the pari passu clause in sovereign debt restructuring · the contractual approach: a trust...

Faculteit Rechtsgeleerdheid

Universiteit Gent

Academiejaar 2015-2016

The Pari Passu Clause in Sovereign Debt Restructuring:

A Short-Lived Victory of Holdouts Over Sovereigns

Masterproef van de opleiding

‘Master in de rechten’

Ingediend door

Karel Bevernaege

01103797

Promotor: Professor Dr. Michel Tison

Commissaris: Meester Yossaman Malekzadem

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ACKNOWLEDGEMENTS

Writing a thesis is an arduous journey riddled with countless hours of research, reading and

rereading, writing and rewriting. Not to mention those teeny tiny moments of absolute horror

when your computer freezes for the umpteenth time and you are utterly convinced that this

time Word will crash forever, destroying your precious brainchild in the process. Fortunately,

it is not always a nerve-racking experience. At times I found myself enjoying a private

chuckle due to some witticism of an author, or being delighted when I finally tackled that

cumbersome sentence. Be that as it may, nothing compares to the immense feeling of

satisfaction when you finally deliver the finished product.

However, in order to achieve that savoury moment of victory and bliss, I relied on the help of

certain people without whom this thesis would never have seen the light of day.

First and foremost, I would like to thank my promoter, Prof. Dr. Michel Tison, for providing

me with an intriguing subject and giving me the necessary guidelines and advice to bring

about this thesis.

Furthermore, I am particularly grateful for the assistance given to me by to the staff of

Clifford Chance LLP. Xavier and Emily, your help was truly instrumental in finding the

necessary materials to write this thesis.

In addition, I would like to thank my parents for the endless support I received during my

studies. Especially my father, for the countless hours he spent proofreading every single

paragraph, word and syllable.

My special thanks, also, to my friends and family for sharing their previous experiences and

putting up with my ceaseless nagging.

Last but not least, a shower of gratitude to my girlfriend, Tia. Your witty puns, smiles and

unwavering confidence fuelled my inspiration.

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TABLE OF CONTENTS

Acknowledgements .................................................................................................................................. i

List of Abbreviations ............................................................................................................................. vii

Introduction ..................................................................................................................................... 1

1.1. Sovereign Debt Restructuring –A Brief Context ..................................................................... 1

1.1.1. Problems During Restructuring Negotiations .................................................................. 1

1.1.2. Solutions to These Negotiation Issues ............................................................................. 3

1.1.3. Sovereign Debt Litigation ............................................................................................... 4

1.1.4. Meticulous Drafting ......................................................................................................... 6

1.2. Problem Statement ................................................................................................................... 6

1.3. Research Method and Limitations ........................................................................................... 7

1.3.1. Research Method ............................................................................................................. 7

1.3.2. Limitations ....................................................................................................................... 7

1.4. Thesis Outline .......................................................................................................................... 8

Holdouts: the Bane or Boon of Sovereign Debt Restructuring ..................................................... 11

2.1. The Basics of Sovereign debt ................................................................................................ 11

2.1.1. The Why and the How ................................................................................................... 11

2.1.2. The Risks Involved in Sovereign Debt .......................................................................... 13

2.2. Restructuring: What Happens Upon a Default? .................................................................... 15

2.2.1. Sovereign Default Options ............................................................................................ 15

2.2.2. Contractual Restructuring in a Nutshell ........................................................................ 19

2.3. Holdouts in Action ................................................................................................................ 21

2.3.1. The Role of Holdouts .................................................................................................... 21

2.3.2. Litigation as Leverage: The Sovereign Immunity Quandary ........................................ 22

2.4. Vulture funds ......................................................................................................................... 27

2.4.1. What are Vulture Funds? ............................................................................................... 27

2.4.2. Vultures: A Different Sort of Holdouts ......................................................................... 29

2.4.3. The Role of Vulture Funds ............................................................................................ 29

2.5. Conclusion: Holdouts Are the Result of Market Failure ....................................................... 31

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Pari Passu Clauses: The Root of the Problem? .............................................................................. 33

3.1. The History of the Pari Passu: the What, the Why and the When ......................................... 33

3.1.1. The 19th Century: Pari Passu and ‘Secured’ Lending .................................................... 34

3.1.2. The Mid-20th Century: Negative Pledges Supplant Pari Passu Clauses ........................ 35

3.1.3. The 1970s: The Rise of Syndicated Loans and the Return of Pari Passu Clauses......... 36

3.2. Ranking vs. Payment: The Pari Passu Conundrum ............................................................... 37

3.2.1. Description .................................................................................................................... 37

3.2.2. Corporate context .......................................................................................................... 38

3.2.3. Sovereign Context ......................................................................................................... 39

3.3. Waves of Litigation and their Consequences ........................................................................ 41

3.3.1. Introductory Remarks .................................................................................................... 41

3.3.2. New York State Law Litigation Waves ......................................................................... 42

3.3.3. English Law Litigation .................................................................................................. 74

3.3.4. Conclusion: Where Did the Waves of Litigation Lead Us? .......................................... 81

3.4. Conclusion: Drafting Is Key? ................................................................................................ 81

Drafting Is Key to the Pari Passu-Holdout Issue ........................................................................... 85

4.1. Tackling the Pari Passu issue ................................................................................................ 85

4.2. Holding the Holdouts ............................................................................................................ 87

4.2.1. Three Approaches to Curb Holdout Power ................................................................... 88

4.2.2. The Statutory Approach................................................................................................. 88

4.2.3. The Market-Based Approach: Exit Consents and Collective Action Clauses ............... 90

4.2.4. The Contractual Approach: A Trust Structure, MDV and Restructuring Triggers ..... 103

4.3. Conclusion: A Possible Approach to Address the Issue ...................................................... 108

General Conclusion: What to Expect in the Future? ................................................................... 111

References ................................................................................................................................... 115

Table of Cases ................................................................................................................................. 115

Australia ...................................................................................................................................... 115

Belgium ....................................................................................................................................... 115

United Kingdom .......................................................................................................................... 115

v

United States of America ............................................................................................................. 115

Case Documents .......................................................................................................................... 116

Table of Legislation ......................................................................................................................... 117

Australia ...................................................................................................................................... 117

Argentina ..................................................................................................................................... 117

Belgium ....................................................................................................................................... 117

United Kingdom .......................................................................................................................... 117

United States of America ............................................................................................................. 118

Bibliography .................................................................................................................................... 118

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LIST OF ABBREVIATIONS

Act 1978 State Immunity Act of 1978 (United Kingdom)

BW Burgerlijk Wetboek (Belgian Civil Code)

CAC Collective Action Clause

F. R. App.

P.

Federal Rules Appellate Procedure

F. R. Civ. P. Federal Rules of Civil Procedure

FMLC Financial Markets Law Committee

FSI Act Foreign State Immunities Act of 1985 (Australia)

FSIA Foreign Sovereign Immunities Act of 1976 (United States of America)

Ger. W. Gerechtelijk Wetboek (Belgian Civil Procedure Code)

HIPC Heavily Indebted Poor Country

ICMA International Capital Market Association

LDC Low Developed Countries

MDV Minimum Default Value

MFCC Most Favoured Creditor Clause

NIL Negotiable Instruments Law

SDRM Sovereign Debt Restructuring Mechanism

SEC Securities and Exchange Commission

TIA Trust Indenture Act of 1939

U.C.C. Uniform Commercial Code

U.S.C. United States Code

UAC Unanimous Action Clause

UK United Kingdom

US United States of America

1

INTRODUCTION

1.1. SOVEREIGN DEBT RESTRUCTURING –A BRIEF CONTEXT

Most countries are continuously in need of financing. Therefore, countries use financing

mechanisms such as the issuance of bonds to obtain the necessary funds. Unfortunately, some

countries accumulate debt to unsustainable levels and as a result, they are faced with a

(possible) default.1

To resolve an impending crisis a sovereign state –theoretically– has three options: a bailout by

the official sector (i.e. the IMF, World Bank, ECB…), commencing restructuring negotiations

with its creditors, or a statutory approach.2 Unfortunately, there is no sovereign insolvency

framework at the moment.3 Although some voices cry out for a statutory approach, no

political consensus can be reached to implement one. However, it is not for lack of trying (e.g.

the SDRM).4

There are a number of reasons why a sovereign state chooses one option over the other. One

of those reasons is debtor and creditor moral hazard.5 A debtor might wonder why he should

bother restructuring when he can rely on the official sector to bail him out, while a creditor

might want to rely on a bailout to see his claim repaid at face value.6 In any case, even if a

sovereign state chooses restructuring over a bailout, its problems are far from over.

1.1.1. Problems During Restructuring Negotiations

The contractual approach has a fair share of problems of its own. It includes the sovereign

state entering into negotiations and trying to exchange the old bonds for new bonds at less

1 Katherine Crispi, ‘Not Just the Luck of the Irish: A Contractual Solution to the Problems of Sovereign Debt

Restructuring’ (2014) 37 FDMILJ 1859, 1868, (hereinafter: Crispi, ‘Not Just the Luck of the Irish’). 2 Ibid 1869; Rodrigo Olivares-Caminal, ‘Is there a Need for an International Insolvency Regime in the Context

of Sovereign Debt? A Case for the Use of Corporate Debt Restructuring Techniques’ (2009) 24 (1) JIBLR 21, 22

(hereinafter: Olivares-Caminal, ‘Is There a Need’). 3 Molly Ryan, ‘Sovereign Bankruptcy: Why Now and Why Not in the IMF’ (2014) 82 FDMLR 2473, 2482,

(hereinafter: Ryan, ‘Sovereign Bankruptcy’). 4 SDRM: Sovereign default restructuring mechanism. The IMF tried to implement a sovereign insolvency

procedure, based on national insolvency procedures. This project was benched due to the amount of criticism it

received. (see Olivares-Caminal, ‘Is There a Need’ (n 2) 29). 5 J. Andritzky, Sovereign default risk valuation (New York Springer 2006) 63. 6 Ibid.

I n t r o d u c t i o n

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favourable terms (so-called ‘debt swaps’)7. During these negotiations the country is exposed

to issues such as holdouts, high costs, conflicts of interests and more.

First and foremost, the issue of ‘holdouts’ or ‘rogue creditors’.8 Though the majority of

bondholders usually agrees to exchange their bonds, some bondholders refuse to participate in

the restructuring procedure. Instead, they try to collect principal and accrued interest in full.

These bondholders are called ‘holdouts’.

To make matters even worse, so-called ‘vulture funds’9 purchase defaulted debt at a steep

discount and try to recover the debt’s par value in court. Obviously, this threat of holdout-

litigation makes the restructuring negotiations even more difficult.

Unfortunately for them, holdouts cannot rely on a sovereign bankruptcy regime. Therefore, to

achieve their objective of full repayment, holdouts require two things: a judgement and

enforcement of said judgement.10 However, this course of action includes surmounting yet

another issue, namely sovereign immunity. While obtaining a judgement is fairly easy

nowadays, sovereign immunity still thwarts holdouts when it comes to enforcement. In a

nutshell, the sovereign immunity-bankruptcy standoff forces holdouts to engage in (far-

fetched) self-help strategies.11

This is where pari passu clauses come into play. Though they have been around for decades,

it was not until the Elliott cases12 that they started to pose a problem. Elliott, being a vulture

fund, used a new interpretation of this clause to block Peru’s cash flow and convinced a

Belgian court to keep Peru from paying interest to the holders of ‘new bonds’.13 All of this to

force Peru into a settlement concerning the sovereign debt that Elliott bought at a steep

7 Rodrigo Olivares-Caminal, ‘Understanding the Parri Passu Clause in Sovereign Debt Instruments: A Complex

Quest’ (2009) 43 INTLLAW 1217, 1218, (hereinafter: Olivares-Caminal, ‘Understanding the Pari Passu’). 8 Ibid 1218. 9 ‘A “vulture fund” is a type of investment fund that operates in the distressed debt market.’ (Olivares-Caminal

‘Understanding the Pari Passu’ (n 7) 1235). 10 Olivares-Caminal ‘Understanding the Pari Passu’ (n 7) 1220. 11 Anna Gelpern, ‘Pari Passu Endgames’ (Credit Slips, 2012) <www.emta.org> accessed on 26 September 2015,

(hereinafter: Gelpern, ‘Pari Passu Endgames’); Gregory R Day, ‘Market Failure, Pari Passu, and the Law and

Economics Approach to the Sovereign Debt Crisis’ (2014) 22 Tul. J. Int'l & Comp. L. 225, 247, (hereinafter:

Day, ‘Market Failure’). 12 See infra 3.3.2.2.6 Elliott Associates v. Banco de la Nacion. 13 Tim R Samples, ‘Rogue Trends in Sovereign Debt’ (2014) 35 Nw. J. Int'l L. & Bus. 58, (hereinafter: Samples,

‘Rogue Trends’).

S o v e r e i g n D e b t R e s t r u c t u r i n g – A B r i e f C o n t e x t

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discount.14 Simply put, this interpretation served as the bedrock for future holdouts and

vulture funds.

The second main issue is the dire circumstances in which these negotiations take place. As

mentioned before, sovereign debt restructuring is faced with a moral hazard issue. Usually,

this leads to no negotiations at all or tardy negotiations, which in turn results in unnecessary

stress levels.15 Other than that, a sovereign state also needs to consider the fact that a

restructuring is accompanied by a lot of reputational and economic costs.16

Finally, all parties are faced with a conflict of interest. These conflicts can be found both on

the level of creditor versus debtor as on the level of the creditors themselves. Some examples

to clarify:17

- Holdouts will try to claim the debt at face value and block all payments to the other

bondholders, while exchange bondholders will wait for new interest payments to

become due.

- A country will try to maintain its cash flow.

- The IMF focuses on stabilizing the global economy, while banks and investment funds

are solely focused on financial gains.

In sum, starting restructuring negotiations is but the first step towards recovery. One thing is

for sure, it is definitely an intricate process.

1.1.2. Solutions to These Negotiation Issues

Since holdouts are a major stumbling block when it comes to sovereign debt restructuring,

countries have started using mechanisms such as collective action clauses (‘CACs’) and exit

consents to mitigate the issue.18 In general, these provisions try to improve creditor

coordination and in doing so, they –at least theoretically– provide for an orderly sovereign

debt restructuring.19

14 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1223. 15 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1873. 16 Ibid 1873. 17 Ibid 1872; Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222. 18 J. Choi and G. Mitu Gulati, ‘Innovation in Boilerplate Contracts: An Empirical Examination of Sovereign

Bonds’, (2004) Emory L.J. 929, (hereinafter: Choi and Gulati, ‘Innovation in Boilerplate Contracts’); J.

Andritzky, Sovereign default risk valuation (New York Springer 2006) 74; Crispi, ‘Not Just the Luck of the Irish’

(n 1) 1887. 19 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502.


4

In addition, some argue that a country should be forced to enter into restructuring

negotiations.20 Due to the lack of a sovereign insolvency regime, sovereign debtors cannot be

forced to start any restructuring.21 Contractual ‘triggers’ might therefore be the solution.22

Triggers are certain events that are put into the contract.23 When these events occur, the debtor

is obligated to engage in restructuring negotiations. By doing so, both parties can reduce the

fear of moral hazard.24

Lastly, countries can rely on the use of ‘carrot features’ or ‘sweeteners’ to increase

bondholder participation.25 One of those sweeteners is the most favoured creditor clause or

‘MFCC’. If a sovereign state exchanges its bonds, this clause will prevent it from reaching a

settlement with holdouts. This way, a bondholder is sure that no one will get a better treatment

than he did and therefore more bondholders will be willing to exchange their bonds.

1.1.3. Sovereign Debt Litigation

As a preliminary point, it should be noted that both governing law and jurisdiction are of vital

importance in international transactions, especially in distressed debt situations where the

viable options for both debtor and creditor greatly depend on the chosen applicable law and

jurisdiction. For instance, a debtor has to be aware that the use of certain contractual

techniques differs under English law compared to New York state law.26 A creditor, on the

other hand, will often have to make do with remedies the enforcing court is already familiar

with, even though those are not necessarily the ones the governing law prescribes. Indeed, it is

known that judges tend to apply the law they know best.27 Hence, it is of the utmost

20 Anna Gelpern, ‘Contract Hope and Sovereign Redemption’ (2013) 8 CMLJ 132, 148, (hereinafter: Gelpern,

’Contract Hope’); Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889. 21 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889. 22 Ibid. 23 Ibid. 24 Ibid. 25 Udaibir S. Das, Michael G. Papaioannou and Christoph Trebesch, ‘Sovereign Debt Restructurings 1950–2010:

Literature Survey, Data, and Stylized Facts’ (2012) IMF Working Paper No. 12/203 22 <https://www.imf.org/

external/pubs/ft/wp/2012/wp12203.pdf> accessed 22 March 2016, (hereinafter: Das and others, ‘Sovereign Debt

Restructurings’); Rodrigo Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments:

Developments in Recent Litigation’ (2013) 72 BIS Papers 121, 122 <http://econpapers.repec.org/bookchap

/bisbisbpc/72-23.htm> accessed 19 March 2016, (hereinafter: Olivares-Caminal, ‘The Pari Passu Clause in

Sovereign Debt Instruments’); Natalie A Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around: Can

Holdout Creditors Ever Have Equal Treatment?’ 2015 83 (4) FDMLR 2171, 2185, (hereinafter: Turchi,

‘Restructuring a Sovereign Bond Pari Passu Work Around’). 26 Olivares-Caminal, ‘Is There a Need’ (n 2) 33. 27 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause and the Argentine Case’ (2012) 13

<www.emta.org> accessed on 26 September 2015, (hereinafter: Allen & Overy Global Intelligence Unit, ‘The

Pari Passu Clause’).

S o v e r e i g n D e b t R e s t r u c t u r i n g – A B r i e f C o n t e x t

5

importance to determine which law is applicable, which court has jurisdiction and what that

entails for both debtor and creditor.

Although borrowers are free to choose, New York state law and English law are by far the

prime systems of governing law with regard to sovereign debt agreements.28 Consequently,

the landmark cases in sovereign debt litigation are also of New York or English descent.

Regarding New York case law, there are three waves of litigation resulting from holdouts’

efforts at enforcement of judgement: the Pravin cases, the Elliott and LNC cases, and finally,

the NML case.

Wave 1: Pravin Banker Associates v. Banco Popular Del Peru:

In essence, this case showed that the sovereign debtors are also subject to the Latin proverb

pacta sunt servanda. Although they can count on some leniency to allow an orderly

restructuring, they cannot avoid enforcement actions forever. Consequently, this case served

as the bedrock for future holdout/vulture fund litigation.

Wave 2: Elliott v. Peru and LNC Investment v. Nicaragua.

As stated before, a wrongful judicial decision concerning the pari passu clause paved the way

for holdouts to disrupt a country’s cash flow. Years later, the pari passu clause still poses a

threat to restructuring, because creditors still claim that ‘sovereigns should be prevented from

making payments to other creditors without paying the litigating creditors’.29 This

interpretation of the pari passu clause is also called the ‘broad’ or ‘payment’ interpretation.

Wave 3: NML Captial Ltd. v. Argentina

This time there truly was a breach of the pari passu clause even in its ‘narrow’ or ‘ranking’

form.30 In casu the Argentinian government subordinated the bonds of the holdouts by

implementing the so-called ‘Lock Law’, which more or less prevented the Argentinian

28 Mitu Gulati and K N Klee, ‘Sovereign Piracy’ (2001) Bus. Law. 635, 646, (hereinafter: Gulati and Klee,

‘Sovereign Piracy’); Olivares-Caminal, ‘Is There a Need’ (n 2) 28. 29 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1223. 30 The ‘narrow’ or ‘ranking’ interpretation has to do with all kinds of ranking such as involuntary subordination

by law. See infra 3.2 Ranking vs. Payment: The Pari Passu Conundrum and 3.3 Waves of Litigation and Their

Consequences.


6

government from entering into settlement negotiations with holdouts.31 Given that the bond

instrument did not provide an adequate remedy for the breach, the plaintiff –a vulture fund

called NML Capital Ltd– proposed a ‘rateable payment’ as remedy. Whenever exchange

bondholders get paid, Argentina should be forced to pay the holdouts as well. The US Court

of Appeals of the Second Circuit followed this line of reasoning due to the lack of remedies

provided by the bond instrument and because of Argentina’s disgraceful behaviour vis-à-vis

the court.32 As a result, the door to a brand-new wave of litigation was opened.

