in international trade104.

Given the recognized interest of sovereign borrowers --and even other lenders-- in

maintaining such a de facto preferred status of International Financial Institutions and

other type of creditors, it is difficult to understand why these parties would incorporate a

pari passuclause in their contracts if this bore the meaning attributed by Lowenfeld.

2.2 The role played by other clauses normally included in international loan

contracts

It is widely recognized by most commentators when referring to the typical

clauses included in international loan contracts, that the pari passu clause is normally

accompanied by a negative pledge clause. Ian F.G. Baxter remarks that [t]he purpose

103Gulati & Klee, supra note 4, at 641.104See Lee C. Buchheit, Of Creditors, Preferred and Otherwise, 10 International Law Review, No. 6 (June1991), at 12.


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of the negative pledge is to prohibit the borrower from granting a security interest in its

assets or funds in favor of another creditor, or other creditors, which would give a priority

over the lender or lenders105. The author explains that the main functions performed by

the negative pledge clause are 1) to prevent the allocation of substantial assets of the

borrower to one or more secured creditors; 2) to produce equality among creditors of the

same class ; and 3) to discourage excessive borrowing, made possible by the grant of

security over assets106.

The rational function of these two clauses, which are normally found together, is

to complement each other within the text of the contract. This is recognized by Walker &

Bucheit, who mention that the negative pledge clause is intended to complement the

protection sought by the lender in thepari passuundertaking by ensuring that subsequent

creditors of the borrower will share the lenders status as a general creditor107.

Under the broad interpretation presented by Lowenfeld, the pari passu clause

could be understood as limiting even any eventual intent of the sovereign borrower to

benefit any of its external creditors by granting them security over any of its assets. Given

the fact that the creditor benefited with the security could eventually foreclose such

assets, this action would be considered as a breach of the pro rata rule suggested by

Lowenfeld. Therefore, under the interpretation argued by the latter, thepari passuclause

would end up performing the function normally attributed to the negative pledge

clause. As mentioned above, both clauses are supposed to complement each other and

105Ian F.C. Baxter,International Banking and Finance, Carswell (1989), at 73-74.106Id.


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not to overlap in their functions. Consequently, this outcome seems to suggest that

Lowenfelds interpretation is not completely accurate.

A very interesting explanation of the historical co-relation between the pari passu

clause and the negative pledge provision is that given by Gulati & Klee. The authors

suggest that one of the possible explanations of the position assumed by Tudor John --

upon which Lowenfelds opinion is based-- is that at the time such argumentation was

elaborated (probably at the beginning of the 20th century) there were no sovereign

security interest and, hence, no negative pledge clauses

108

. They conclude speculating

that [t]he pari passu clause, therefore, probably served as something as a substitute

because the primary risk to guard against was not collateralization but subordination109.

Along with the negative pledge clause, international loan agreements also include

other type of clauses with a very straightforward meaning, whose purpose and function

can be deemed as overlapping with the significance attributed by Lowenfeld to the pari

passu clause. The two most prominent clauses in this group are the mandatory

prepayment clause and the sharing clause110.

The sharing clause, also known as pro rata sharing clause, has been defined

in the international banking context as a syndicate equality clause designed to share

individual receipts by one bank but not the others (e.g. set-offs, proceeds of litigation,

107Walker & Buchheit, supra note 94, at 464.108Gulati & Klee, supranote 4, at 640, footnote 29.109Id.110See Id., at 646. See also Lee C. Buchheit, supra note 76, at 12.


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direct payment by the borrower, etc.)111. In the words of Wood, it provides that if any

bank receives a greater proportion of its share, it must pay the excess to the agent who

redistributes to the banks pro rata112. Put in simple terms, it is a clause whereby

whatever one lender receives has to be shared ratably with the others113. The meaning

of this clause has been expressly recognized by US courts. In a recent case, a creditor

sued the Republic of Congo and was able to find a US court imposing an effective

sharing clause on the payments made by the sovereign to other creditors114. There is,

therefore, a general consensus about the basic concept involved in this clause: the sharing

of individual receipts on a pro rata basis. But, what is the purpose of this clause and its

relation to the pari passu clause? First, it is argued that this clause helps to fill the

vacuum caused by the absence of an enforced pari passu bankruptcy code115 by

discouraging the piecemeal seizure of the borrowers assets. Second, the clause aims to

avoid the borrowers making of preferential discriminatory payments to favored

creditors, so that the clause merely carries into effect the doctrine of recapturing

preferences universally adopted by municipal bankruptcy law116. Surprisingly, according

to Lowenfeld, these are allegedly the same objectives of thepari passuclause.

111 See Von Holger Langer, International Finance Law, in Syndicated Loan Agreements I TheSyndication Process, available at http://www.ganz-recht.de/stlehre/Ausland/finl1.htm(visited on April 8,2002)112Philip R. Wood, supra note 69, at 166.113Gulati & Klee, supra note 4, at 646. See also Lee C. Buchheit, Changing Bond Documentation: TheSharing Clause, in International Financial Law Review (July 1998), at 17. (Sharing clauses are provisions

that force a creditor receiving a disproportionate payment under a multi-creditor debt instrument like asyndicated loan (including a payment following litigation) to share that payment on a ratable basis withother creditors in that facility. These provisions are standard in syndicated commercial bank loans but arenot common in publicly-issued bonds).114 See Nouriel Roubini, Bail-ins, Bailouts, Burden Sharing and Private Sector Involvement in Crisis

Resolution: The G-7 Framework and Some Suggestions on the Open Unresolved Issues, Sterns School ofBusiness (NY 2001), available at http://www.stern.nyu.edu/~nroubini/asia/bailins.doc(visited on April 8,2002)115Philip R. Wood, supra note 69, at 166.116Id.