English courts, on the other hand, see the pari passu issue differently. A landmark case in this

context is Kensington International Ltd v. Republic of The Congo.33 Although the court only

implicitly rejected the ‘payment’ interpretation, most authors agree that such an interpretation

flouts basic contractual interpretation principles under English law.34

1.1.4. Meticulous Drafting

As the recent crisis of ‘07-‘09 has shown us, meticulously drafted contracts are a must. If your

contract is flawed, you will pay for it tenfold in dire times. Bond issuances are no exception.

If the contract is badly written, the sovereign debtor will regret it because holdouts will

exploit the situation. For example, in NML vs. Argentina35 the MFCC clause lacked the word

‘settlement’ rendering it useless and opening the door to holdouts. So even though these

contractual solutions might resolve the holdout issue, all parties should still be careful and

choose detailed over boilerplate clauses.36

1.2. PROBLEM STATEMENT

Sovereign debt restructuring is faced with the issue of ‘holdouts’, meaning creditors who

refuse to exchange their old bonds for new ones in the hope of getting a better deal or

repayment in full. Apparently, pari passu clauses are at the epicentre of this phenomenon and

more specifically, their different interpretations play a big part in the resulting litigation. To

counter this issue, sovereign states have started to use defence mechanisms such as collective

31 Rodrigo Olivares-Caminal, ‘To Rank Pari Passu or Not to Rank Pari Passu’ (2009) 15 Law & Business

Review of the Americas 745, 757. 32 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012). 33 [2003] EWHC 2331 (Comm). Upheld on appeal in Kensington International Ltd. v. Republic of the Congo

[2003] EWCA Civ 709, A3/2003/1036. 34 See infra 3.3.3 English Law Litigation. 35 Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 121. 36 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889.

R e s e a r c h M e t h o d a n d L i m i t a t i o n s

7

action clauses and exit consents. At first glance these clauses might solve the issue, but deeper

analysis shows they may pose problems of their own.

1.3. RESEARCH METHOD AND LIMITATIONS

1.3.1. Research Method

For the most part, this thesis is the result of desk research. This implies a study of papers,

books and monographs available on EMTA, LexisNexis and SSRN. Their subjects range from

sovereign default debt in general to specific materials on the history of pari passu clauses and

the purpose of CACs. To supplement this basic knowledge, recent articles from journals and

law firms’ client briefings were also reviewed.

In search for those reading materials, the focus lay on the authorities in the field.

Nevertheless, some innovative ideas were found in the works of less known authors.

Moreover, this thesis also provides a clear overview of recent pari passu –or related– holdout

litigation. As mentioned before, there are two kinds of applicable law that are common in

bond contracts: English law and New York law. Therefore, this thesis examined the

differences of opinion between the English courts and their American brethren. In the interest

of intelligibility, the following method for reviewing these cases was used: (i) relevant facts,

(ii) relevant arguments, (iii) reasoning of the court and (iv) impact or importance of the case

vis-à-vis the holdout-issue.

Finally, the empirical data found in this thesis are also the result of desk research. Ergo, data

such as the percentage of bond contracts containing pari passu clauses or CACs, are not the

result of empirical analysis done by the author. Instead, they were implemented after careful

consideration and critical reading.

1.3.2. Limitations

Due to the limited time and pages allotted to me, the scope of this thesis does not encompass

the possible existence of a statutory mechanism. Instead, the focus lay on contractual

sovereign debt restructuring. More specifically, how contractual mechanisms are initiated and

where pari passu clauses, collective action clauses and the like come into play.


8

In addition, this thesis is limited to litigation and literature regarding the use of pari passu

clauses in an English or New York Law setting. This is due to the fact that most bond

issuances choose English or New York law as the applicable law.37

Furthermore, this thesis does not provide any empirical or extensive historical analysis of

contract provisions. This is partly due to the limited time available, but also due to the lack of

resources and connections to acquire the necessary materials.

As a final note, it should be pointed out that the conclusions in this thesis are primarily based

on contract mechanisms that are purely theoretical. At present, there is no way to determine if

any of the proposed countermeasures will be successful in practice. That would require a

sovereign default. Besides, every issuance of bonds has its own features and specificities,

which makes an all-round solution to the holdout issue virtually impossible.

1.4. Thesis Outline

At the moment, there is quite a bit of uncertainty regarding the use of certain clauses or the

rationale behind certain techniques with regard to sovereign debt restructuring. This

uncertainty ultimately leads to increased borrowing costs, reputational damage and other

kinds of problems such as holdout creditors.

Therefore, this thesis provides a general overview of what happens when a sovereign debt

default is imminent. It discusses the holdout issue in a sovereign debt restructuring context by

explaining why restructurings are plagued by holdouts and how this issue can be prevented or

at least mitigated. More specifically, it examines the part pari passu clauses play in this

context and determines if countermeasures such as collective action clauses and exit consents

really do help or not.

In Chapter 2, this thesis starts out with some essential background information on sovereign

debt and the holdout issue, beginning with the whys and wherefores of sovereign immunity-

bankruptcy standoff and then turning to the rise of vulture funds and their (far-fetched)

strategies. Chapter 3 examines sovereign debt litigation at length and shows how vultures

make use of a pari passu clause to force a sovereign state to settle. It discusses the

consequences of said litigation and highlights the differences between the English courts and

their American brethren. Chapter 4 introduces some legislative and contractual techniques to

37 Olivares-Caminal, ‘Is There a Need’ (n 2) 8.

T h e s i s O u t l i n e

9

prevent or at least mitigate the holdout issue and determines the pros and cons of each

solution. In addition, it suggests which approach should be endorsed to address the holdout

situation and what challenges this approach faces. Finally, chapter 5 summarises the present

situation and discusses what we can expect in the future.

11

HOLDOUTS: THE BANE OR BOON OF SOVEREIGN DEBT RESTRUCTURING

To know who or what holdouts are and why they exist, one needs to determine how they tie

into the whole sovereign debt scenario. Therefore, this chapter starts out with a basic

overview of sovereign debt and its terminology. Then, it gives a succinct enumeration of

restructuring options and provides an analysis of the immunity-bankruptcy standoff.38 Finally,

it examines the role of vulture funds, their existence and their goals.

2.1. THE BASICS OF SOVEREIGN DEBT

2.1.1. The Why and the How

Sovereign states are continuously in need of financing for a wide array of state activities,

ranging from education, healthcare and infrastructure to war, economy and humanitarian

aid.39 Obviously, their first course of action is taxation, but that only goes so far. That is why

sovereigns have been ‘borrowing from time immemorial’.40 Hence the existence of the

‘sovereign debt’ market.

In general, sovereign debt consists of two types of debt instruments, namely (commercial)

loans and sovereign bonds. The fact that bonds are predominant at the moment, is largely due

to historical events. During the 1970s most developing countries used commercial loans to

finance their operations.41 This was the result of multiple factors, but chief among them was

the existence of so-called ‘petrodollars’.42 Starting in 1973, the oil prices rose sharply and oil-

exporting countries were faced with a ‘surplus’ in revenue which they deposited in large

commercial banks located in the United States and Western Europe.43 These banks became

flush with cash and seeking high returns, they decided to recycle the petrodollars into loans

38 Gelpern, ‘Pari Passu Endgames’ (n 11). 39 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2177. 40 Mitu Gulati and Robert E Scott, The Three and a Half Minute Transaction: Boilerplate and the Limits of

Contract Design (University of Chicago Press 2013) 18, (hereinafter: Gulati and Scott, The Three and a Half

Minute Transaction). 41 Olivares-Caminal, ‘Is There a Need’ (n 2) 21. 42 Jill E Fisch and Caroline M Gentile, ‘Vultures or Vanguards?: The Role of Litigation in Sovereign Debt

Restructuring’ (2004) 53 Emory L.J. 1048, 1058, (hereinafter: Fisch and Gentile, ‘Vultures or Vanguards’);

Jonathan I Blackman and Rahul Mukhi, ‘The Evolution of Modern Sovereign Debt Litigation: Vultures, Alter

Egos and Other Legal Fauna’ (2010) 73 LCPR 47, 50, (hereinafter: Blackman and Mukhi, ‘Vultures, Alter Egos

and Other Legal Fauna’). 43 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1058.

H o l d o u t s : T h e B a n e o r B o o n o f S o v e r e i g n D e b t R e s t r u c t u r i n g

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for Latin-American countries.44 The sovereign debtors were only too happy to oblige, since

they were being strangled by the ever increasing oil-prices.45

Unfortunately, the oil crisis raged on and the world was plunged into a global recession

between 1980 and 1982.46 In addition, commodity prices fell and the US dollar hardened by

about 25 per cent.47 Consequently, servicing debt became impossible for many Latin-

American sovereign debtors and they defaulted.48

However, their creditors were also in a predicament. These large banks had granted enormous

loans to sovereign debtors who were now unable to pay.49 As a result, the banks were facing

potential insolvency and the sovereign debt crisis suddenly became a banking crisis.50

To solve this issue, US Treasury Secretary Nicholas F. Brady came up with the ‘Brady

Plan’.51 In essence this plan consisted of securitization. It replaced all the commercial loans by

new ‘Brady Bonds’ which were then sold publicly on the international market.52 The resulting

proceeds were then used to repay the loans.53 Not only did this solve the banking crisis, this

also marked the end of banks monopolizing the sovereign debt market.54 Instead, they were

replaced by investors.55

Creditors and debtors quickly realised the benefits sovereign bonds provided.56 Compared to

traditional commercial loans, bonds provided longer maturities and were easily listed and

traded on the international market.57 In addition, rating agencies assigned credit ratings to

sovereign bonds, which benefitted the investors twofold.58 On the one hand, it alleviated the

44 Ibid 1058; Anthony Mauger, ‘Sovereign Debt Restructuring: the practical background’ (1986) JIBL 100, 100

(hereinafter: Mauger, ‘Sovereign Debt Restructuring’); Alexander Shapos, ‘Breaking the Impasse: A Two-

Pronged Approach for Resolving Sovereign Debt Holdout Disputes’ (2015) 17 CDZJCR 243, 243, (hereinafter:

Shapos, ‘Breaking the Impasse’). 45 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 42) 50. 46 Mauger, ‘Sovereign Debt Restructuring’ (n 44) 100. 47 Ibid 101, Olivares-Caminal, ‘Is There a Need’ (n 2) 21. 48 Ibid 101; Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 42) 50. 49 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1061. 50 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178. 51 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1071; Olivares-Caminal, ‘Is There a Need’ (n 2) 21; 52 Ibid. 53 Ibid. 54 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1071; Blackman and Mukhi, ‘Vultures, Alter Egos and

Other Legal Fauna’ (n 42) 50. 55 Ibid. 56 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178. 57 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1072. 58 Ibid.

T h e B a s i c s o f S o v e r e i g n D e b t

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issue of information asymmetry by allowing them to assess their risks better.59 On the other

hand, this information enhanced the pricing and trading of the bonds.60 As a result of all these

benefits the sovereign debt market blossomed and ever since the 1990s bonds have been the

primary source of sovereign debt.61

To make their bonds even more appealing, sovereign states often use legal or financial

‘sweeteners’.62 These terms include covenants regarding jurisdiction, applicable law or even

sovereign immunity waivers.63 The latter can be of utmost importance in the event of a

default, especially for foreign creditors.

Indeed, more often than not, sovereign bonds take on the form of so-called ‘external debt’.

Simply put, this means sovereign bonds issued under a foreign applicable law and/or

denominated in foreign currency and/or issued to foreign creditors.64 However, this type of

sovereign bonds raises concerns about all kinds of matters, chief among them ‘inter-creditor

equity in the treatment of foreign and domestic creditors’.65

To sum up, sovereign debt is incurred to finance a wide range of state activities, generally by

way of sovereign bonds and this is a widespread phenomenon.66 For instance, recent figures

published by the Emerging Markets Trade Association show that the sovereign debt market

holds up to US$ 1.137 trillion in value.67 A blossoming market indeed.

2.1.2. The Risks Involved in Sovereign Debt

Although sovereign debt offers a lot of benefits for investors, it is not a bed of roses. For

starters, certain situations or events can lead to debt at unsustainable levels. The Latin

American sovereign debt crisis of the 80s is a prime example of that fact. Investors faced with

such a default situation are hardly in an enviable position. While corporate debtors might be

declared bankrupt, there is no statutory framework whatsoever when it comes to sovereign

59 Ibid. 60 Ibid. 61 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1073; Turchi, ‘Restructuring a Sovereign Bond Pari Passu

Work Around’ (n 25) 2178. 62 Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122; Turchi, ‘Restructuring a

Sovereign Bond Pari Passu Work Around’ (n 25) 2185. 63 For example, Argentina’s Fiscal Agency Agreement of 1994. 64 Anna Gelpern and Brad Setser, Domestic and External Debt: The Doomed Quest for Equal Treatment’ (2004)

35 Geo. J. Int'l L.795, 796; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2176. 65 Ibid 2177. 66 Ibid 2178. 67 EMTA, ‘EMTA Survey: Quarterly Emerging Markets Debt Trading Drops to Six Year Low at US$1.137

trillion’ <www. emta.org> accessed 19 March 2016.


14

debtors.68 Instead, the parties involved have to rely on voluntary restructuring negotiations

organised on a case-by-case basis.69

Moreover, in the event of a default there is also the matter of sovereign immunity to consider

and this issue is twofold. Creditors might be unable to obtain a judgement against a sovereign

debtor or they might be unable to enforce a judgement obtained.70

Then, there is also the possible issue of discrimination. As stated before, foreign creditors face

the risk of being discriminated against in the event of a default.71 A sovereign debtor might –

for political reasons– decide to give domestic creditors a preferential treatment. For instance, a

law might be passed that involuntarily subordinates foreign creditors.72

In addition, some sovereign debtors might find it politically more appealing to opt for a

default rather than making internal financial sacrifices that might not sit well with the local

populace.73 Besides, their position as default-debtor is practically unassailable due to a lack of

bankruptcy regime and their sovereign immunity. So, there is definitely something to be said

for the whole ‘debtor moral hazard’ issue.74 Countries do get incentives to ‘opportunistically

default’.75

Nevertheless, it should be noted that the official sector76 imposes severe austerity measures

when it bails out a sovereign debtor.77 Not to mention the fact that any default situation results

in significant reputational costs, which, according CRISPI, makes future fundraising very

difficult for the sovereign debtor in question.78 She asserts that the biggest cost of a sovereign

default is its effect on future access to capital market, because investors are reluctant to invest

for fear of a new default.79 So, one could say that the consequences of a default are so severe

that it discourages ‘opportunistic defaults’.

68 Olivares-Caminal, ‘Is There a Need’ (n 2) 29; Robert A Cohen, ‘”Sometimes a Cigar Is Just a Cigar”: the

Simple Story of the Pari Passu (2011) 40 Hofstra L. Rev. 11, 16, (hereinafter: Cohen, ‘Cigar’). 69 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2180. 70 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220. 71 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2177. 72 See infra 3.3.2.3.8 NML Capital Ltd v Argentina. 73 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1048. 74 Ibid 1053. 75 Ibid; William Bratton, ‘Pari Passu and a Distressed Sovereign’s Rational Choices’ (2004) 53 Emory L.J. 823,

843 (hereinafter: Bratton, ‘Pari Passu and a Distressed Sovereign’). 76 E.g. IMF, World Bank, ECB… 77 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1874. 78 Ibid 1873. 79 Ibid 1874.

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15

Be that as it may, the fact remains that the sovereign-default-debtor can be in a strong

bargaining position. Due to their sovereign immunity and the lack of a bankruptcy regime,

they are well-nigh unassailable. This signifies yet another risk for their creditors, because they

might be faced with unreasonable restructuring terms without any viable recourse to other

remedies.

Finally, much like the corporate context, agency conflicts also plague the sovereign debt

context.80 For example, the ‘government-creditor agency problem’ and the ‘intergenerational

agency problem’.81 A politician’s primary concern is staying in office and obtaining the

necessary votes to do so. Therefore, he might not have the correct incentive to use the

proceeds of the fundraising wisely, instead he might rather do things to please his voters.82

Similarly, politicians sometimes choose to incur sovereign debt now and leave the problems

to the future generations.83 So, these agency conflicts are definitely something to keep in mind

when dealing with sovereign debt.

Obviously some of the risks mentioned here are hedged by way of bond or loan covenants,

but the fact remains that no contractual system is perfect. These risks do exist and need to be

factored in when deciding to invest in sovereign debt.

2.2. RESTRUCTURING: WHAT HAPPENS UPON A DEFAULT?

2.2.1. Sovereign Default Options

When faced with a default, a sovereign has few options available. It can either hope for a

bailout by the official sector, or it can initiate sovereign debt restructuring.

2.2.1.1. A Bailout

In order to stabilize the international financial system, institutions such as the IMF or the ECB

might decide to provide a sovereign debtor with new loans.84 However, this might fuel the

‘opportunistic default’ issue and in addition it discourages (imminent) default-debtors from

80 Gulati and Scott, The Three and a Half Minute Transaction (n 40) 20. 81 Ibid 19-20. 82 Ibid 19. 83 Ibid 20; J. Andritzky, Sovereign default risk valuation (New York Springer 2006) 63. 84 William W. Bratton and G. Mitu Gulati, ‘Sovereign Debt Reform and the Best Interest of Creditors’ (2004) 57

Vand. L. Rev. 1, 3 (hereinafter: Bratton and Gulati, ‘Sovereign Debt Reform’).


16

making concessions or even starting restructuring negotiations.85 So, the official sector should

tread carefully and impose the necessary measures to prevent any misuse.

2.2.1.2. Sovereign Debt Restructuring

Lacking a bailout, a sovereign debtor’s only other course of action is a sovereign debt

restructuring. OLIVARES-CAMINAL superbly defines it as ‘the mechanism used by a sovereign

to prevent or resolve debt issues and to achieve debt sustainability levels’.86 Nevertheless, a

distinction must be made between the statutory approach and the contractual approach.

2.2.1.2.1. ‘Statutory’ Sovereign Debt Restructuring

A statutory approach refers to a bankruptcy reorganisation procedure or a court-supervised

debt restructuring using equitable powers.87 However, this is where sovereign debt differs

from corporate debt. As stated before, there is no such thing as a sovereign insolvency regime,

nor is there any other court-supervised restructuring available for sovereign defaults.

Still, it should be noted that there is a widespread agreement on the need for a ‘revamped’

sovereign debt restructuring process.88 Unfortunately, the creation of such a framework has

proven to be politically impossible.89 For instance, the IMF has come up with the Sovereign

Debt Restructuring Mechanism (the ‘SDRM’), but this initiative was never endorsed.90 Other

authors such as GELPERN and DAY advocated a contractual reform, in combination with a

statutory reform or otherwise.91 Lamentably, their proposals never surpassed the theoretical

stage. In sum, a statutory approach is not really an option for a sovereign debtor.

2.2.1.2.2. ‘Contractual’ Sovereign Debt Restructuring

Absent any other recourse, debtors and creditors willing to resolve the default situation need

to come to the bargaining table.92 In case of sovereign bond restructuring, their negotiations

will revolve around the exchange of outstanding bonds for new bonds under less favourable

85 Ibid. 86 Olivares-Caminal, ‘Is There a Need’ (n 2) 29. 87 Ibid. 88 Ibid. 89 Ibid; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1094; Blackman and Mukhi, ‘Vultures, Alter Egos and

Other Legal Fauna’ (n 42) 48; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2180. 90 Anna Gelpern and Mitu Gulati, ‘Public Symbol in Private Contract: A Case Study’ (2006) 84 Wash. U. L.

Rev. 1627, 1649, (hereinafter: Gelpern and Gulati, ‘Public Symbol’); Olivares-Caminal, ‘Is There a Need’ (n 2)

29; 1649- Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2206. 91 Gelpern, ’Contract Hope’ (n 20) 148; Day, ‘Market Failure’ (n 11) 262. 92 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3.


17

terms for creditors.93 Such a ‘debt swap’ or ‘debt exchange’ is usually characterised by a ‘debt

rescheduling’, a ‘debt reduction’, or a combination of both.94

DAS and others define a debt rescheduling as ‘a lengthening of maturities of the old debt,

possibly involving lower interest rates.’95 They add that this offers some form of relief to the

sovereign, because payments are shifted to the future.96 A debt reduction, on the other hand,

means a decrease in the actual face value of the debt, namely a reduction of the principal or

the interest rate.97 As such it offers an immediate form of relief that perhaps is more preferable

and definitely more visible than that of a debt rescheduling.

In addition, it should be noted that both types of debt operations require some kind of

‘haircut’, i.e. a ‘decrease in the amount of repayment owed to the creditors as a result of the

restructuring’.98 In case of a debt rescheduling, the lowering of interest rates lessens the value

of repayment,99 while in case of a debt reduction the actual face value of the bonds is

curtailed.100

However, there are quite a few bumps on the road to successful renegotiations. These issues

include getting parties to the table, being faced with unreasonable terms and multiple conflicts

of interest.

First of all, getting parties around the bargaining table might not be as easy as it sounds. Even

though restructuring negotiations are usually the last viable course of action, there are some

reasons why both parties might not want to give it a try. For instance, there is the issue of

‘debtor-creditor moral hazard’.101 As stated before, some countries might opt for an

‘opportunistic’ default, especially if they think a bailout is a distinct possibility. Creditors, on

the other hand, might also be tempted to await a bailout. Instead of risking unreasonable terms

and severe haircuts, a bailout provides a sovereign with fresh cash to service its debt

93 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work

Around’ (n 25) 2184. 94 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1218; Crispi, ‘Not Just the Luck of the Irish’ (n 1)

1869; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184. 95 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 7. 96 Ibid; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869. 97 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184. 98 Ibid. 99 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1869. 100 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 3. 101 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1053.


18

payments.102 Consequently, the prospect of a bailout might not incentivise creditors or

sovereign debtors to come to the bargaining table.103

In addition, the bargaining position of sovereign debtors is disproportionally strong compared

to that of creditors. Due to sovereign immunity and the lack of a bankruptcy regime,

sovereigns are well-nigh unassailable. As a result, some of those debtors might be tempted to

impose unreasonable terms. This is another reason why creditors –who do not have the time

or money to litigate– might be discouraged from entering into restructuring negotiations.

Then, there is also the issue of creditor coordination. A major downside of the switch from

syndicated loans to sovereign bonds is the atomisation of bond ownership.104 In the olden

days, large institutions such as major commercial banks monopolised the sovereign debt

market.105 Their limited number made it easier to coordinate any restructuring negotiations.

Nowadays, bondholders are spread wide around the globe.106 The investors include banks,

hedge funds or even retail investors.107 Hence, any restructuring operation is faced with a

coordination issue, namely getting these parties to negotiate. In addition, the existence of

unanimous action clauses (‘UACs’) makes things even worse. Prior to 2003, these clauses

were boilerplate in bonds issued under New York law.108 In essence, they required the

agreement of every creditor before any bond alteration could take place.109 Consequently, this

boilerplate term hampered the success of many a restructuring.110

Finally, restructuring negotiations are also plagued by conflicts of interests. Sovereign debtors

for one have interests that are completely contrary to those of their creditors. In the event of a

default, a sovereign will want to limit its payment obligation, while creditors will obviously

want to see their payment in full. However, this issue is not necessarily limited to debtors

versus creditors. Indeed, a lot of conflicts arise from creditors’ non-aligned interests.111 The

increased diversity in the composition of lenders is mirrored in their various concerns and

102 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1870. 103 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3. 104 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182. 105 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 50; Das and others, ‘Sovereign

Debt Restructurings’ (n 25) 17. 106 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182. 107 Ibid. 108 Choi and Gulati, ‘Innovation in Boilerplate Contracts’ (n 18) 932-933. 109 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work

Around’ (n 25) 2183. 110 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 3. 111 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871.


19

interests.112 For instance, the IMF might want to resolve a crisis as soon as possible for fear of

a ‘contagion’ that spreads to the global economy.113 Banks and investment funds, on the other

hand, are solely focused on financial gains and will be trying to make the best of the sovereign

default situation.114

In sum, a contractual restructuring is hardly a walk in the park. Moreover, even if a debt swap

occurs, a sovereign debtor’s problems are far from over. Bondholders who want to take the

deal might see their new interest payments blocked by creditors suing the sovereign debtor

and trying to get paid in full by way of litigation.115 These last ones are called holdout

creditors or rogue creditors and are discussed in detail below.

2.2.2. Contractual Restructuring in a Nutshell

Assuming that parties do get around the table, a restructuring process can be boiled down to

four key moments: (i) a trigger event, (ii) some form of negotiations, (iii) an exchange offer

and (iv) a debt swap.116

The sovereign debt restructuring process starts with a trigger event.117 This event can either be

a default on payment obligations or an announcement that the sovereign debtor will no longer

be able to service its debt.118 Thereafter, negotiations119 ensue with the key purpose of solving

the default debt situation.120 In the 80s, when syndicated loans were restructured, these

negotiations were usually led by a committee of banks.121 At that time, the limited number of

investors made that practice possible. Nowadays, however, sovereign bonds are the primary

source of sovereign debt and, as mentioned before, dispersed bond-ownership creates a

creditor-coordination problem. As a result, the process requires reconciling all parties’

interests and it makes restructuring operations extremely time-consuming. Sometimes

112 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2182. 113 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1871. 114 Ibid. 115 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222. 116 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 12. 117 Ibid; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2184. 118 Ibid; Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1868. 119 It should be noted that before or during negotiations the sovereign debtor will often contact the official sector

(i.e. the IMF, the ECB, the World Bank…). This is beneficial for the sovereign debtor, because the official sector

will either help to structure the negotiations, or provide a bailout if necessary. (Mauger, ‘Sovereign Debt

Restructuring’ (n 44) 103). 120 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 12; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1868. 121 Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1059.


20

negotiations take years to finalise. Eventually, if parties do reach an agreement, their solution

might range from a temporary standstill of payments to a fully-fledged debt swap.122

A solution involving a debt swap has one major objective: a high participation rate.123 In order

to achieve that goal, the terms of the agreement might hold some ‘carrot features’ or

‘sweeteners’ to convince the bondholders.124 These incentives come in a wide variety.

Creditors might be swayed by financial sweeteners such as upfront cash repayments, or they

might prefer advantageous legal provisions included in the new bonds. In 2005 Argentina

even tried its hand at a regulatory sweetener, but the ‘Lock Law’ turned out to be a disaster.125

Be that as it may, the phenomenon of legal or financial sweeteners is definitely widespread

and statistics do show a significant increase in the participation rate because of them.126

Unfortunately, the voluntary nature of a sovereign debt restructuring results in some

bondholders who refuse to participate in the debt swap. These bondholders are called

‘holdouts’ or ‘rogue creditors’.127 It is safe to say that these holdouts are responsible for the

biggest disruptions in sovereign debt restructurings.128 They hope to achieve better terms by

making life difficult for the sovereign debtor. Though some are content with merely refusing

to participate, others take it up a notch and sue the sovereign demanding full payment.129 How

they manage that, is discussed below.

In a nutshell, the contractual restructuring process can be summarized in a comprehensive

figure:

122 Mauger, ‘Sovereign Debt Restructuring’ (n 44) 103; Das and others, ‘Sovereign Debt Restructurings’ (n 25)

12. 123 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 22. 124 Ibid; Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instrument’ (n 47) 122; Turchi,

‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185. 125 See infra 3.3.2.3.8 NML Capital Ltd v Argentina. 126 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 24-26. 127 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1218. 128 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872. 129 Ibid; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079.

H o l d o u t s i n A c t i o n

21

Figure 1: Contractual Restructuring

2.3. HOLDOUTS IN ACTION

2.3.1. The Role of Holdouts

Holdouts are often characterised as the major stumbling block in a sovereign debt

restructuring process.130 It is said that they have a disruptive effect, because their refusal to

cooperate lengthens the restructuring process and in doing so it increases legal and

reputational costs.131 Furthermore, if holdouts achieve their goal of better restructuring terms,

the actual burden falls on the distressed country’s citizens.132 Finally, it must be noted that

their actions create a disincentive for sovereigns and creditors alike to enter into restructuring

negotiations.133 On the whole, the majority of authors view them as ‘mavericks’ in the

sovereign debt market.134

130 Samuel E Goldman, ‘Mavericks in the Market: The Emerging Problem of Holdouts in Sovereign Debt

Restructuring’ (2000) 5 UCLA J. Int'l L. & Foreign Aff. 159, 164, (hereinafter: Goldman, ‘Mavericks in the

Market’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 22; Fisch and Gentile, ‘Vultures or Vanguards’

(n 42) 1092; Olivares-Caminal, ‘Is There a Need’ (n 2) 29; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872;

Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185; Shapos, ‘Breaking the Impasse’

(n 44) 246. 131 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1092; Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1872. 132 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1092. 133 Ibid; Christopher C Wheeler and Amir Attaran, ‘Declawing the Vulture Funds: Rehabilitation of a Comity

Defense in Sovereign Debt Litigation’ (2003) 39 Stan. J. Int'l L. 253, 260, (hereinafter: Wheeler and Attaran,

‘Declawing the Vulture Funds’). 134 Goldman, ‘Mavericks in the Market’ (n 130) 164.

•Default on (interest) payments

•Restructuring announcement

Trigger Event

•Contacting the official sector

•Starting (in)formal negotiations with (major) creditors

•Negotiating terms

Negotiations•Debt reduction or debt

rescheduling

•Haircut of x %

•Legal or financial 'sweeteners'

Exchange Offer

•Creditors either agree or refuse to swap

•Participation rate of x %

Debt Swap


22

However, this mainstream view of holdouts is not shared by everyone. FISCH and GENTILE,

for example, argue that holdouts act as ‘vanguards’ vis-à-vis a sovereign’s misuse of

power.135 According to them, the existence of holdouts keeps the sovereign debtor in check by

preventing opportunistic defaults and by precluding abuse of sovereign immunity.136 So, one

could argue that holdouts do serve an essential role in the whole sovereign debt scenario.

Even though it is often viewed as distasteful or unfair.

2.3.2. Litigation as Leverage: The Sovereign Immunity Quandary

Holdouts try to achieve better terms or full repayment, but how do they realise that goal? In a

corporate context, a creditor faced with a default would try to obtain a money judgement and

enforce it by seizing a debtor’s assets.137 Similarly, a sovereign debt creditor can use litigation

as leverage during restructuring negotiations.138 However, in a sovereign context this

approach faces a couple of hurdles.139 Some even go as far as claiming that sovereign debt is

well-nigh unenforceable.140

In fact, GELPERN aptly surmises that holdouts find themselves in a sovereign ‘immunity-

bankruptcy standoff’.141 They simply cannot rely on bankruptcy remedies such as those found

in the Chapter 11 USC, nor can they easily obtain an enforceable judgement.142 Indeed,

sovereigns try to prevent any enforcement from happening by invoking their sovereign

immunity. Although the courts have become more lenient over the years, sovereign immunity

remains a formidable hurdle to clear.143

In a nutshell, holdouts will try to achieve better terms or full repayment by finding ways to

circumvent the sovereign ‘immunity-bankruptcy standoff’. In particular, they will use tactics

that eat away at the sovereign immunity defence.144

135 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1051. 136 Ibid. 137 Samples, ‘Rogue Trends’ (n 13) 49. 138 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185. 139 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220. 140 Gelpern, ’Contract Hope’ (n 20) 132; Samples, ‘Rogue Trends’ (n 13) 55. 141 Gelpern, ‘Pari Passu Endgames’ (n 11). 142 Ibid; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50; Day, ‘Market Failure’ (n 11) 232. 143 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1101. 144 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 51; Turchi, ‘Restructuring a

Sovereign Bond Pari Passu Work Around’ (n 25) 2185.


23

2.3.2.1. Forum Options

Holdouts seeking a money judgement have three forum options.145 They can either try their

luck in the sovereign debtors’ domestic courts, or they will have to find recourse in foreign

courts and arbitral bodies. Due to the risk of prejudicial treatment, chances are slim for

creditors to get lucky in a sovereign’s domestic courts.146 Moreover, most sovereign bonds do

not include an arbitration clause, which makes arbitration highly unlikely.147 Instead, creditors

usually seek judgement in foreign courts even though that requires clearing the hurdle of

sovereign immunity.148

2.3.2.2. Double trouble: The Sovereign Immunity Issue

The problem with sovereign immunity is actually twofold.149 A foreign court might refuse to

claim jurisdiction and even if a creditor obtains a money judgement, sovereign immunity will

most likely protect the sovereign debtors’ assets from attachment.

2.3.2.2.3. Jurisdictional Immunity

Nowadays, the jurisdiction issue has largely been done away with, but until the mid-twentieth

century sovereigns enjoyed ‘absolute’ immunity from suit in national courts.150 The rationale

behind this approach was that it offended a sovereign’s dignity to be brought before foreign

courts.151 However, over the course of years, sovereigns liberalised their policy vis-à-vis

sovereign immunity. The United States, for example, adopted a ‘restrictive theory’ via the

‘Tate Letter’ in 1952 and a few years later, this new policy was codified in the Foreign

Sovereign Immunities Act of 1976 (the ‘FSIA’).152

In essence, this new approach held to the basic idea of sovereign immunity, but it enumerated

a few important exceptions. For instance, a sovereign retained its immunity for public acts,

but private litigants obtained the right to sue the foreign sovereign in US Courts in the event

145 Day, ‘Market Failure’ (n 11) 232. 146 Ibid; W Mark C Weidemaier, ‘Contracting for State Intervention: The Origins of Sovereign Debt Arbitration’,

(2010) 73 Law & Contemp. Probs. 335, 337, (hereinafter: Weidemaier,’Contracting for State Intervention’). 147 Weidemaier,’Contracting for State Intervention’ (n 146) 336. 148 Ibid 335; Day, ‘Market Failure’ (n 11) 233. 149 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220; Shapos, ‘Breaking the Impasse’ (n 44) 252-253. 150 W Mark C Weidemaier, ‘Sovereign Immunity and Sovereign Debt’ (2014) U. Ill. L. Rev. 67, 68, (hereinafter:

Weidemaier, ‘Sovereign Immunity’). 151 Simon James, Julia Machin, Tim Morris and Andrew Yianni, ‘Sovereign Immunity: Don’t Cry for Me’

(Clifford Chance Client Briefings, July 2011) <http://www.cliffordchance.com/briefings.html> accessed 13

March 2016, (hereinafter: James, Machin, Morris and Yianni, ‘Sovereign Immunity’). 152 28 U.S.C. §1604-1605; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079; Shapos, ‘Breaking the

Impasse’ (n 44) 252.


24

of an immunity waiver or a commercial act.153 As a matter of fact the reference point for such

a ‘commercial act’ is a private party.154 If the latter could have engaged in the same behaviour

as the sovereign, then it is deemed ‘commercial act’ by the court.155 In other words, under the

restrictive theory sovereign immunity only shields explicit acts of state.156

Furthermore, in Republic of Argentina v Weltover157 the Supreme Court clarified the

commercial act exception and specifically stated that issuing sovereign bonds is a commercial

act, regardless of the activity’s purpose.158 Some considered this a huge win for holdouts, but

WEIDEMAIER points out that most sovereign bonds include immunity waivers anyway, thus

fulfilling another FSIA exception.159 In any event, regulation, case law and practices (such as

‘carrot features’)160 have done away with the absolute sovereign immunity in the United

States.

However, the restrictive theory did not limit itself to the FSIA. Other countries soon followed

the United States’ example. In the United Kingdom and Australia similar laws were enacted

that implemented the ‘restrictive theory’, namely the State Immunity Act of 1978 and the

Foreign State Immunities Act of 1985 (the ‘FSI Act’).161 Just like their American counterpart,

these acts enumerated a couple of exceptions, such as the ‘commercial act’ exception, while

holding to the basic rule of sovereign immunity.

In brief, it is nowadays globally accepted that in principle foreign states have immunity from

suit, unless certain criteria are fulfilled. For instance, if it pertains to a ‘commercial activity’,

or if an immunity waiver is in play. Consequently, these days it is rather easy for holdouts to

arraign a sovereign before a national court.

153 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1079; Weidemaier, ‘Sovereign Immunity’ (n 150) 69;

Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 52; Day, ‘Market Failure’ (n 11)

234; Shapos, ‘Breaking the Impasse’ (n 44) 252. 154 Day, ‘Market Failure’ (n 11) 234. 155 Ibid. 156 Ibid; Samples, ‘Rogue Trends’ (n 13) 56. 157 504 U.S. 607 (1992). 158 Day, ‘Market Failure’ (n 11) 234. 159 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1080; Blackman and Mukhi, ‘Vultures, Alter Egos and

Other Legal Fauna’ (n 27) 51; Weidemaier, ‘Sovereign Immunity’ (n 150) 69; Day, ‘Market Failure’ (n 11) 234;

Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2185; Samples, ‘Rogue Trends’ (n 13)

56. 160 See supra 2.2.2 Contractual Restructuring in a Nutshell. 161 Diana Chang, Jason Mendens, Julia Dreosti, Laura Sheridan Mouton and Rossalyn Warren, ‘Australian High

Court Gives Guidance on Sovereign Immunity for Foreign State Owned Entities’ (Clifford Chance Client

Briefings, September 2012) <http://www.cliffordchance.com/briefings.html> accessed 26 September 2016;

James, Machin, Morris and Yianni, ‘Sovereign Immunity’ (n 151) 1; Samples, ‘Rogue Trends’ (n 13) 57.


25

This brings us to the content of money judgements. Most sovereign debt instruments include

‘acceleration’ as remedy for a default, but no way to enforce it.162 How then do judgement-

holders get a sovereign debtor to pay in full, especially since the debtor cannot even pay in

part (i.e. interest and principal)? In other words, obtaining a ‘money judgement’ might no

longer be the real issue, but enforcement of said judgement is. Lacking any other course of

action, a holdout is left with trying to attach a sovereign debtor’s assets, even though

sovereigns are quite skilled at sheltering them.163 Small wonder that so-called ‘asset hunting’

is considered the centrepiece of a sovereign debt dispute these days.164

2.3.2.2.4. Enforcement Immunity: The Hunt for Assets

Under normal circumstances, a debtor’s refusal to comply with a court order to pay would result in a

seizure of his assets.165 In a sovereign debt context, however, this is seldom the case.166 Usually the

assets are beyond the reach of creditors, because the process of attachment is extremely difficult or

virtually impossible.167

A holdout’s first course of action will be an attempt at executing the money judgement before

a sovereign debtors’ domestic courts. 168 However, it is highly unlikely that a national court

will enforce a foreign judgement due to the risk of prejudicial treatment.169 Therefore, the next

step will be an execution abroad, but unfortunately that is often just as unsuccessful.170

In the olden days, a sovereign’s assets enjoyed an absolute sovereign immunity similar to that

of immunity from suit.171 Even the Tate Letter, which introduced a restrictive immunity

policy, did not provide judgement-holders with rights to enforce a judgement.172 It was not

until the FSIA that enforcement became possible with a legal framework akin to that of the

Tate Letter.173 In principle, a sovereigns’ property was immune from execution, unless an

exception applied.174 For instance, if a sovereign waived its immunity from execution, or if its

162 Day, ‘Market Failure’ (n 11) 230. 163 Weidemaier, ‘Sovereign Immunity’ (n 150) 69. 164 Samples, ‘Rogue Trends’ (n 13) 57. 165 Day, ‘Market Failure’ (n 11) 230; Samples, ‘Rogue Trends’ (n 13) 55. 166 Ibid. 167 Ibid. 168 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1220. 169 Ibid. 170 Ibid. 171 Weidemaier, ‘Sovereign Immunity’ (n 150) 78. 172 Ibid 78-79. 173 Ibid. 174 28 U.S.C. § 1609-1610(a).


26

assets were used for a commercial activity.175 Unfortunately, the FSIA does not provide

judgement-holders with an ironclad guarantee of success.176 A fortiori, if a sovereign debt

instrument does not include a specific immunity waiver for execution then judgement-holders

are back to square one.

For starters, the exception under §1610(a) FSIA only grants a right to attach ‘commercially

used’ assets.177 A landmark case in this context is Connecticut Bank of Commerce v. Republic

of Congo178 in which the Fifth Circuit specifically emphasised the words ‘used for’.179 The

fact that the money is raised by means of a commercial activity such as sovereign bonds is

irrelevant.180 What matters is how it is spent.181 Besides, the targeted assets need to be used

for ‘the commercial activity upon which the claim is based’.182 As a result, courts have been

reluctant in permitting holdouts to attach a sovereign’s property, since the activity is

borrowing and that money has usually been spent.183 Lacking any other assets that fall under

the FSIA exception, judgement-holders often see their enforcement claims blocked.184

Nowadays, the criterion of ‘commercially used assets’ is used globally to break through

sovereign immunity. By way of example, article 1412quinquies of the Belgian Civil

Procedure Code and article 13(4) of the UK’s State Immunity Act 1978 specifically exclude

175 Ibid. 176 Weidemaier, ‘Sovereign Immunity’ (n 150) 80; Day, ‘Market Failure’ (n 11) 234. 177 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Day, ‘Market Failure’ (n 11)

236. 178 309 F.3d 240. 179 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Day, ‘Market Failure’ (n 11)

236; 180 309 F.3d 240 at 253. 181 Ibid. 182 28 U.S.C. § 1610(a)(2). 183 Day, ‘Market Failure’ (n 11) 236. 184 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 57; Samples, ‘Rogue Trends’ (n

13) 61.