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On the other hand, the mandatory prepayment clause has been defined as a

provision whereby borrowers can be barred from making non-ratable prepayments to

other creditors117. This provision is basically aimed at assuring lenders that they will be

paidpro rataon their credits. Joseph Norton mentions that the clause in question requires

that, whenever a creditor is prepaid, the borrower must prepay the rest of creditors on a

pro rata basis118. The content and effects of the clause are explained in the following

terms:

This clause is designed to provide remedies to banks andfinancial institutions which have restructured their debt ifthe obligor concerned services comparable indebtedness ina manner which is more preferential to that of therestructuring or new money agreement. For example, theclause would require that if the obligor pays 10% of thedebt to a free rider, then the creditors who have restructuredare entitled to 10% of the debt owing to them (at most), orthe actual amount paid to the free rider (at least), dependingon how the clause is drafted.119

Under the same reasoning applied when comparing the role of the negative

pledge clause and Lowenfelds construction of thepari passu provision, it is clear that

the latter interpretation evidently overlaps with the role widely recognized for the

aforementioned clauses, and hence, renders them meaningless. If Lowenfelds assertion

were correct, would there be any reason to include any of the referred two clauses in a

117SeeGulati & Klee, supra note 4, at 646. See also Lee C. Buchheit, supra note 76, at 12.118See Joseph J. Norton,International Syndicated Lending: The Legal Context for Economic Developmentin Latin America, in NAFTA: Law and Business Review of the Americas (Summer 1996).119 See UNITAR Training and Capacity Building Programmes in the Legal Aspects of Debt, FinancialManagement ad Negotiation; Online Resource Center, Glossaries. Available at


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contract together with a pari passuprovision? Apparently, there would not. It could be

considered as redundant or as a typical act of over-lawyering. Such clauses are,

nonetheless, likely to be found in practice along with pari passu provisions in

international loan contracts. Again, international financial practice seems to disagree with

Lowenfelds position120.

2.3 Variations on the conventional terms of the pari passu clause

The text of the pari passu clause included in the 1983 Letter Agreements

guaranteed by Peru is generally acknowledged as the standard text of the clause. It

represents what can be deemed as the pari passu provision in its basic form: rank and

will rank at leastpari passuin priority of payment. However, the international financial

arena has witnessed different variations of the basic terms of the clause.

Buchheit121makes reference to several different types of variation introduced by

practitioners. Thus, for instance, it is possible to come across pari passu provisions

bearing the following phrase: will rankpari passuin priority of payment and in all other

respects. Likewise, though less frequently, it is possible to find the text: will rank pari

http://www.unitar.org/dfm/Resource_Center/TrainingPackage/TP10/GlossaryP.htm (visited on March 17,2002)120SeeGulati & Klee, supra note 4, at 646. (Besides the clauses already referred to above, there are twoothers, the turnover clause [creditors who receive preferential payments have to turn it over to the others]as well as the acceleration clause [creditors who hold debts in default gets to ask for all of the debt to bepaid immediately], that can be subject to the same analysis).121See Lee C. Buchheit, supra note 76, at 12.


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passu in priority of payment with all other External Indebtedness of the Borrower and

will be paid as such122.

It is claimed that the additional language incorporated in the text of the basic pari

passuclause reinforces the argument against the interpretation presented by Lowenfeld.

The author quoted above suggests that the variation introduced shows that practitioners

recognize that the clause, under its conventional terms, throws only a blubbery arm in

the path of a sovereign borrower intent on mischief123. Gulati & Klee agree. They

mention that if the standardpari passuclause means what [Lowenfeld] says it does, then

lawyers have been wasting their time in specifically contracting for this additional

language124.

This argument does not seem to be, however, irrefutable. By the same token, it

could easily be argued that the drafting variations introduced to the conventional terms of

thepari passu clause, were made only for the sake of clarity and preciseness.

2.4 International Public Policy Issue: The holdout creditor problem

122See Id. (Buchheit expressly consigns the text of a provision that he refers to as the mother of all pari

passuclauses: Pari Passu status. The obligation of the Borrower to pay the principal of and interest on the

Loans shall at all times rank pari senior to, or pari passuwith all other indebtedness, direct or contingent,of the Borrower for borrowed money, payable, or which at the option of Borrower or a creditor maybecome payable, in Dollars or any currency other than [local currency] without any preference in favor ofany such other indebtedness by reason of priority of the date of issue, priority by reason of form, securitythereof by way of pledge, assignment, mortgage, security interest or any other encumbrance on gold orholdings of foreign currency deposits, agreements to maintain deposits, agreements to turn over specificmoneys or in any other way, direct or indirect, express or implied, or by way of any other agreement, orother terms or provisions).123Id.


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Under the current international financial scenario, there is no longer possible to

restructure the external debts of sovereign countries using the same strategy applied at the

beginning of the eighties. By then, when any of the sovereign borrowers was going

through a liquidity crisis and, therefore, was unable to meet its international financial

obligations, creditors (mostly commercial banks125), represented by a Bank Advisory

Committee, would promptly negotiate with the sovereign the restructuring of the debt.

Anne Kruger explains s

sovereign debt restructuring: should we be worried about elliott?

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