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such assets.185 Consequently, holdouts find themselves on a veritable hunt for commercially

used assets, which can lead to ridiculous little squabbles. For instance, in 2012 a holdout

named NML Capital persuaded Ghanaian authorities to seize Argentina’s sailing frigate the

‘ARA Libertad’.186 Some time later, Argentina saw its presidential plane grounded and to top

it off, even its central bank funds were targeted.187 Futility and ridiculousness set aside, these

skirmishes are hardly efficient or even effective. With costs easily running in the millions and

reputational damage skyrocketing, this tactic is both extremely expensive and ever so time-

consuming.188

Enter the vulture funds. The emergence of the sovereign bond market in the 1980s also

marked the rise of vulture funds.189 These big investors saw a new business opportunity and

started buying distressed debt at a discount. With time and money on their side, these

investors were far better placed to endure the hardships of being a holdout. Consequently, the

number of sovereign debt litigation increased.

2.4. VULTURE FUNDS

As mentioned before, holdouts are the major stumbling block of a sovereign debt

restructuring. They try to receive full repayment by way of litigation, often to the detriment of

the exchange bondholders and the debtor’s citizens. However, the sovereign-immunity-

bankruptcy situation makes enforcing judgements virtually impossible. Why then does

sovereign debt litigation occur? More specifically, how do vulture funds tie into this whole

scenario?

2.4.1. What are Vulture Funds?

A sovereign debt restructuring usually results in an exchange offer. Upon such a debt swap

there are two types of creditors, namely exchange bondholders and those who refuse to

cooperate. The latter are called holdouts. In general, holdouts can be subdivided into

‘institutional or sophisticated’ creditors such as investment funds, retirement funds or vulture

185 Day, ‘Market Failure’ (n 11) 238. 186 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2496; Samples, ‘Rogue Trends’ (n 13) 61. 187 Anna Gelpern, ‘Sovereign Damage Control’ (2013) PB13-12 Peterson Institute for International Economics

Policy Brief at 5 <http://www.iie.com/publications/pb/pb13-12.pdf> accessed 7 March 2016, (hereinafter:

Gelpern, ‘Sovereign Damage Control’). 188 Samples, ‘Rogue Trends’ (n 13) 61. 189 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50.


28

funds, and ‘retail or individual’ creditors.190 Consequently, holdouts might therefore be

vulture funds, but the opposite is not necessarily true.

The term vulture fund refers to a certain type of holdout-creditor that operates in the sovereign

debt market in a –according to most authors– morally deplorable way.191 More specifically, it

buys up the distressed debt of poor countries at a steep discount with the sole intention of

suing the sovereign debtor for repayment at par value.192 Unsurprisingly, advocates of the

vulture funds’ operations usually refer to them as ‘distressed debt investors’ rather than

vultures.193

According to SOOKUN the key features of a vulture fund can be summarised as follows:194

(i). It is not the primary lender of the money.

(ii). It purchases distressed debt on the secondary market at a steep discount; and

(iii). It sues the sovereign debtor for full value of the debt, including interest, generating

a return of 300 to 2000 per cent.195

Understandably, most authors view ‘vulturing’ is morally deplorable. These funds pray on

financially distressed countries and bleed them dry. However, SAMPLES justly points out that

‘[f]airness and ethics aside, vulturing is [still] a legal activity’.196 Therefore, it is up to

regulators and drafters to take note of this risk.

The most famous vulture fund, the rock star of the bunch as it were, is Elliott Associates,

which was founded by billionaire Paul Singer.197 This vulture fund gained notoriety for its use

of a creative enforcement device based on the pari passu clause, i.e. a boilerplate clause in

190 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1235. 191 Devi Sookun, Stop Vulture Fund Lawsuits (the Commonwealth Secretariat 2010) 7, (hereinafter: Sookun,

Stop Vulture Fund Lawsuits). 192 Ibid; Manmohan Singh, ‘Recovery Rates from Distressed Debt –Empirical Evidence from Chapter 11 Filings,

International Legislation, and Recent Sovereign Debt Restructurings’ (2003) IMF Working Paper No. 03/161 9

<http://www.imf.org/external/pubs/ft/wp/2003/wp03161.pdf> accessed 6 April 2016, (hereinafter: Singh,

‘Recovery Rates’); Wheeler and Attaran, ‘Declawing the Vulture Funds’ (n 133) 254; Fisch and Gentile,

‘Vultures or Vanguards’ (n 42) 1049; Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27)

49; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 50; Cohen, ‘Cigar’ (n 68) 12; Ryan, ‘Sovereign

Bankruptcy’ (n 3) 2496; Samples, ‘Rogue Trends’ (n 13) 59. 193 Sookun, Stop Vulture Fund Lawsuits (n 191) 7. 194 Ibid. 195 Singh, ‘Recovery Rates’ (n 192) 9. 196 Samples, ‘Rogue Trends’ (n 13) 59. In the same sense: Goldman, ‘Mavericks in the Market’ (n 130) 171 and

Sookun, Stop Vulture Fund Lawsuits (n 191) 12. 197 Sookun, Stop Vulture Fund Lawsuits (n 191) 7; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2495-2496.

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29

debt instruments.198 Backed by this devastating new technique Elliot managed to force

sovereign debtors into settling cases such as Elliot v Peru and NML Capital v. Argentina.199

2.4.2. Vultures: A Different Sort of Holdouts

Vulture funds have the time and the money to act upon the litigation threat. They are able to

withstand the hardships of obtaining and enforcing a judgement in any possible way. Besides,

in contrast to commercial banks during the ‘80s, vulture funds cannot be cajoled or coerced

into an exchange offer.200 During the Latin American sovereign debt crisis of the ‘80s banks

were willing participants in the restructuring negotiations.201 They simply did not opt for

litigation. This was largely due to the fact that they risked bankruptcy themselves, but also

because but they faced peer/political pressure to accept the exchange offers.202 When the

sovereign debt landscape evolved from syndicated loans to sovereign bonds, this all changed.

Although there are still some banks in the mix that are subject to the same old coercion

techniques, there are others types of bondholders as well. These atomised bondholders are far

more ‘independent’ and they have diverging interests.203 As a result, it is virtually impossible

to coerce them, especially vulture funds whose sole purpose is to force sovereign debtors into

settlements by way of litigation.

2.4.3. The Role of Vulture Funds

Advocates for vulture funds and holdouts in general claim that holdouts play an essential role

in a sovereign default scenario.204 To support that claim, they proffer several arguments.

First of all, they assert that vulture funds provide liquidity to the market which encourages

market participation and benefits retail investors.205 By buying up distressed debt, they free up

198 Blackman and Mukhi, ‘Vultures, Alter Egos and Other Legal Fauna’ (n 27) 55. 199 For a detailed overview of the pari passu clause in sovereign debt litigation, see infra 3 Pari Passu Clauses:

The Root of the Problem? 200 Lee C Buchheit, Mitu Gulati and Ignacio Tirado, ‘The Problem of Holdout Creditors in Eurozone Sovereign

Debt Restructurings’ (2013) 4 JIBFL 191. 201 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1064-65; Samples, ‘Rogue Trends’ (n 13) 56. 202 Ibid; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2178. 203 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1093; Samples, ‘Rogue Trends’ (n 13) 56. 204 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1235; Fisch and Gentile, ‘Vultures or Vanguards’ (n

42) 1047; Elizabeth Broomfield, ’Subduing the Vultures: Assessing Government Caps on Recovery in Sovereign

Debt Litigation’ (2010) Colum. Bus. L. Rev. 473, 514, (hereinafter: Broomfield, ‘Subduing the Vultures’);

Aaron L Warren and Ryan E Avery, ‘Investors of Prey: Seeking Relief in Distressed Debt Markets’ (2010) 18 U.

Miami Int'l & Comp. L. Rev. 213, 227, (hereinafter: Warren and Avery, ‘Investors of Prey’); Cohen, ‘Cigar’ (n

68) 13-14; Shapos, ‘Breaking the Impasse’ (n 44) 246; Samples, ‘Rogue Trends’ (n 13) 59. 205 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1104; Cohen, ‘Cigar’ (n 68) 13; Samples, ‘Rogue Trends’

(n 13) 59; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2188.


30

cash for bondholders who cannot afford to await the outcome of court proceedings or even the

end of restructuring negotiations. Secondly, these authors claim that issuers benefit from

having a distressed debt market where they can sell new debt to investors. Particularly since

those investors are aware that an investment in sovereign debt might not be lucrative in the

long run.206 Finally, the proponents are of the opinion that vulture funds’ existence keeps

sovereign debtors in check. According them, vulture funds prevent opportunistic defaults and

unreasonable restructuring terms.207 Or as COHEN puts it: ‘[vultures] maintain balance in the

sovereign debt market. The threat of enforcing the terms of the contract […] gives them

leverage [and as such it keeps] sovereign debtors […] cocooned in sovereign immunity in

check.’208 Moreover, BROOMFIELD and others even assert that vulture funds serve as a check

on corruption.209 In the oft-cited case of Kensington International v Congo210 Kensington’s211

team of private investigators and forensic accountants laid bare a corruption scandal that

otherwise would have continued undisturbedly.212 In sum, there are a number of reasons why

vulture funds could be considered ‘essential’ for the sovereign debt market.

Be that as it may, critics are of the opinion that vulture funds –being holdouts– disrupt the

restructuring process, needlessly burden a sovereign debtor’s citizens and create a disincentive

for creditors and sovereign debtors to negotiate.213 Moreover, one cannot deny a certain

distaste for the whole vulture operation, even though they only hold sovereigns to their

contractual obligations. The fact that they bleed the country dry and make an outrageous

amount of money in the process, only strengthens the dismalness of the situation.

In addition, the critics refute the proponents’ arguments. Regarding the ‘check’ on

opportunistic defaults, they assert that sovereigns have multiple compelling reasons to pay.214

For instance reputational costs, political consequences and access to the market.215 Also, the

206 Cohen, ‘Cigar’ (n 68) 13; Sookun, Stop Vulture Fund Lawsuits (n 191) 11. 207 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1053 and 1103; Bratton, ‘Pari Passu and a Distressed

Sovereign’ (n 75) 843; Broomfield, ‘Subduing the Vultures’ (n 204) 514; Warren and Avery, ‘Investors of Prey’

(n 204) 227; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2188. 208 Cohen, ‘Cigar’ (n 68) 13. 209 Broomfield, ‘Subduing the Vultures’ (n 204) 516; Warren and Avery, ‘Investors of Prey’ (n 204) 227. 210 [2005] EWHC 2684 Queen’s Bench Division (Commercial Court). 211 It is worthy of note that Kensington International Ltd is in fact an affiliate of Elliott Associates.

<https://en.wikipedia.org/wiki/Elliott_Management_Corporation#Affiliates_and_units> 212 Broomfield, ‘Subduing the Vultures’ (n 204) 516; Warren and Avery, ‘Investors of Prey’ (n 204) 227. 213 See supra 2.3.1 The Role of Holdouts. 214 Ibid 63. 215 Ibid.

C o n c l u s i o n : H o l d o u t s A r e t h e R e s u l t o f M a r k e t F a i l u r e

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corruption argument is utterly absurd.216 Claiming that one person’s or one government’s

activities reflect the situation of an entire continent is ridiculously far-fetched.217

Given these arguments, it is quite clear that this whole issue is a matter of perspective. Neither

critics nor advocates can give any conclusive evidence to support their assertions.

Nevertheless, no matter what side you are on, there is one simple truth you cannot deny:

‘Fairness and ethics aside, vulturing is [still] a legal activity.’218 Consequently, the only way

forward is a regulatory response or a contractual solution to resolve or mitigate the holdout

issue in general.

2.5. CONCLUSION: HOLDOUTS ARE THE RESULT OF MARKET FAILURE

When faced with a sovereign debt default situation there are simply no contractual or

regulatory mechanisms in place to resolve the debtor-creditor dispute. As a result, sovereign

debtors are practically obliged to enter into restructuring negotiations. Often these

restructurings lead to an exchange offer whereupon the creditors have the opportunity to

exchange their old debt for new debt at different –often inferior– terms. Usually, the majority

of bondholders participate in the debt swap. The chief reason behind this is that a bird in the

hand is worth two in the bush. Since sovereign debtors cannot be declared bankrupt and since

they are virtually cocooned in sovereign immunity, it is often deemed cheaper to accept a

‘haircut’ than to hope for a positive outcome in lengthy ‘asset hunt’ litigation. However, due

to the voluntary nature of sovereign debt restructuring, some creditors refuse to cooperate.

These so-called holdouts do not shirk from the sovereign-immunity bankruptcy situation and

seek repayment in full via the courts.

Vulture funds go even one step further. These holdouts actually purchase distressed debt with

the sole intention of making a profit by way of litigation, simply because they have the time

and money to withstand the hardships of being a holdout. Nevertheless, vulture funds still find

themselves in a sovereign-immunity-bankruptcy standoff situation. Therefore, they try to find

creative ways of piercing or circumventing a sovereigns’ defences. One of those tactics, is

suing states for alleged breaches of the pari passu clause, which –if successful– forces

sovereign debtors to choose between defaulting on exchanged bonds or paying holdouts. In

216 TransAfrica Forum, ‘Stop Vulture Culture’ <http://www.jubileeusa.org/fileadmin/user_upload/Resources/

Vulture_Funds/Vulture_Funds_TAF_7_09.pdf> accessed 8 April 2016. 217 Ibid. 218 Samples, ‘Rogue Trends’ (n 13) 59.


32

essence, this tactic completely bypasses the issue of ‘asset hunting’ and has been a favourite

of vulture funds ever since its first appearance in Elliott v. Peru.219 A detailed overview of the

pari passu clause, its history and (mis)use, can be found in the next chapter.

219 Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.

33

PARI PASSU CLAUSES: THE ROOT OF THE PROBLEM?

In the previous chapter it became apparent that holdouts are caught between a rock and a hard

place, namely sovereign immunity and the lack of a sovereign bankruptcy regime.

Consequently, they had to resort to all kinds of (far-fetched) strategies to force a sovereign

state to its knees. One of those so-called self-help stratagems220 is blocking cross-border

payments through litigation based on an alleged breach of the pari passu clause.

Hence, this chapter will shed some light on the history of the pari passu clause, its meaning

portrayed in litigation and the implications of the different interpretations from both a New

York and English law perspective. All that in order to identify the actual problem and how it

might be resolved or mitigated.

3.1. THE HISTORY OF THE PARI PASSU: THE WHAT, THE WHY AND THE

WHEN

Before delving into the technicalities of a matter, it is often advisable to take a look at the

bigger picture. Pari passu clauses are no exception. Nowadays they are considered boilerplate

in international bond issues and syndicated loan agreements221, but this was not always the

case. Once upon a time, this little Latin phrase meaning ‘in equal step’ or ‘equally’, was

introduced into these debt instruments for a very specific reason.222 The question therefore

becomes: What was that reason and what does the clause mean today?

The evolution of the pari passu clause can be boiled down to three stages.223 It first appeared

in secured lending in the 19th century, was replaced in the middle of the 20th century by

negative pledges and later re-emerged in the ‘70s with the rise of the syndicated loan

agreement. Closely linked to these three stages is the wording of the clause, which underwent

220 Day, ‘Market Failure’ (n 10) 247. 221 Philip R Wood, ‘Pari Passu Clauses –What Do They Mean’ (2003) JIBFL 371, 371 (hereinafter: Wood, ‘Pari

Passu clauses –What do they mean?’). 222 Francis B Palmer, Company Precedents 109-110 (8th ed. Stevens and Sons, 1900); C. DE KONINCK, Latijnse

rechtstermen, Maklu, Antwerpen, 2003, 83; Lee C Buchheit and Jeremiah S Pam, ‘The Pari Passu Clause in

Sovereign Debt Instruments’ (2004) 53 Emory L.J. 869, 871, (hereinafter: Buchheit and Pam, ‘Sovereign Debt

Instruments’). 223 Clifford Chance LLP, ‘Pari Passu Clauses –Do you really know what they mean’ (Clifford Chance Client

Briefings, 2004) at 1, 2 <www.emta.org> accessed 26 September 2015 (hereinafter: Clifford Chance LLP, ‘Pari

Passu Clauses’); Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 894.

P a r i P a s s u C l a u s e s : T h e R o o t o f t h e P r o b l e m ?

34

significant changes as well. It evolved from “pari passu in point of priority and security” to its

present version of “pari passu in priority of payment”.224

The following paragraphs will address these stages in more detail and indicate how this

evolution has served as the bedrock for the holdout-issue we are faced with today.

3.1.1. The 19th Century: Pari Passu and ‘Secured’ Lending

Originally, the pari passu clause was only present in (sovereign) debt instruments when they

included collateral security. At that time, companies often issued multiple series of bonds and

secured them against a common pool of collateral.225 However, bondholders wishing to

enforce their claims were faced with the ‘first-to-be-issued’ rule, which applied under English

law.226 This rule created priorities in claims depending on the date of issue of the bond series.

Here is an example by BUCHHEIT and PAM of how this rule operated in practice:

[A] series of bonds issued in 1876 would have had a priority claim over the disposition of

the common collateral as against a second series issued, say, in 1877.227

Evidently, bondholders sought to protect themselves against this bothersome rule and this is

where the pari passu clause comes into play. English law stated that the ‘first-to-be-issued’

rule could be changed by contract.228 Thus, the pari passu clause was intended to ensure that

enforcement of the security would result in all bondholders sharing equally and rateably in the

proceeds of a liquidation.229 For example, a typical clause at that time might have read:

[A]nd will rank pari passu in point of charge, without preference or priority as to the date

of issue.230

Still, it should be noted that the scope of the clause was exclusively limited to enforcement. It

did not prohibit the creditor from obtaining (judgement and) payment from the debtor directly,

224 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 894 and 902. 225 Ibid 895; 226 Ibid 895; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 833; Clifford Chance LLP, ‘Pari Passu

Clauses’ (n 223) 2. 227 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 895. 228 Ibid 896. 229 Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2; Buchheit and Pam, ‘Sovereign Debt Instruments’ (n

222) 896. 230 Example of debenture stock of Adelaide Electric Supply Company Limited in 191. (See ‘Share Market and

Mining’ (1911, July 4), The Register (Adelaide, SA: 1901 - 1929) 4 <http://nla.gov.au/nla.news-

article58444025> accessed November 29 2015 (Emphasis added).

http://nla.gov.au/nla.news-article58444025


T h e H i s t o r y o f t h e P a r i P a s s u : T h e W h a t , W h y a n d W h e n

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without resorting to the liquidation of the collateral.231 Hence, the first kind of ‘ranking’

interpretation of the pari passu clause was born.

3.1.2. The Mid-20th Century: Negative Pledges Supplant Pari Passu Clauses

While the 19th century was characterised by secured lending, the early 20th century clearly

was not. In those days, countries often resorted to the technique of ‘earmarking’ instead. 232

These aptly named ‘quasi-security interests’233 consisted of tagging certain revenues or assets

for individual creditors without actually creating any formal security interest. Even though

these commitments were questionable at best, pari passu clauses were often included to

prevent them.234

Lacking the security of olden times, ‘secured’ lending to sovereign states quickly diminished.

Especially after the Great Crash of 1929, which had shown lenders how difficult it was to

actually enforce collateral.235 With the decline of secured lending, the pari passu clause lost

its purpose and thus became redundant.

To fill the void, negative pledges were introduced. These clauses essentially prohibited both

sovereign states and governmental agencies from pledging any collateral at all.236 Although

they were already common in U.S. domestic bond issues237, they only gained ground

following the development lending after World War II.238 Particularly so when it became the

World Bank’s policy to lend without seeking any collateral security.239 On the other hand, the

231 Francis B Palmer, Company Law, 197 (2nd ed. 1898). 232 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 897; Bratton, ‘Pari Passu and a Distressed

Sovereign’ (n 75) 834. 233 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 834. 234 Andrew Shaw, ’Ways to get paid in a sovereign default’ (2014) 10 JIBFL 629, 629, (hereinafter: Shaw,

’Ways to get paid in a sovereign default’); EMTA, ‘The Pari Passu Clause – What is Fair Treatment’ (2004) 3

<www.emta.org> accessed 26 September 2015; FMLC, ‘Analysis of the role, use and meaning of pari passu

clauses in sovereign debt obligations as a matter of English law’ (2005) 79 FMLC Papers 1, 7,

<www.fmlc.org/uploads/2/6/5/8/26584807/79.pdf> accessed on 26 September 2015, (hereinafter: FMLC,

‘Analysis of the role, use and meaning of pari passu clauses’). 235 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 898. 236 Ibid 899; Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2. 237 Francis W Jacob, ‘The Effect of Provision for Ratable Protection of Debenture Holders in Case of Subsequent

Mortgage’ (1938) 52 Harv. L. Rev. 77, 78. 238 Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2. 239 As referenced by Devesh Kapur, John Prior Lewis and Richard Webs in The World Bank: History, vol 1

(Brookings Institution Press 1997) 921:

As a general principle the Bank does not seek or accept liens on specific revenues or assets as

security for loans to member governments. (From IBRD, ‘Bank’s Policy on Security for Loans to

Member Governments’, Resolution 145, M-208, June, 26 1950.


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World Bank used a very strict negative pledge to compensate for that lack of collateral. 240

Consequently, the “unsecured” lending trend had begun.241

3.1.3. The 1970s: The Rise of Syndicated Loans and the Return of Pari Passu Clauses

The final stage of the pari passu evolution coincides with the appearance of two novelties:

commercial banks and syndicated loan agreements.242 Using money that was raised on the

Eurodollar market, this new type of lender started using the Syndicated Eurodollar Loan

Agreements in the late ‘60s, early 70s.243 Boilerplate amongst these agreements were the

negative pledge and pari passu clause. Early on, these clauses were often combined into one,

but later they appeared as stand-alone clauses.244

Since these Eurodollar Agreements often did not request collateral, there was no need to

protect the commercial banks from the ‘first-to-be-issued’ rule.245 This raises the question:

‘What were pari passu clauses doing in those agreements?’ The answer can be found in the

brand-new danger commercial banks had to face, namely (involuntary) subordination.246

Under New York and English law, involuntary subordination was impossible.247 Domestic

credit agreements therefore did not include pari passu clauses. Cross-border lending on the

other hand, was subject to national law regimes that differed from the US and English

approach. For example, Spain and the Philippines both allowed unsecured creditors to achieve

priority over other unsecured creditors simply by notarising their credit agreements.248

Moreover, creditors were faced with the possibility that sovereign states might pass a law

240 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 899; Clifford Chance LLP, ‘Pari Passu Clauses’ (n

223) 2. 241 Georges R Delaume, Legal Aspects of International Lending and Economic Development Financing (1967),

233 n. 52; Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900. 242 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900, Clifford Chance LLP, ‘Pari Passu Clauses’ (n

223) 2. 243 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 900; Philip R. Wood, ‘Sovereign Syndicated Bank

Credits in the 1970s’ (2010) 73 Law & Contemp. Probs. 7, 21. 244 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 902. 245 Ibid 902. 246 Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 2. 247 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 834. 248 William Tudor John, ‘Sovereign risk and immunity under English Law and Practice’, (1983) 1 International

Financial Law 79, 95; Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371.

R a n k i n g v s . P a y m e n t : T h e P a r i P a s s u C o n u n d r u m

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subordinating all foreign lenders in favour of others.249 Needless to say, creditors quickly

became aware of these risks and started to use pari passu clauses to protect themselves.

This new rationale was also reflected in the wording of the clause, which had changed

remarkably compared to the pari passu clauses found in the 19th century secured debt

agreements. For instance, the words ‘rank pari passu in point of charge/in point of security’

were exchanged for ‘rank and will rank pari passu in point of priority of payment/in right of

payment’. Apparently, the legal ‘ranking’ of the debt had become a priority for drafters.250

To conclude, history clearly shows one and only one interpretation of the pari passu clause,

namely anything that has to do with ‘ranking’. Where one form focussed on a rateable interest

in a common pool of assets, the other focussed on preventing subordination of debt. Be that as

it may, recent litigation251 has introduced a brand-new interpretation of the clause, the

‘payment’ interpretation. What this entails and how this came to be, will be discussed below.

3.2. RANKING VS. PAYMENT: THE PARI PASSU CONUNDRUM

3.2.1. Description

For decades, pari passu clauses have been present in secured and unsecured, corporate and

sovereign debt obligations. Their function ranging from a representation or covenant in credit

agreements to terms and conditions in bond issues.252 Below are some examples of typical

pari passu clauses:

The bonds and the coupons are direct, unconditional and unsecured obligations of the

issuer and rank and will rank at least pari passu, without any preference among

themselves, with all other outstanding, unsecured and unsubordinated obligations of the

issuer, present and future.253

The Notes rank, and will rank pari passu in right of payment with all other present and

future unsecured and unsubordinated External Indebtedness of the Issuer.254

249 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 905. 250 Ibid 902 and 905. 251 Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/; Brussel (9e Kamer) 19 maart 2004, Republiek

Nicaragua t/ LNC Investments LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831; NML

Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012). 252 Clifford Chance LLP, ‘Pari Passu Clauses’ (n 223) 1. 253 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 4. 254 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 902 and 871


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Clearly, the wording of this type of clause is very vague and differs from drafter to drafter.

Not to mention the fact that it appears in both a corporate and a sovereign context, which

makes divining the actual meaning of the clause even more of a chore. Nevertheless, there are

a few things which can be derived from the words themselves.

(i). The key word is ‘rank’; 255 and

(ii). There are two limbs to this clause (in case of bond issues).256

a. an internal limb: bonds rank pari passu with each other.

b. an external limb: bonds rank pari passu with other (unsecured) debt.

Still, it must be noted that studies have revealed that the meaning of the clause does not

change, regardless of the wording.257 Hence, the question: What does this clause actually

mean? Particular because it appears in two very distinct situations, namely the corporate and

the sovereign context.

3.2.2. Corporate context

In a corporate context, the notion of ‘ranking equally’258 is closely linked to bankruptcy.259

When a company goes bankrupt, its assets are liquidated. Insolvency regulation then provides

for an orderly distribution of the resulting proceeds and ensures that every ‘equally ranking’

unsecured creditor gets his proportional share. However, there are a number of ways whereby

an unsecured creditor might see his claim subordinated. For example: 260

(i). In many jurisdictions taxes and wages rank senior to other unsecured claims.

(ii). Retail depositors with banks, or holders of insurance policies might also benefit

from a statutory seniority.

255 Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372; 256 Ibid; FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 4. 257 Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372; FMLC, ‘Analysis of the role, use and meaning

of pari passu clauses’ (n 234) 5. 258 Pari Passu means ‘in equal step’ in Latin. (See C. DE KONINCK, Latijnse rechtstermen, Maklu, Antwerpen,

2003, 83). 259 Benjamin Chabot and Mitu Gulati, ‘Santa Anna and his Black Eagle: The Origins of the Pari Passu?’ (2014) 9

(3) CMLJ 216, 220 <http://cmlj.oxfordjournals.org/content/9/3/216.full.pdf+html> accessed 16 February 2016

(hereinafter: Chabot and Gulati, ‘Santa Anna and his Black Eagle’). 260 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 6.

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(iii). Some countries (e.g. the Philippines and –formerly– Spain)261 even allow

involuntary subordination.262

(iv). The date of issue might play a part in the ranking for payment in liquidation.

There is little a creditor can do to prevent seniority resulting from statutory rules but, as

explained above,263 involuntary subordination can be averted by inserting a pari passu clause

in the agreement.

In short, the purport of the pari passu clause in a corporate context is to obtain a promise, a

commitment or warranty that the status of the unsubordinated debt will remain unchanged and

that unsecured lenders will be entitled to a pro rata payment in case of a distribution of assets

resulting from insolvency.264

3.2.3. Sovereign Context

The crucial difference between a corporate and a sovereign context, is the lack of an

insolvency regime for sovereign debtors.265 They simply cannot be declared bankrupt266 under

any domestic or international law. It follows that there must be a different reason for the

presence of pari passu clauses in such a cases. Said reason will be discussed below.

Until a few years back, no one really made a fuss about the presence of the clause. Some even

asserted that its presence was the result of ignorant copy-pasting of drafters.267 Nevertheless,

over the course of years two interpretations of the pari passu clause have surfaced: the

‘ranking’ interpretation and the ‘payment’ interpretation.268

(i). Ranking or narrow interpretation

For a long time, the ruling interpretation was the so-called ‘ranking’ or ‘narrow’

interpretation. Simply put, this interpretation argues that the pari passu clause merely seeks to

261 In the meantime, the law in Spain has been changed. Involuntary subordination is no longer possible under the

‘Ley Concursal’, which states that every unsecured creditor must be paid on a pro rata basis upon insolvency of

a debtor. (See FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 6). 262 See supra 3.1.3 The 1970s: The Rise of Syndicated Loans and Return of the Pari Passu Clause. 263 Ibid. 264 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7. 265 Ibid; Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 5. 266 Theoretically they cannot even become insolvent, because they have the ability to keep raising taxes (See

Olivares-Caminal, ‘Is There a Need’ (n 2) 21). 267 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 875; Olivares-Caminal, ‘Understanding the Pari

Passu’ (n 7) 1233; Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 219. 268 Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 372; Buchheit and Pam, ‘Sovereign Debt

Instruments’ (n 222) 876; FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7.


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prevent a borrower from performing actions that would result in a change of legal ranking of

the debt,269 i.e. preventing actions ‘having the effect of preferring one set of creditors against

the others’.270 For example, preventing the sovereign state from ‘earmarking’ certain revenues

or assets, or from involuntarily subordinating a debt via domestic law.

(ii). Payment or broad interpretation

The Elliott case, however, introduced a brand new interpretation.271 The so-called ‘payment’

or ‘broad’ interpretation essentially argues that ‘a borrower will not pay one creditor anything

without also paying its other creditors pro rata so that nobody is preferred’, i.e. an obligation

for the borrower to pay all its equally-ranking debt on a strictly lockstep basis.272

This interpretation clearly raises a few questions: (i) Where does this interpretation stem

from? How did the ranking interpretation suddenly evolve into a payment interpretation? (ii)

Who would benefit and (iii) what is there to gain from such an interpretation? The answer lies

in vulture funds, self-help strategies and the subsequent waves of litigation: Pravin, Elliott,

LNC and NML.273

269 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 876. 270 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 7. 271 Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363 (2d. Cir. 1999). 272 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 876; Wood, ‘Pari Passu clauses –What do they

mean?’ (n 221) 372. 273 Pravin Banker Associates v Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997); Brussel 26 September

2000, 8e Kamer, AR nr. 2000/QR/; Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments

LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831.; NML Capital Ltd. v. Republic of

Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).

W a v e s o f L i t i g a t i o n a n d t h e i r C o n s e q u e n c e s

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3.3. WAVES OF LITIGATION AND THEIR CONSEQUENCES

3.3.1. Introductory Remarks

Before delving into the case-law, it should be noted that both governing law and jurisdiction

are of vital importance in international transactions, especially in distressed debt situations

where the viable options for both debtor and creditor greatly depend on the chosen applicable

law and jurisdiction. For instance, a debtor has to be aware that the use of exit consents274 or

CACs275 significantly differs under English law compared to New York state law.276 A

creditor, on the other hand, will often have to make do with remedies the enforcing court is

already familiar with, even though those are not necessarily the ones the governing law

prescribes. Indeed, it is known that judges tend to apply the law they know best.277 Hence, it is

of the utmost importance to determine which law is applicable, which court has jurisdiction

and what that entails for both debtor and creditor.

Although borrowers are free to choose, New York state law and English law are by far the

prime systems of governing law with regard to (sovereign) debt agreements.278 For instance,

in notional value English law represents approximately 40 percent of international sovereign

bonds.279 Therefore, the cases discussed below are the most prominent ones of those two law

regimes. First, we will take a look at the three waves of litigation under New York state law.

This means analysing Pravin Banker Associates v. Banco Popular Del Peru280, followed by

Elliott v. Peru, LNC Investment v. Nicaragua 281 and finishing up with NML Capital v

Argentina.282 Then we shall cross the Big Pond to take a look at things from an English law

perspective in Kensington International v Congo.283

274 For a full discussion on exits consents see infra 4.2.3.2 Exit Consents. 275 For a full discussion on CACs see infra 4.2.3.1 Collective Action Clauses or CACs. 276 Olivares-Caminal, ‘Is There a Need’ (n 2) 33. 277 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 13. 278 Gulati and Klee, ‘Sovereign Piracy’ (n 28); Olivares-Caminal, ‘Is There a Need’ (n 2) 28. 279 International Monetary Fund, ‘Strengthening the Contractual Framework to Address Collective Action

Problems in Sovereign Debt Restructuring’ IMF 40 <http://www.imf.org/external/pp/ppindex.aspx> accessed 15

December 2015, (hereinafter: IMF, ‘Strengthening the Contractual Framework’). 280 Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997). 281 Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92; Brussel (9e Kamer) 19 maart 2004, Republiek

Nicaragua t/ LNC Investments LLC en NV Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831. 282 NML Capital, Ltd. v. Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012). 283 Kensington International, Ltd. v. Republic of the Congo, [2003] EWCA Civ 709, A3/2003/1036.


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In the interest of intelligibility, the method for reviewing these cases will be as follows: (i) relevant

facts, (ii) relevant arguments, (iii) reasoning of the court and (iv) impact or importance of the case vis-

à-vis the holdout-issue.

3.3.2. New York State Law Litigation Waves

3.3.2.1. The First Wave: Dear Sovereign, Pacta Sunt Servanda.

3.3.2.1.5. Pravin Banker Associates v. Banco Popular Del Peru:

The Pravin cases are considered to be the starting point of (successful) sovereign debt

litigation;284 paving the way for Elliott and associates in the infamous Elliott cases. Hence,

they rightly deserve the title of ‘first wave of litigation’ and merit a closer look.

RELEVANT FACTS285

In 1983, Banco Popular del Peru (“Banco Popular”), a Peruvian state-owned bank, had

accumulated debt to an unsustainable level and as a result, the Peruvian government was

forced to renegotiate with its creditors. One of those creditors was Mellon Bank (“Mellon”)

that, over the course of years, had extended a number of loans to Banco Popular. After intense

negotiations, the Mellon Letter Agreements were signed. These letters extended the maturity

dates of the loans for 365 days. In return for this leniency, Peru agreed to collateralize the debt

and become guarantor.

Unfortunately, extending these loans was to no avail. In the following year, 1984, the

negotiations for a longer-term solution failed and Peru subsequently imposed new restrictions

on the payment of foreign exchange. As a result, Banco Popular stopped making principal

payments and from then on only paid interest. Essentially, this meant that Banco Popular del

Peru defaulted on its loans and that Peru became liable as guarantor. Consequently, Mellon

decided to sue for the outstanding debts.

Following a change of government,286 a stay on proceedings and the start of Brady Plan287

negotiations under the auspices of the IMF, Mellon decided to sell its debt to Pravin Banker

284 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222. 285 Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850, 852-854.

(https://casetext.com/case/pravin-banker-assoc-ltd-v-banco-popular) (4 February 2016). 286

In 1990, after Alberto Fujimori was elected President of Peru, Peru's economic policies changed

dramatically. President Fujimori began a major reform of the Peruvian economy and in doing so

attempted to comply with International Monetary Fund (“IMF”) policies. Following these changes,

https://casetext.com/case/pravin-banker-assoc-ltd-v-banco-popular


43

Associates (“Pravin”) at a steep discount. The Peruvian government and Banco Popular were

informed of this assignment and Banco Popular started making interest payments to Pravin

directly, until suddenly those payments stopped.

Consequently, Pravin demanded to be paid in full (at face value) on both principal and unpaid

interest. When this demand was not met, Pravin declared Banco Popular in default on the

debt. Subsequently, the Peruvian Central Bank decided that Banco Popular should be

liquidated and liquidation proceedings (negotiations) were started. Pravin, however, refused to

enter into either Brady or insolvency negotiations. So, in 1993 Pravin Banker decided to file

an action against Peru as guarantor.288

In the ensuing proceedings (Pravin I and II) the courts decided that the circumstances called

for leniency. These decisions were largely based on the fact that granting a stay would allow

for an orderly winding up of Banco Popular under Peruvian law, without actually endangering

the long-term enforceability of the debt.289 Essentially, Peru got an eight months reprieve to

get its affairs in order.

Nevertheless, the deadline came and went and Peru asked for leniency once more. A further

stay, however, was denied in Pravin III and the court granted Pravin’s motion for summary

judgement,290 thereby allowing enforcement of the debt. This resulted in a judgement (Pravin

the Bank Advisory Committee, a committee of Peru's creditors headed by Citibank, N.A., signed

an agreement with Peru to stay all pending lawsuits in order to promote negotiations to resolve the

entire problem of the unpaid foreign debts.(See Pravin Banker Associates v. Banco Popular Del

Peru, 109 F.3d 850, 852 <https://casetext.com/case/pravin-banker-assoc-ltd-v-banco-popular>

(accessed 4 February 2016)).

287 The Brady Plan was a plan designed by the Bush Administration in 1989 to tackle the issue of the Low

Developed Countries (LDC) Debt Crisis. Although the terms and conditions of every Brady negotiation was

unique, some major aspects were common in all Brady restructurings. (i) There was some form of substantial

debt reduction. (ii) This reduction was linked to ambitious economic reform programmes. (iii) The resulting

Brady Debt was more highly tradable, which allowed creditors to diversify their risk more widely. As a result of

the Brady Plan, the participating LDCs (Brady Countries such as Mexico, Peru and Argentina) were able to

significantly reduce their debt levels, while being able to re-access the international capital markets.

(See EMTA, ‘the Brady Plan’<http://www.emta.org> accessed on 29 September 2015; Olivares-Caminal, ‘Is

There a Need’ (n 2) 21; Natalie Wong, ‘NML Capital, Ltd. v. Republic of Argentina and the Changing Roles of

the Pari Passu and Collective Action Clauses in Sovereign Debt Agreements’ (2015) Colum. J. Transnat'l L. 396,

401, (hereinafter: Wong, ‘NML Capital, Ltd. v. Republic of Argentina’). 288 Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 at 852, https://casetext.com/case/pravin-

banker-assoc-ltd-v-banco-popular (visited on 4 February 2016); EMTA, ‘Preliminary Analysis of Creditor

Litigation in the Non-HIPC Sovereign Debt Restructuring Context’ 3 <www. emta.org> accessed on 29

September 2015. 289 Charles Proctor, ‘Sovereign Debt Restructuring and The Courts –Some Recent Developments, Part 1’ (2003)

8 JIBFL 302. 290 A motion for summary judgement is subject to two conditions under Fed. R. Civ. P. 56(c):





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IV) in favour of Pravin, sentencing Banco Popular to pay $US 2,161,539.78 along with pre-

and post-judgement interest.

Faced with this judgement, Peru yet again asked for another stay due to the ongoing Brady

Plan Negotiations. When the district court denied this request, they appealed, which brings us

to the case before the United States Court of Appeals for the Second Circuit.291

RELEVANT ARGUMENTS

Pravin essentially argued that Banco Popular (and Peru as guarantor) had failed in its

obligation under the Mellon Letter Agreements and as such, was liable for non-payment of the

debt.292 Peru, on the other hand, argued that the courts had erred, in Pravin III and IV, by

‘failing to extend international comity to Peru’s negotiations’.293 Besides, enforcement would

‘result in a creditor stampede to find and attach Peruvian assets, and such a stampede would,

in turn disrupt Peru’s structural reform.’294 Therefore, Peru argued that an (indefinite) stay

was necessary.

REASONING OF THE COURT

Taking note of the Peru’s arguments, the court based its decision on the analysis of the

principles of international comity. It explained in short the meaning of those principles and

which exceptions applied.

International comity is “the recognition which one nation allows within its territory to the

legislative, executive or judicial acts of another nation.” […] Under the principles of

international comity, United States courts ordinarily refuse to review acts of foreign

governments and defer to proceedings taking place in foreign countries, allowing those

acts and proceedings to have extraterritorial effect in the United States. [e.g. insolvency

proceedings] […]

a) No genuine issue as to any material fact exists; and

b) The moving party is entitled to a judgement as a matter of law.

If granted, there will be no trial and the judge will immediately enter judgement. Moreover, judges are free to

grant partial summary judgement.

See ‘What is Summary Judgment?’ <https://www.litigation.findlaw.com> and <https://www.law.cornell.edu/

wex/summary_judgment> both accessed on 17 December 2015. 291 Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 at 853. 292 Ibid 852. 293 Ibid 853. 294 Ibid 852.


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Comity [however] remains a rule of “practice, convenience, and expediency” rather than

of law. […] Courts will [therefore] not extend comity to foreign proceedings when doing

so would be contrary to the policies or prejudicial to the interests of the United States

[…].295

After this brief overview, the court applied these rules to the facts. Whereupon the court came

to the following conclusions:296

(i). Peru’s negotiation efforts were acts of a foreign government with extraterritorial

effect in the United States;

(ii). It is the policy of the United States’ government to encourage Brady Plan

negotiations;

(iii). Ensuring enforceability of valid debt under principles of contract law, is of vital

interest to the United states, especially when it concerns foreign debt owed to

United States lenders; and

(iv). Brady Plan negotiations are strictly voluntary and debts remain enforceable

throughout the negotiations.

As such, the court decided that an indefinite stay would not be in the interest of the United

States and that the lower courts had not erred with regard to international comity.

IMPORTANCE OF THE CASE

In essence, this case clearly shows that the Latin proverb pacta sunt servanda also applies to

sovereign borrowers. Although they can count on some leniency and obtain a stay on

enforcement, thereby allowing for an orderly restructuring, they cannot avoid enforcement

actions forever. The basic principles of contract law also apply to sovereigns.297 Contractual

reform is still strictly voluntary and –from a holdout’s point of view– contracts should

therefore remain enforceable before as well as after restructuring.298

Needless to say, this ‘successful’ case has served as the bedrock for future holdout/vulture

fund litigation in the context of sovereign debt.299 For instance, the Elliott cases and LNC

Investment v. Nicaragua.

295 Ibid 853 (emphasis added). 296 Ibid 854. 297 EMTA, ‘Preliminary Analysis of Creditor Litigation (n 94) 4. 298 Ibid 4. 299 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1222.


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3.3.2.2. The Second Wave: The Rise and Fall of the Payment Interpretation

3.3.2.2.6. Elliott Associates v. Banco de la Nacion

The Pravin cases might have been the starting point of (successful) sovereign debt litigation,

but it were the Elliott Cases that truly affected the sovereign debt market. In one of those

cases the ‘broad’ or ‘payment’ interpretation of the pari passu clause saw the light of day and

in doing so, holdouts/vulture funds obtained a viable way to pressure a sovereign state into

reaching a settlement. How this came to be, is discussed below.

RELEVANT FACTS

It should be noted that the facts of the Elliott cases are fairly similar to those of the Pravin

cases.300

In 1995, the Peruvian Government announced that it would enter into Brady Negotiations301

concerning defaulted Peruvian commercial bank loans. Shortly thereafter, Elliott –a vulture

fund based in New York– began purchasing the distressed debt at a steep discount. The

vulture fund only paid ca. US$ 11.4 million instead of US$ 20.7 million.

Similarly, to the situation in the Pravin cases, Peru had guaranteed the debt. Only this time, it

concerned debt that had been accumulated by Banco de la Nacion.302

After acquiring the debt, Elliott adamantly refused to take part in any ‘Brady Negotiations’.

Instead, it decided to sue Peru and Banco de la Nacion and demand the payment of the debt at

face value.303 Interestingly enough Elliott had started to buy debt merely two weeks after the

(successful) Pravin Case.304 Allegedly, this suggested an intention to litigate from the start,

instead of considering other options such as the Brady Deal.305 In this context, it must be

noted that New York Courts allowed for the “Champerty” defence.306 According to case law,

this doctrine was ‘developed hundreds of years ago to prevent or curtail the commercialization

300 See supra 3.3.2.1.5 Pravin Banker Associates v. Banco Popular Del Peru:. 301 See note 287 for more info on the Brady Plan. 302 Eduardo Luis Lopez Sandoval, ‘Sovereign Debt Restructuring: Should We Be Worried About Elliott?’ (2002)

8 <http://www.finanzaonline.com/forum/attachments/obbligazioni-titoli-di-stato/1672493d1352831920-argentin

a-obbl-emesse-cambio-dei-titoli-default-4-x-gli-onesti-scambisti-sovereign-debt-restructuring-hal-scott-howell-

jackson-.pdf.> accessed on 5 February 2016, (hereinafter: Sandoval, ‘Sovereign Debt Restructuring’). 303 Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 401. 304 See supra 3.3.2.1.5 Pravin Banker Associates v. Banco Popular Del Peru:. 305 Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9. 306 Ibid 9.


47

of or trading in litigation.’307 Needless to say, the facts referred to above did suggest such a

pattern. No wonder that the New York District Court followed this line of reasoning and

decided that:

[…] the timing of Elliott's purchases of Peruvian debt and the closing of the assignment

agreements paralleled key events in Pravin Banker Assocs., Ltd. v. Banco Popular del

Peru, Civ. No. 93-0094 (S.D.N.Y.). 308 […] Assignments taken for the purpose, or motive,

of stirring up litigation and profiting thereby are prohibited. 309

Thus, the acquisition of debt by Elliott was found to be in violation of the Champerty doctrine

codified in §489 of the New York Judiciary Law. As a result, this case allowed a debtor to

successfully use a Champerty defence for the first time.310

Elliott, however, filed an appeal and (quite easily) obtained a reversal of the District Court’s

Ruling. The United States Court of Appeals for the Second Circuit, decided that §489 of the

New York Judiciary Law was not violated by Elliott. It reasoned that “the accused party's

‘primary goal’ is found to be satisfaction of a valid debt and its intent is only to sue absent full

performance”.311 Moreover, it stated that the District Court’s decision would create ‘a

perverse result’ by allowing a Champerty defence under such circumstances.

The interpretation posited by the district court would also create "a perverse result"

because it "would permit defendants to create a champerty defense by refusing to honor

their loan obligations." […] An obligor could simply declare unwillingness to pay,

thereby making it plain that no payment would be received without suit. Under such

circumstances, prospective purchasers would not be able to acquire the debt instruments

without opening themselves up to the defense that their purchase or assignment

necessarily was made "with the intent and for the purpose of bringing an action or

proceeding thereon," as barred by Section 489.312

At first, Elliott’s strategy was clearly focussed on attaching collateral, which would prevent

the Peruvian government from successfully closing the Brady Deal and would subsequently

307 Bluebird Partners, L.P. v. First Fidelity Bank, N.A., 94 N.Y.2d 726, 733 (2000).

<https://casetext.com/case/bluebird-partners-lp-v-first-fidelity-bank-na> 308 Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363, 367 (2d. Cir. 1999),

<https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion> (accessed on 5 February 2016). 309 Ibid 369. 310 Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9. 311 Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363, 381 (2d. Cir. 1999),

<https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion> (accessed on 5 February 2016). 312 Ibid 380.

https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion

https://casetext.com/case/elliott-associates-lp-v-banco-de-la-nacion


48

force the government to settle. The court, however, denied the motion for attachment and Peru

succeeded in closing the Brady Deal.313

After litigating back and forth, Elliott finally obtained judgement versus Peru in June 2000.

Essentially, the court ordered Peru to pay US$ 55.7 million and allowed Elliott to attach all

property used for commercial activity in the USA.314 Thus, Peru was forced to circumvent

New York in order to fulfil its payment obligations under the Brady Bonds. In turn, this

evasive action caused Elliott to devise new strategies. As a result, Elliot gave attachment a go

in other countries such as Germany, Belgium and Luxembourg, but all to no avail.315

On September 7th 2000, the first Peruvian Brady coupon was due. Elliott was aware of this

and therefore sought to intercept the funds, which would then result in a default on Peru’s

Brady Bonds.316 Ultimately, this strategy was aimed at forcing Peru into a settlement. In order

to do so, Elliott initiated legal proceedings against clearinghouses based in three separate

jurisdictions, namely Depository Trust Company (DTC) in New York, Euroclear in Belgium

and Clearstream in Luxemburg.317 However, it should be noted that the only relevant case in

the context of the pari passu clause, is the one before the Belgian Court.318 There, the pari

passu clause received an (erroneous) new interpretation.

In said case, the Commercial Court of Brussels was asked to grant an ex parte motion319

seeking to restrain Morgan Guaranty Trust Company –the operator of the Euroclear System–

from processing payments intended for the Brady Bondholders. However, the Court decided

to deny the ex parte motion due to a lack of ‘absolute necessity’ and ‘extreme urgency’. This

meant that Elliott had only one shot left to intercept the payments. It had to file for an appeal

and convince the court that the conditions for an ex parte motion were met.320

313 Sandoval, ‘Sovereign Debt Restructuring’ (n 302) 9. 314 Ibid 11. 315 Ibid 12. 316 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 877. 317 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 877; Sandoval, ‘Sovereign Debt Restructuring’ (n

302) 16. 318 Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92. 319 Under Belgian law, an ex parte motion will –if granted– result in a provisional measure, without causing any

actual passing of judgement on the underlying dispute. In order to obtain a favourable judgement, the motion

itself needs to comply with two conditions, namely absolute necessity and extreme urgency. If those are not

present, the judge will deny the motion. (Art. 584 Ger. W.) 320 Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.


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RELEVANT ARGUMENTS

Since this was an ex parte motion ex art. 584 Ger. W., only Elliott proffered any arguments.

First of all, it provided the Court of Appeals with a summary of the facts: (i) Elliott had a

claim of $US 55 million against Peru, (ii) Elliott was not obligated to enter into Brady

Negotiations, due to their strictly voluntary nature, and (iii) there were already two

enforceable judgements in place from a New York judge.321 Other than that, Elliott came

forward with a brand new argument to address the situation, namely a brand new

interpretation of the pari passu clause. This argument, intended to convince the court, was the

result of an affidavit that Elliott had commissioned from a New York University professor,

Andreas F. Lowenfeld.322 Regarding the pari passu clause, LOWENFELD opined:

I have no difficulty in understanding what the pari passu clause means: it means 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 state. A borrower from Tom, Dick

and Harry can’t say “I will pay Tom and Dick in full, and if there is anything left over I’ll

pay Harry”. If there is not enough money to go around, the borrower faced with a pari

passu provision must pay all three of them on the same basis. 323

In sum, LOWENFELD claimed that a sovereign state could not pay one creditor without also

paying the others. Therefore, all payments must be made on a pro rata basis. To support this

statement, LOWENFELD added the following example:

Suppose, for example, the total debt is $50,000 and the borrower has only $30,000

available. Tom lent $20,000 and Dick and Harry lent $15,000 each. The borrower must

pay three fifths of the amount owed to each one – i.e., $12,000 to Tom, and $9,000 each

to Dick and Harry. Of course the remaining sums would remain as obligations of the

borrower. But if the borrower proposed to pay Tom $20,000 in full satisfaction, Dick

$10,000 and Harry nothing, a court could and should issue an injunction at the behest of

Harry. The injunction would run in the first instance against the borrower, but I believe

(putting jurisdictional considerations aside) to Tom and Dick as well.324

321 Ibid. 322 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878; International Monetary Fund, ‘Involving the

Private Sector in the Resolution of Financial Crises –Restructuring International Sovereign Bonds’ 12

<http://www.imf.org/external/pubs/ft/series/03/IPS.pdf> accessed 8 February 2016. 323 A declaration of Prof. Andreas F. Lowenfeld, dated Aug. 31, 2000, filed in Elliott Assocs., L.P. v. Banco de la

Nacion, U.S.D.C., S.D.N.Y. 96 Civ. 7916 (RWS) as referenced in Buchheit and Pam, ‘Sovereign Debt

Instruments’ (n 222) 878. (hereinafter: the ‘Lowenfeld Decleration’). 324 Lowenfeld Decleration (n 323).


50

At first glance, this literal reading of the pari passu clause seems sensible. However,

LOWENFELD did not cite any authorities supporting his opinion.325 The question therefore

becomes: ‘Did this keep the Belgian court from agreeing with his line of reasoning?’


The court started out with recognizing the facts provided by Elliott, but quickly addressed the

issue at hand, namely the interpretation of the pari passu clause in view of Peru’s

obligations.326 It stated that:

The basic agreement regulating the reimbursement of the Peruvian foreign debt, also

indicates that the different creditors enjoy a “pari-passu clause”, which has as a result that

the debt should be paid down equally towards all creditors in proportion to their claim.

From this, one seems to have to conclude that, in case of the payments of interests, no

creditor can be excluded from its proportional part.327

The court then used this reasoning to justify a reversal of Commercial Court’s judgement.

[…] Petitioner is acting in order to prevent the violation of a right that is seriously

threatened, and the requested relief appears reasonable to resist such a threat. […] The

appeal is substantiated. The request must be granted. 328

Clearly, the court did not mind the lack of substantiated evidence to support a ‘payment’

interpretation. It did not even consider any other options, but merely endorsed professor

LOWENFELD’S declaration simply to justify its decision to grant an ex parte motion.329

According to the court, Elliott had an enforceable claim against Peru and interest payment via

Euroclear facilitated Peru to escape the enforcement.330 However, simply deciding that the

pari passu clause constituted a pro rata rule made it quite easy to prevent such an ‘escape of

enforcement’, especially if a violation of the judgment resulted in a monetary penalty

(‘dwangsom’).

325 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878. 326 Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92. 327 Unofficial translation of Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92 <www.emta.org.>

accessed 26 September 2015, (emphasis added). 328 Ibid. 329 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 879; Cohen, ‘Cigar’ (n 68); Sandoval, ‘Sovereign

Debt Restructuring’ (n 302) 16; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 402. 330 Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.

http://www.emta.org/


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The Belgian decision was instrumental to the final outcome of the Elliott cases. In the end,

Elliott managed to realise its goal and forced the Peruvian government to settle.331 However,

what did this actually mean for the future? Was the interpretation correct? What about future

litigation?

Some argue that if Peru had been able to proffer its own arguments, the outcome of the case

might have been a different story altogether.332 This line of reasoning deserves credit, because

there are a lot of reasons why the ‘payment’ interpretation should be considered a faulty one.

‘Broad/Payment’ Interpretation v. Historical Meaning and Market Understanding

First of all, LOWENFELD did not cite any authorities to support his claim.333 Moreover, history

has repeatedly shown that it was never the intention of the drafters to create a pro rata equal

treatment for creditors via the pari passu clause.334 Unfortunately, drafters did insert

additional ‘payment’ language and later drafters mindlessly copy-pasted it. The pari passu

clause of Peru’s guaranty was not any different. It read:

[…] The Guarantor [i.e. Peru] represents and warrants as follows: […] The obligations of

the Guarantor hereunder do rank and will rank at least pari passu in priority of payment

with all other External Indebtedness of the Guarantor, and interest thereon.335

Understandably, the vague wording of the pari passu clause might have given the impression

that the ‘payment’ interpretation was indeed what the drafters meant. In fact, the actual

purpose of the ‘payment language’ was accentuating the different purposes of the pari passu

clause depending on the context. Where at first the pari passu sought to protect creditors from

the ‘first-to-be-issued’ rule, it later sought to prevent sovereigns from taking actions that

might subordinate creditors or classes of creditors.336 In any event, it always concerned some

sort of ‘ranking’ rather than ‘payment’.

331 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 879; Sandoval, ‘Sovereign Debt Restructuring’ (n

302) 20. 332 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 638. 333 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 878. 334 See 3.1 The History of the Pari Passu: the What, the Why and the When. 335 Lowenfeld Decleration (n 323) (emphasis added). 336 Supra Paragraph…


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Under normal circumstances New York law defers to the standard market understanding to

divine the meaning of a certain clause.337 It generally does not get into the specific intentions

of the parties. The reasoning behind this stems from a case before the United States Court of

Appeals for the Second Circuit. In Sharon Steel it said:

Whereas participants in the capital market can adjust their affairs according to a uniform

interpretation, whether it be correct or not as an initial proposition, the creation of

enduring uncertainties as to the meaning of boilerplate provisions would decrease the

value of all debenture issues and greatly impair the efficient working of capital markets.

Such uncertainties would vastly increase the risks and, therefore, the costs of borrowing

with no offsetting benefits either in the capital market or in the administration of

justice.338

In other words, the court concluded that boilerplate provisions ought to be interpreted

uniformly, irrespective of parties’ intentions. Indeed, if everyone in the market understands

and knows what the standard terms mean and if they can rely on the courts to defer to this

standard market understanding, then that will increase certainty and in turn promote

efficiency.339

Although the Sharon Steel reasoning sounds quite sensible and easy, the tricky part is actually

finding out what the ‘standard market understanding’ is. Unfortunately, the search for the

actual meaning of the pari passu has thus far been unsatisfying. Prominent members of the

academia, such as BUCHHEIT and GULATI, concluded that the market is far from crystal-clear

when it comes to the standard meaning of the pari passu clause.340 Nevertheless, LOWENFELD

and the Belgian court knowingly disregarded this fact and blindly applied the ‘plain-meaning’

understanding.341 Even though this approach is not unprecedented in the context of contracts,

they should at least have considered other interpretation options such as a historical approach,

especially if you take into account the peculiar situation of the sovereign debt context. 342

337 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 643. 338 Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F2d 1039, 1048 (2d Cir. 1982). (emphasis added) 339 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 643. 340 Lee C. Buchheit, ‘the Pari Passu Clause Sub Specie Aeternitis’ (1991) 10 Int'l Fin. L. Rev. 11, 11; Buchheit

and Pam, ‘Sovereign Debt Instruments’ (n 222) 875; Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646. 341 Cohen, ‘Cigar’ (n 68) 14. 342 MHR Capital Partners LP v. Presstek, Inc., 912 N.E.2d 43, 47 (N.Y. 2009).


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The (Absurd) Consequences of ‘Payment’ Interpretation

The consequences of this interpretation could lead to absurd outcomes. For instance, countries

tend to prioritise certain payments in the event of economic distress.343 This so-called

‘financial triage’344 includes paying the IMF, the World Bank and any other multilateral

organisation who de facto enjoy a status as preferred creditor.345 In practical terms, these

essential payments help governments to prevent the economy from grinding to a halt.

Whereas the ‘payment’ interpretation would result in countries being unable to pay for

commodities and public services such as police forces, judges and teachers. To put it bluntly,

it would render them unable to pay the milk man.346

Furthermore, the ‘payment’ interpretation of the pari passu clause would render some loan

agreement clauses completely meaningless, because, in practice, parties occasionally do draft

clauses that actually provide for ‘equality of payment’.347 These so-called ‘equality’ clauses,

basically come in all shapes and sizes, sometimes even three or four pages long.348 According

to GULATI and KLEE at least five clauses can be distinguished, namely:349

(i). a ‘mandatory prepayment clause’, which imposes a restriction on non-rateable

prepayments;

(ii). a ‘turnover clause’, which essentially forces the beneficiaries of prepayments to

hand them over to other creditors;

343 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 13; Joe Kogan, ‘Pari Passu and

the Ecuador 15s’ (2009) Barclays Capital Research 2 <www.emta.org> accessed 16 December 2015,

(hereinafter: Kogan, ‘Pari Passu and the Ecuador 15s’); Allen & Overy Global Intelligence Unit, ‘The Pari Passu

Clause’ (n 27) 2. 344 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 883; Lee C Buchheit and Sofia D Martos, ‘What to

Do about Pari Passu’ (2014) B.J.I.B.& F.L. 491, 491. 345 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 2. However, due to the limited scope

of this thesis, I will not elaborate on the (de facto) preferred status of the IMF. 346 Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371. 347 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884; Gulati and Klee, ‘Sovereign Piracy’ (n 28)

646; NML Plaintiffs’ Brief 37-38; Dechert LLP_Case 109-cv-01708-TPG at 19; Allen & Overy Global

Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10. 348 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884. 349 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646. Other ‘equality clauses’ include: the most favoured

debt/nation/creditor clause or a cross default clause (See also Olivares-Caminal, ‘Understanding the Pari Passu’

(n 7) 1232; Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10).


54

(iii). a ‘pro rata sharing clause’, which basically guarantees that if one creditor receives

a greater (i.e. disproportionate) payment, he has to share rateably with the

others;350

(iv). a ‘negative pledge clause’, which precludes debtors from pledging any

collateral;351 and

(v). an ‘acceleration clause’, which enables creditors to demand the immediate

payment of all debt in the event of a default.

Other than that, it should also be noted that parties sometimes modify the pari passu clause

itself to specifically include a pro rata payment rule.352 However, drafting such a pari passu

clause is no walk in the park. For instance, the parties need to provide detailed carve-outs

regarding ‘financial triage’.

Clearly, contracts contain these clauses for a reason. If parties really do intend to provide for

‘equality of payment’, they would insert such clauses in their contracts. Elliott’s claim that the

basic pari passu clause implicitly contains ‘equality of payment’, is simply a bridge too far.

Lawyers would not waste their time in drafting other clauses with the same effect, for time is

money.353 Hence the ‘payment’ interpretation once again shows its lack of efficiency.

Last but not least, the ‘payment’ interpretation might have potential systemic consequences. If

Elliott’s tactic of intercepting cash flows would be left unchallenged, the international

payment and securities settlement systems could be interrupted.354

To summarise, most authors agree that the practical consequences of a ‘payment’

interpretation are so extreme, so far-reaching that they can never have been the intention of

the parties. In other words, parties would never have agreed to such terms and if they did, they

would have set it out in the contract expressly.355

350 Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2; Allen & Overy Global Intelligence Unit, ‘The Pari Passu

Clause’ (n 27) 10; Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1231; United States Court of

Appeals_NML, p 38; Essay Sovereign Syndicated Bank Credits in 1970s, 25. 351 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 10. 352 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646; Allen & Overy Global Intelligence Unit, ‘The Pari Passu

Clause’ (n 27) 10. 353 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 884; Gulati and Klee, ‘Sovereign Piracy’ (n 28) 646. 354 Wood, ‘Pari Passu clauses –What do they mean?’ (n 221) 371. 355 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 886; Wood, ‘Pari Passu clauses –What do they

mean?’ (n 221) 371; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 825; FMLC, ‘Analysis of the role,

use and meaning of pari passu clauses’ (n 234) 13; Allen & Overy Global Intelligence Unit, ‘The Pari Passu

Clause’ (n 27) 12; Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 270.


55

However, as stated before, not everyone is on the same page. Some authors, such as BRATTON

and COHEN, proclaim the ‘payment’ interpretation as the correct one.356 In his argumentation,

BRATTON does offer some interesting points regarding potential positive consequences of a

‘payment’ interpretation. If we follow his line of reasoning, we come to the following benefits

of a ‘payment’ interpretation: (i) it would tackle the moral hazard of a sovereign state, by

making it less likely that sovereigns would externalize effects of economic reverses, (ii) it

would discourage a sovereign from putting the burden of restructuring on a particular series or

class of bonds and (iii) it would greatly improve a holdout’s bargaining position. In other

words, the ‘payment’ interpretation constrains a sovereign’s choices, enhances enforcement

powers of holdout-creditors and lowers the long-run costs of sovereign debt capital. 357

COHEN on the other hand merely reiterates the plain-meaning argument. According to him, “a

cigar is just a cigar”.358 The pari passu clause just means what it says. It provides equal

treatment protection for creditors. Thereby, he clearly endorses LOWENFELDS’ view on the

matter.359 Moreover, he claims this interpretation fits in with “common sense and business

realities”. For what use is a mere right not to be ‘legally’ subordinated? How can you possibly

enforce that?360 A ‘payment’ interpretation on the other hand prevents a sovereign from

‘functionally’ subordinating the debt by choosing one creditor over the other. Therefore, it

provides essential protection and encourages investors to trade in destressed sovereign debt.361

Furthermore, he completely disagrees with prominent figures such as BUCHHEIT and WOOD,

claiming that their legal ranking interpretation does not find any support in the actual text of

the pari passu clause362. But, just like LOWENFIELD and the Belgian Court, he completely

disregards the historical context of the clause. Whereas the historical context clearly shows

the whys and wherefores regarding the ranking interpretation.363

It must be noted however that COHEN was legal counsel for Elliott and is currently

representing NML Capital Ltd. in its sovereign debt litigation with Argentina.364 So, his view

on the matter is far from neutral, but, as KOGAN rightly puts it, there are arguments on both

356 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 826; Cohen, ‘Cigar’ (n 68) 17. 357 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 827. 358 Cohen, ‘Cigar’ (n 68) 17. 359 Ibid 14-15. 360 Ibid 17. 361 Ibid 14 and 17. 362 Ibid 18. 363 See supra 3.1 The History of the Pari Passu: the What, the Why and the When. 364 Cohen, ‘Cigar’ (n 68) 11.


56

sides of the discussion. Either party has an interest in supporting their pari passu

interpretation.365 The ‘broad’ interpretation would clearly benefit the holdouts creditors and

incentivize them to buy up debt for litigation purposes, whereas ‘narrow’ would greatly

support the sovereigns and take away a strategy for the holdouts altogether.

In sum, most critics initially thought of the Elliott case as an aberration.366 They opined that

‘[the] decision was [made] by an obscure commercial court in Brussels that probably [did] not

even know what a sovereign bond [was]. No English or New York court (and most foreign

issued sovereign bonds today are governed by the laws of one of those two jurisdictions)

would ever rule in that fashion.’367 Unfortunately, the opposite proved true. The ‘obscure’

Belgian Decision henceforth served as the bedrock for holdout litigation. It was not even

limited to debt governed by New York law, instead it quickly spread to debt governed by

English Law.368

Ever since, sovereigns have been forced to rely on more drastic measures to keep the holdouts

at bay. For instance, practitioners under New York and English law have addressed the

situation with exit consents and collective actions clauses respectively.369 Both solutions,

however, have their own downsides to deal with, which will be discussed in Chapter 4

Drafting Is Key to the Pari Passu-Holdout Issue.

3.3.2.2.7. LNC Investment v. Nicaragua

As set out above, the potential implications of the Elliott case were enormous. The Belgian

Court had inadvertently provided holdouts with a veritable sledgehammer in terms of

settlement coercion.370 Needless to say, litigation soon ensued and LNC Investment (“LNC”)

found itself before the same Belgian Court as Elliott years before.371 To LNC’s dismay,

however, the court did not adhere to its previous ‘payment’ interpretation and refused to

freeze the payments passing through Euroclear. Why the court suddenly had that change of

heart, is set out below.

365 Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2. 366 Kogan, ‘Pari Passu and the Ecuador 15s’ (n 343) 2; Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75)

825. 367 Chabot and Gulati, ‘Santa Anna and his Black Eagle’ (n 259) 220. 368 Kensington…& 369 Gulati and Klee, ‘Sovereign Piracy’ (n 28) 637. 370 Ibid 638. 371 Buchheit and Pam, ‘Sovereign Debt Instruments’ (n 222) 882.


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RELEVANT FACTS

In 1980 Nicaragua entered into loan agreements under New York law. These agreements

contained a pari passu clause and also prevented creditors from enforcing their claims on

Nicaraguan territory.372 When Nicaragua defaulted, sovereign debt restructuring ensued and

although the Nicaraguan offer was extremely low (only 8% of the principal amount was

offered), 70% of the creditors agreed to it. In the interest of completeness, it must also be

noted that Nicaragua issued bonds in 1990.373

Meanwhile, LNC Investment (“LNC”) had bought some of the defaulted debt and thus had

become creditor. Nevertheless, it was no surprise when it adamantly refused Nicaragua’s 8%

offer and chose to sue instead. Just like Elliott before it, LNC successfully obtained a

judgement against Nicaragua. It convinced a New York judge to order Nicaragua to pay $US

86.9 million of principal and interest in the light of the defaulted debt. However, enforcement

proved to be very difficult.374

So, it took a page from Elliott’s book and tried its hand at an ex parte motion before Belgian

commercial court in the summer 2003. This time, however, the holdout-creditor did not seek

to strike at the creditors who had participated in the restructuring. Instead, it targeted another

set of creditors altogether, namely the bondholders of Nicaragua’s bonds. In order to do so,

LNC asked for measures precluding payments via Euroclear. Obviously, it sought to coerce

Nicaragua into a settlement and, just like Elliott, LNC used the ‘payment’ interpretation of the

pari passu to do it.

On July 25th 2003 the Belgian Commercial Court granted the ex parte motion. As a result,

payments passing through Euroclear were frozen and Euroclear also needed to adhere to some

other measures. Since these measures were all under penalty of €1-2 million, Euroclear

obeyed the court.375

Needless to say, Nicaragua was far from happy with this court order. So, in August of 2003

Nicaragua filed for third-party opposition (‘derdenverzet’). However, the court denied the

motion.376 In the meantime, however, Nicaragua risked a default on its bonds, which would

372 Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en NV Euroclear

Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831, §1-2, (hereinafter: the ‘LNC Decision’). 373 LNC Decision (n 372) §4. 374 Ibid §2,3 and 5. 375 Ibid §8-9. 376 Ibid §10.


58

expose it to a cross-default on other international loans.377 Faced with this risk, Nicaragua

filed for an appeal and asked the court to:

(i). Annul the decision of 11 September 2003 (which had denied Nicaragua’s motion);

(ii). declare LNC’s demands unfounded;

(iii). retract the judgement of 25 July 2003; and

(iv). condemn LNC to pay for all the costs that the measures had caused for

Nicaragua.378

RELEVANT ARGUMENTS

To convince the court, LNC claimed that the loan agreements of 1980 precluded any issuance

of bonds. Additionally, according to LNC, the agreements also prevented that Nicaragua

could pay bondholders to the detriment of the loan-creditors, because in doing so it would

breach the pari passu clause contained in the loan agreement.379

Nicaragua and Euroclear, however, did not agree with LNC’s view. They claimed that (i) the

conditions for an ex parte motion were not met, because there was no absolute necessity, nor

extreme urgency and (ii) that LNC pursued illegitimate interests, namely it illegitimately

asserted pressure on Nicaragua in order to coerce it into a settlement (cf. Elliott and Peru).380


The court started out with the alleged illegitimate interests of LNC and it concluded:

While it is true that LNC appears to have established a strategy that deprived Nicaragua

of all possibility of annulling the [ex-parte] decision before 1 August 2003 so that it could

honour its payment obligations under the Bonds, it remains the case, as is stated below,

that this strategy was the only one that could have assured the efficacy of the ordered

measures, […] As the final objective of the measures being sought through the ex-parte

mechanism was to obtain payment of a debt that was due and certain, one must ascertain

that LNC had a legitimate interest to act.381

377 Ibid §13. 378 Ibid §14. 379 Ibid §7. 380 Ibid §15-16. 381 Unofficial translation Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en

NV Euroclear Bank, A.R. nr. 2003/KR/334, §16 <www.emta.org> accessed 30 September 2015, (emphasis

added).


59

So, even though LNC clearly waited to file its ex parte motion and in doing so prevented

Nicaragua from annulling it, the strategy was deemed necessary to ensure efficacy of the

measures. Moreover, the objective of the measures was to obtain payment of a due and certain

debt. Thus, LNC did have a legitimate interest to act and its recourse to an ex parte motion

was justified by absolute necessity.382

However, the Court of Appeals did not agree with LNC’s recourse to the pari passu

argument. On the one hand, it recognised that the ‘payment’ interpretation was heavily

contested.383 On the other hand, it refused to see Euroclear as a proper party to the litigation.

According to the court, Euroclear was not a third party accomplice to a breach of contract. It

stated that, under Belgian law, the principle of ‘privity of contract’ applied, which precludes

measures that would make a third party a guarantor of a contractual performance. Hence, the

Court of Appeals decided that the lower court had violated Belgian law by passing the

injunction and consequently annulled the lower court’s order.384


The Brussels Court of Appeals did not choose one pari passu interpretation over the other.

Instead, it relied on another legal basis altogether to deny LNC’s motion to freeze Euroclear’s

assets, namely civil and procedural law. So, claiming that the court had reversed the

‘payment’ interpretation in LNC v Nicaragua, would be a bridge too far.

However, the case did put pari passu clauses on the radar. Following the case, the Settlement

Finality Law385 was amended in such a way that it would prevent any future attempt to

intercept payments at Euroclear.386 The new provision read:

Any cash settlement account maintained with the operator of a system or with a cash

settlement agent, as well as any cash transfer, through a Belgian or foreign credit

institution, to be credited to such cash settlement account, cannot be attached, put under

382 Ibid §17-18. 383 Ibid §21. 384 Ibid §22. 385 Wet van 28 april 1999 houdende omzetting van Richtlijn 98/26/EG van 19 mei 1998 betreffende het

definitieve karakter van de afwikkeling van betalingen en effectentransacties in betalings- en

afwikkelingssystemen (de ‘finaliteitswet’). 386 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1234; Euroclear Amicus Brief for NML 10

<www.emta.org> accessed 16 December 2015; Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott

Case: A Brilliant Strategy but an Awful (Mid-Long Term) Outcome?’ (2011) 40 Hofstra L. Rev. 39, 52-53,

(hereinafter: Rodrigo Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott Case’); IMF, ‘Strengthening

the Contractual Framework’ (n 279) 40.


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sequestration or otherwise blocked by any means by a participant (other than the operator

or the settlement agent), a counterpart or a third party.387

This amendment effectively thwarted any further impediments to the proper functioning of

payment or settlement system and hence safeguarded the credibility and liquidity of the

financial markets.388 Still, the success of this provision should not be overestimated.

OLIVARES-CAMINAL rightly points out that the ‘payment’ interpretation is still out there. The

Belgian law might have prevented Belgian courts from passing similar judgements to the

Elliott case, but this does not rule out other jurisdictions, for instance, NML Capital’s beef

with Argentina. 389

3.3.2.3. The Third Wave: The Return of the Pari Passu?

3.3.2.3.8. NML Capital Ltd. v Argentina

Pravin led to more sovereign debt litigation. Elliott’s ‘payment’ interpretation paved the way

for even more holdout disputes, but in LNC the court clearly took a step back. Nevertheless,

the ‘payment’ interpretation of the pari passu clause was still out there and when Argentina

defaulted in 2001, NML Capital came to the fore. Litigation ensued, but the outcome was far

from certain. The ‘payment’ interpretation was either about to solidify its position, or about to

be dealt yet another blow. Little wonder that some dubbed this the ‘sovereign debt trial of the

century’.390 In the end, the ‘rateable payment’ won the day and the holdouts managed yet

again to coerce their sovereign debtor into a settlement offer. How this came to be and what

this means for the future, is set out below.

RELEVANT FACTS

NML Capital, Ltd. v. Argentina391 is the story about Argentina’s staggering US$ 100 billion

default in 2001 and the subsequent holdout litigation. It all started with the Fiscal Agency

Agreement of 1994 or ‘FAA’. Pursuant to this agreement, bonds were issued (‘FAA Bonds’)

to finance Argentina. However, in order to enhance the marketability of the FAA Bonds the

387 Unofficial translation from Euroclear’s amicus brief for NML at 10 <www.emta.org> accessed 16 December

2015. It should be noted, however, that the Settlement Finality Law was amended again in 2011. Although the

wording of the provision was tweaked a bit, the essence remained the same. 388 Euroclear amicus brief for NML at 10 (available at www.emta.org) (visited on 16 December 2015). 389 Rodrigo Olivares-Caminal, ‘The Pari Passu Interpretation in the Elliott Case’ (n 286) 52-53; IMF,

‘Strengthening the Contractual Framework’ (n 279) 40; NML Capital Ltd. v. Republic of Argentina, No. 08-cv-

6978 (S.D.N.Y. Nov. 21, 2012). 390 FT Alphaville, 16th November 2012 <http://ftalphaville.ft.com/2012/11/16/> accessed 24 February 2016. 391 NML Capital, Ltd. v. Argentina, 699 F.3d 246, 251 (2d Cir. 2012).



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Argentinian government decided to provide the creditors with a few (financial) ‘sweeteners’

and therefore it made a few promises.392

(i). The FAA bonds would be governed by New York law;

(ii). Any dispute would be adjudicated before New York Courts;

(iii). Periodically, interest would be paid and in the event of default an acceleration

clause would be activated, meaning any unpaid interest –along with principal–

would immediately become due in full;

(iv). The bonds would be freely transferable and payable to a transferee, regardless of

his/her status. Even if the transferee was a ‘vulture’ fund; and

(v). A pari passu clause would ensure the equal treatment of the creditors and read:

The Securities will constitute […] direct, unconditional, unsecured and unsubordinated

obligations of the Republic and shall at all times rank pari passu and without any

preference among themselves. The payment obligations of the Republic under the

Securities shall at all times rank at least equally with all its other present and future

unsecured and unsubordinated External Indebtedness […].393

Unfortunately, in 2001 Argentina was struck by a devastating economic crisis and

consequently it defaulted.394 As a result, the acceleration clause was activated and lacking a

sovereign insolvency regime, Argentina was forced to take measures. While entering into debt

restructuring negotiations, the President of Argentina declared a ‘temporary moratorium’ on

all principal and interest payments, thus preventing the FAA bondholders from reaping the

benefits of their acceleration clause.395

Eventually, the negotiations led to an exchange offer in 2005. Basically, this offer allowed the

FAA bondholders to exchange their bonds for new unsecured and unsubordinated external

debt at 25 cents to the dollar.396 Obviously, this was a bitter pill to swallow, but the

Argentinian government went even further.

392 NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 5. 393 Paragraph 1 c) Fiscal Agency Agreement of 1994 <http://www.shearman.com/~/media/Files/Services

/Argentine-SovereignDebt/2013/FiscalAgency AgreementOct191994.pdf> accessed 25 February 2016. 394 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2197. 395 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 251; S Gee, ‘Injunctions, non-parties and

default on sovereign bonds’ (2013) 10 JIBFL 609, 609, (hereinafter: Gee, ‘Injunctions‘); Wong, ‘NML Capital,

Ltd. v. Republic of Argentina’ (n 287) 404. 396 Ibid.


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To induce FAA bondholders to accept the deal the new prospectus contained a section on

‘Risks of Not Participating in [the] Exchange Offer’. In it, Argentina made the following

declaration: ‘The Government […] has no intention of resuming payment on any [FAA]

bonds […] Consequently, if you elect not to tender your bonds in an exchange offer there can

be no assurance that you will receive any future payments.’397 Additionally, to assert even

more pressure, the Argentinian legislature also enacted Law 26,017 (the ‘Lock Law’) which

‘prohibited [the state] from conducting any type of in-court, out-of-court or private settlement

with respect to the bonds’.398 Essentially, this Lock Law made non-payment of holdouts

mandatory by law.399 Faced with this kind of pressure, a lot of FAA bondholders succumbed

to the will of Argentina. The end result was an acceptance rate of 76% that represented

roughly US$ 62 billion of the outstanding debt.400

In 2010 the remaining FAA bondholders got a second chance at an exchange offer.401 The

terms were more or less the same as before and the Lock Law was temporarily suspended to

make this offer possible.402 A lot of bondholders chose to exchange bonds and Argentina

successfully restructured up to 91% of the defaulted debt of 2001. However, a few holdout

creditors still remained.

Meanwhile, NML Capital Ltd. (‘NML’), an affiliate of Elliott Management Corporation, had

bought the FAA Bonds at a steep discount on the secondary market. This vulture fund refused

to participate in the exchange offers and opted to sue instead.403 Just like Elliott and countless

others before it, NML tried to force Argentina into a settlement by way of injunctions based

on an alledged pari passu breach.404 However, the main objective of the vulture fund was to

assert pressure on third parties such as Bank of New York Mellon.405 While the injunctions

would obviously bind Argentina itself, they would also affect non-parties because of Fed. R.

Civ. P. 65(d)(2).406 According to said rule, injunctions also bind ‘agents’ and ‘other persons

397 Argentina, Prospectus Supplement to Prospectus Dated December 27, 2004 <http://www.mecon.gov.

ar/finanzas/download/us_prospectus_and_prospectus_supplement.pdf> accessed 25 February 2016. 398 Ley 26.017 de fecha 9 de febrero de 2005 [30.590] B.O., (hereinafter: ‘Lock Law’). 399 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 5. 400 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 252. 401 Ibid. 402 Ibid.; Gee, ‘Injunctions‘ (n 395) 609. 403 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 253; Wong, ‘NML Capital, Ltd. v. Republic

of Argentina’ (n 287) 404. 404 Ibid. 405 NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 239; Sovereign pari passu clauses:

don’t cry for Argentina- yet; Gee, ‘Injunctions‘ (n 395) 609. 406 NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013) at 239.


63

who are in active concert or participation’. Therefore, anyone assisting Argentina in evading

the court’s injunctions, would risk being held in contempt of court.407 In sum, the pari passu

remedy sought by NML was not intended to target Argentina at all, but rather indirectly force

it into a settlement.408

After years of litigation, Judge GRIESA finally ruled in December 2011 that Argentina had

breached the pari passu clause included in the FAA.409 As a result, Argentina was enjoined on

23 February 2012 by a court order (‘the 2012 order’) which prohibited any payment of

‘exchanged’ bondholders, unless the FAA bondholders (such as NML) got a rateable share as

well. Furthermore, third parties were also bound, which increased the pressure on Argentina

even more.410 Needless to say, Argentina tried to wriggle out of this situation and appealed.

Pending the appeal, Argentina requested for a stay on enforcement of the 2012 order and

Judge GRIESA granted it.411

When the United States Court of Appeals of the Second Circuit eventually ruled in October

2012, GRIESA’s order was only partly affirmed and partly remanded.412 The Court of Appeals

agreed with the breach as such, but required more details concerning the actual

implementation of the payment prohibition. Soon thereafter, in November 2011, GRIESA

amended his original order.413 Seemingly, Argentina was finally with its back against the wall.

However, Argentina appealed again. This time to request the Court of Appeals for a rehearing

en banc.414 Meanwhile, the stay on enforcement remained in force.415

Some months passed and in August of 2013 the Court of Appeals denied the motion for an en

banc rehearing.416 Again, this seemed the end of the line for Argentina, but it still had one

407 Ibid. 408 Gelpern, ’Contract Hope’ (n 20) 134. 409 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Feb. 23, 2012). 410 Ibid. 411 Ibid.; Transcript of Court Hearing at 52 (10-11), NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978

(S.D.N.Y. Feb. 23, 2012), (hereinafter: ‘Transcript of Court Hearing (Feb. 23, 2012)’). 412 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012) at 265. 413 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012). 414 A rehearing en banc is a rehearing by a court consisting of all the appeal judges. It can either be requested by

the parties and agreed to by the court, or it may be ordered by a majority of circuit judges. The only reason why

such a rehearing would take place, is to secure uniformity of the court’s decisions, or when there is a significant

issue at stake. (see Fed. R. App. P. 35) 415 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012); Transcript of Court

Hearing at 22 (4-7), NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012),

(hereinafter: ‘Transcript of Court Hearing (Nov. 21, 2012)’). 416 NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013).


64

final ace up its sleeve: a petition for a writ of certiorari.417 Furthermore, it convinced the Court

of Appeals to extend the stay on enforcement pending the Supreme Court’s decision.418

On June 16th 2014, the Supreme Court finally ended the NML debacle and denied the petition

for a writ of certiorari.419 However, this did not come as a surprise since the Supreme Court

only grants a limited amount of the writs. Some say it grants only four percent of cert

petitions, others say it grants but one percent.420 So all in all, this outcome was to be expected.

As a consequence of the Supreme Court’s decision, the enforcement of the 2012 order finally

became possible. This meant that Argentina could no longer pay the exchange bondholders,

without paying the remaining FAA bondholders as well. Hence, it had to choose between

doing away with its anti-holdout policy, or defaulting on the Exchanged Bonds.

Unfortunately, it opted for the latter.421

As the pressure on Argentina slowly increased, a settlement offer seemed the only way out.

Still, the FAA bondholders had to wait until February 2016 to receive an offer.422

RELEVANT ARGUMENTS

Due to the possible impact of this case, there were a lot of briefs, letters, and other supportive

documents from both the parties and amici curiae such as banks, governments (USA), the

emerging markets association, and so on. Therefore, it deserves merit to give a brief overview

of their interpretation of the facts.

NML claimed that Argentina had breached the pari passu clause included in the FAA.423

More specifically, it argued that Argentina had intentionally subordinated the FAA

bondholders by enacting the Lock Law. For that reason, NML asked the court to grant a

417 A petition for a writ of certiorari is a petition whereby a party asks the Supreme Court to exercise its

discretionary appellate function. The conditions for granting a cert are set in the Supreme Court’s Rules (Rule

10). (See H Weisburg, A E Stolper and P Clancy, ‘Don’t Cry for Me Argentine Bondholders: Argentina and

Exchange Bondholders File Certiorari Petitions’ (Shearman & Sterling LLP Client Briefings, 25 February 2014)

<www.emta.org> accessed 26 September 2015, (hereinafter: Weisburg, Stolper and Clancy, ‘Don’t Cry for Me

Argentine Bondholders: Argentina and Exchange Bondholders File Certiorari Petitions’). 418 NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013). 419 Republic of Argentina v NML Capital Ltd, 573 U. S. (2014). 420 K S Bhatia, ‘Likelihood of a Petition Being Granted’ (Daily Writ, 10 January 2013)

<http://dailywrit.com/2013/01/likelihood-of-a-petition-being-granted/> accessed 28 February 2016; Weisburg,

Stolper and Clancy, ‘Don’t Cry for Me Argentine Bondholders: Argentina and Exchange Bondholders File

Certiorari Petitions’ (n 417) 2. 421 Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 83. 422 See supra 3.3.2.3.8 NML Capital Ltd. v Argentina. 423 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Dec. 7, 2011).


65

summary judgement, since there was no dispute to any material fact and therefore it was

entitled to a judgement as a matter of law.424 As remedy for this breach NML requested

injunctive relief and/or specific performance of the pari passu clause. According to the

plaintiff, the ‘payment’ interpretation of the pari passu clause was to be upheld and

consequently, Argentina was to be prohibited from paying any Exchange bondholders, unless

the remaining FAA bondholders (such as NML) received a rateable payment as well.425

Moreover, NML asserted that in doing so, the court would not just add another piece of paper

to the pile of judgements and obligations Argentina already ignored. Instead, they asserted

that this new injunctive approach would seriously impede Argentina to comply with the

payment obligations under the Exchanged Bonds of 2005 and 2010, because pursuant to Rule

65 of the Federal Rules of Civil Procedure also people ‘aiding and abetting Argentina’ would

be bound by the order.426 In sum, NML claimed that this order would force Argentina to settle

and end the litigation once and for all.

Obviously, the Republic of Argentina refuted the rateable payment theory set forth by the

plaintiffs. It did admit that it had two obligations, namely paying the exchange bondholders

and paying the FAA bondholders. However, according to the Republic there was no legal

authority, no legal basis whatsoever to condition one payment on the other.427 It added that

such mechanisms did exist (e.g. sharing clauses), but that those required specific language in

the contract.428 Besides, the text of the FAA’s pari passu clause could not be used to support a

rateable payment theory, simply because the clause only meant that ‘you can’t create a senior

rank of debt’.429 In other words, the republic proclaimed the ‘ranking’ interpretation of the

clause.

Nevertheless, the Republic did (eventually) recognize the breach of the pari passu clause. The

only thing it refuted was the remedy. According to the Republic, the remedy was

‘acceleration’ and not mandatory payment.430 In other words, by requesting specific

performance, NML essentially asked for a ‘turnover order’ ex Fed. R. Civ. P. 69, which is

limited by the Foreign Sovereign Immunities Act (‘FSIA’). The court can order a sovereign

424 Fed. R. Civ. P. 56(a). 425 Transcript of Court Hearing (Feb. 23, 2012) (n 411) 3 (13-19). 426 Ibid 4 (18-19). 427 Ibid 28 (6-15). 428 Ibid 28 (18-20). 429 Ibid 28 (16-17). 430 Ibid 36 (13-15).


66

debtor to turn over certain assets, but only if it concerns assets located in the United States of

America and if those are used for a commercial activity.431 In brief, the Republic asserted that

acceleration was the only possible remedy and a that payment order would be in direct

violation of the FSIA.

As previously mentioned, there were a lot of amici curiae present in this litigation, needless to

say the biggest victims were the Exchange Bondholders who claimed that they were

essentially being held hostage by vulture funds.432 Next in line were intermediaries such as

Euroclear Bank SA/NV. Euroclear asserted that it was not a ‘participant’ under Fed. R. Civ. P.

65(d), but an intermediary and as such it could not be bound by the order of 2012.433

Moreover, it claimed that the order was in direct violation of Belgian law.434 After the LNC

Investment v. Nicaragua –where the court ostensibly dismissed the ‘payment’ interpretation–

Belgian law was amended to prevent future holdouts from attacking the settlement systems.435

By making this order binding for Euroclear, the court allows NML to do just that which

Belgian law prohibits.436 Other amici included the United States government, Clearing House

of New York and Bank of England, all of whom said the ‘payment’ interpretation was

incorrect.437

It should be noted, however, that NML had some supporters too. Amongst others, these

included Argentinian and American professors. The Argentinian professors mainly supported

NMLs claim that by enacting the Lock Law the Republic of Argentina had breached the pari

passu clause, because (i) it rendered the claims of NML (and others) meaningless and (ii) it

was a sovereign binding act rather than an intention not to pay NML.438 In turn, Professor K.

DAM pointed out that the order of 2012 would not affect the future ability of countries to

restructure and besides, Argentina was perfectly capable of paying NML.439 Other amici

431 Ibid 39 (3-9). 432 Transcript of Court Hearing (Nov. 21, 2012) (n 415) at 27 (12, 21-25). 433 Affidavit in support of motion for permission to file letter brief as amicus curiae, NML Capital Ltd. v.

Republic of Argentina, No. 12-105 (2d Cir. 2012) at 6. 434 Ibid 7. 435 Ibid 7; Art. 9 Finaliteitswet. 436 Ibid 8. 437 Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 29 (1-9). 438 Brief of amici curiae Argentine law professors in support of affirmance, NML Capital Ltd. v. Republic of

Argentina, No. 12-105 (2d Cir. 2012) at 5 and 16. 439 Brief of amici curiae Kenneth W. Dam in support of affirmance, NML Capital Ltd. v. Republic of Argentina,

No. 12-105 (2d Cir. 2012) at 5 and 16.


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included professor Mann, the Washington Legal Foundation and EM Ltd.440 It is clear that

NML’s views were supported by a lot of people.


In 2011, the court decided that the Republic of Argentina had breached the FAA’s pari passu

clause. In fact, its ruling on the matter was crystal-clear.441

It is declared, adjudged, and decreed that the Republic is required under of Paragraph 1(c)

of the FAA at all times to rank its payment obligations pursuant to NLM’s Bonds at least

equally with all the Republic’s other present and future unsecured and unsubordinated

External Indebtedness. […]

It is declared, adjudged, and decreed that the Republic lowered the rank of NML’s bonds

in violation of Paragraph 1(c) of the FAA when it enacted Law 26,017.

The court reasoned that by enacting legislation, which forbade future payment on the old

bonds, while at the same time continuing to pay interest on subsequently issued debt,

Argentina had breached its promise of equal treatment.442 Consequently, the court agreed in

February 2012 that something needed to be done, although at first it did not see any merit in

yet another judgement ordering Argentina to pay.443

I have no doubt that an order should be entered […], but […] I cannot help but wonder

what good such an order will be. The Republic has already been obligated to pay these

bondholders and they won’t do it. […] I have already entered an order saying the

Republic has violated the pari passu clause. […] Now, […] if I enter an order requiring

payment, which I think should be done, is there anything going to happen except they will

default on this obligation?444

Moreover, it initially doubted that NML’s ‘rateable payment’ solution had any legal basis.

While the Republic did have two obligations, namely an obligation to pay the Exchange

Bondholders and an obligation to pay NML, the court did not see how one payment could be a

condition for the other.

440 NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012). 441 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Dec. 7, 2011). 442 Ibid. 443 Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 3. 444 Ibid at 3 (22-25) and 4 (1-11).


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I accept the idea, […] that the Republic has two obligations; […] but that […] does not

necessarily mean that as a condition of paying the exchange offers they must pay an

amount [to NML]. […] I don't understand the pari passu clause to mean that the Republic

is forbidden to pay the exchange offers.445 I don't see a legal authority for me saying to the

Republic, you cannot pay the exchange offer people unless you pay NML.446

Besides, the court initially refused to accept that banks and intermediaries, who fulfilled their

obligations for a legal payment of the exchange bondholders, could be seen as ‘aiding and

abetting’ Argentina.447

However, after a brief recess and hearing NML’s counsel, the court reached a different

conclusion altogether. It actually badgered the opposing counsel to come up with answers for

the real issue, namely the remedy required for the pari passu breach. Time and time again it

repeated the same questions: ‘Tell me what remedy they are entitled to […]. The pari passu

clause is in there. Is it meaningless?’.448

Unfortunately for the Republic, the court did not take kindly to their counsel’s answers. It

refused to see acceleration as a remedy for a pari passu breach.449 Instead, it decided that

desperate times, called for desperate measures.

The republic has flagrantly violated its legal obligations. […] Now if there was any belief

that the Republic would honestly pay its obligations, there wouldn’t be any need for these

kinds of [strategies]. If there is merit to the pari passu argument, then there could be a

court order. […] Nobody really has any hope that the Republic will honestly honor its

obligations without some unusual mechanisms. That's why this is being done.450

According to the court, both parties had been jumping through hoops and twisting things for

years on end.451 It was time to end this farce once and for all and the pari passu clause was the

way to do it. Although the court recognized the potential problems the rateable payment

remedy would create, it argued that ending the Republic’s lawfulness was the ‘bigger

445 Ibid at 11 (17-25) and 12 (1-8). 446 Ibid 9. 447 Ibid 16. 448 Ibid 34, 37. 449 Ibid 38. 450 Ibid 30 (9, 21-25) and 31 (1-3). 451 Ibid 30.


69

overriding problem’.452 Hence, it decided to grant NML’s request and prohibited Argentina to

pay the Exchange Bondholders without paying the FAA Bondholders rateably.453

Next came the Court of Appeals. While it mainly reiterated judge GRIESA’s contempt for the

whole situation and partly reaffirmed his decision, one cannot fail to notice that the court

emphasized the remedy issue rather than that of the pari passu breach. According to the court

‘NML [did] not interpret the pari passu clause as requiring ‘ratable’ payments, [NML]

proposed ratable payments as a remedy for Argentina’s breach’.454

Moreover, the court added that:

‘[E]ven under Argentina’s interpretation of the [pari passu clause], as preventing only

“legal subordination” of the FAA Bonds to others, the Republic breached the

Provision.’455 […] [T]he combination of Argentina's executive declarations and legislative

enactments have ensured that plaintiffs' beneficial interests do not remain direct,

unconditional, unsecured and unsubordinated obligations of the Republic and that any

claims that may arise from the Republic's restructured debt do have priority in

Argentinian courts over claims arising out of the Republic's unstructured debt. Thus we

have little difficulty concluding that Argentina breached the Pari Passu Clause of the

FAA.456

Evidently, the Court of Appeals saw eye to eye with judge GRIESA on the matter of the pari

passu breach, regardless of the arguments made by both Argentina and its amici.

Since a breach had been ascertained, the only thing left to do was find an appropriate

remedy.457 The Court of Appeals did consider the Argentina’s counterarguments, but

dismissed them rather quickly. First of all, according to the Court, the FAA did not

specifically limit the available remedies to acceleration.458 Therefore, in accordance with New

York case law, the Court could consider other remedies.459 Secondly, the FSIA argument did

not stick either. The mere fact that the injunctions would incidentally affect Argentina was

452 Ibid 48-49. 453 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Feb. 23, 2012). 454 NML Capital, Ltd. v. Argentina, 699 F.3d 246, 259 (2d Cir. 2012). 455 NML Capital, Ltd. v. Argentina, 699 F.3d 246, 260 (2d Cir. 2012). 456 Ibid. 457 Ibid 261. 458 Ibid 262. 459 Ibid.


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insufficient for the court to determine a violation of Section 1609 of the FSIA.460 Finally, the

Court was not convinced that the injunction would ‘plunge the republic into a new financial

economic crisis’, because there was no evidence to support that claim.461 On the contrary, the

fact that the Republic was able to pay the Exchange Bondholder was proof that it did have the

required funds to uphold its obligation vis-à-vis the FAA bondholders. 462

However, the Court of Appeals did take issue with the injunctions’ effect on third parties, in

particular intermediaries.463 In the eyes of the Court, ‘pure’ intermediaries fell under the scope

of article 4A of the U.C.C. and as such, these intermediary banks –which have no obligations

to any party with whom they do not deal directly– cannot be subject to injunctions relating to

payment orders.464 With these remarks in mind, the Court of Appeals remanded the

injunctions to the District Court, for clarification regarding the Injunctions' application to third

parties and to address the operation of the payment formula.465

Other than affirming and remanding the District Court’s decisions, the Court of Appeals also

pointed out the existence of CACs and their potential vis-à-vis holdouts.466 The Court even

went as far as to assert that ‘collective action clauses [would] effectively eliminate the

possibility of “holdout” litigation.’467 Although this might have been a premature conclusion,

it definitely shows that the Court urged sovereigns to try and prevent future holdout-charades.

When the injunctions came back before the District court, Judge GRIESA made short work of

his amendment order and addressed the Court of Appeals’ remarks.468 Other than that, he

mainly repeated his previous frustration with the situation and rebuked the Republic for the

umpteenth time.469 Nevertheless, he did show some sympathy for the Exchange Bondholders

who were ‘being held hostage’, but basically saw them as ‘collateral damage’.470 According to

460 Ibid. 461 Ibid 263. 462 Ibid. 463 Ibid 264. 464 Ibid. 465 Ibid 265. 466 Ibid 264. 467 Ibid. 468 NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012). 469 Transcript of Court Hearing, NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21,

2012) at 30. 470 Ibid 28.


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him, the real issue was Argentina’s behaviour. It could pay the Exchange Bondholders, if it

did so in accordance with his court order.471

It is clear from both the judgements and the transcripts that judge GRIESA and the Court of

Appeals were fed up with Argentina’s behaviour. More than once did the words lawbreaker,

disrespect and dishonest debtor appear.472 Obviously, their main goal was finding a way to

remedy to pari passu breach situation and the ‘rateable payment’ remedy was their solution.


In this case, the US Courts ostensibly endorsed the ‘payment’ interpretation, but as Romain

ZAMOUR has justly pointed out, there is a ‘crucial distinction between […] the issue of a [pari

passu] breach and the issue of a remedy’.473 While the pari passu clause was undoubtedly

breached in this case, the court did not actually rule on the interpretation of the clause.

Instead, it followed the NML’s line of reasoning and applied a ‘rateable payment’ as remedy

for the pari passu breach. Besides, it should be noted that the court realised that this was not a

perfect solution. On the contrary, the court admitted that this use of the pari passu clause

caused a lot of problems in itself, but nevertheless served a ‘higher purpose’, namely ending

the lawlessness and disrespect of Argentina. In sum, the court’s outbursts make it clear that it

figured it was time for Argentina to pay the piper and finally bring an end to this charade of

litigation.

The court order did have its desired effect. Recently, Argentina was blessed with a new

government that brought about winds of change and threw open the doors of settlement

negotiations.474 After fifteen years of intense litigation President Mauricio Macri decided to

present the holdout creditors with a new exchange offer.475 Mainly, the new government

reasoned that the country had suffered enough because of this protracted dispute which

restricted the country’s access to international credit.476 So, to induce the holdouts, it offered

to pay 75% of the amount awarded by US courts in 2012 which is approximately US$ 6.5

471 Ibid. 472 Transcript of Court Hearing (Feb. 23, 2012) (n 411) at 14; Transcript of Court Hearing, NML Capital Ltd. v.

Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012) at 15 473 Romain Zamour, ‘NML v. Argentina and the Ratable Payment Interpretation of the Pari Passu Clause’ (2013)

Yale J. Int'l L. 55, 64, (hereinafter: Zamour, ‘NML v. Argentina’). 474 H Bronstein and S Marsh, ‘Argentina's Macri sworn in as president, ousting Peronists’ (Reuters, 11 December

2016) accessed on 26 February 2016; ‘Argentina's Macri says wants to resolve debt fight with U.S. creditors’

(Reuters, 12 January 2016) accessed on 26 February 2016. 475 ‘Argentina makes offer to foreign creditors’ (BBC News, 6 February 2016) <http://www.bbc.com/news/world

-latin-america-35508907> accessed 6 February 2016; 476 Ibid.


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billion.477 On March 1st 2016 the settlement negotiations finally came to an end and this

nightmarish case was finally put to rest.478

One thing is for sure, the holdouts ‘won’ again, but some might classify it as a pyrrhic victory

because of the years of waiting they have had to endure.479 However, where does NML leave

us? What can we expect in the future?

GELPERN puts it this way: ‘NML v Argentina may or may not change the world of sovereign

debt restructuring as we know it.’480 For instance, according to the United States’ government,

judge GRIESA’s reasoning ‘threatens core U.S. policy regarding international debt

restructuring [and its] effect could well extend beyond Argentina.’481 By creating new ways of

enforcement, the court has taken away all leverage a sovereign has over holdouts.482 Thus, ‘if

enough creditors adopt this strategy, sovereign debt restructuring will become impossible.’483

This view was endorsed by Allen & Overy’s Global Law Intelligence Unit that pointed out

that the decision ‘could have disruptive implications for work-outs and the resolution of

financial difficulties in the case of sovereign debtors.’484 GELPERN goes into detail on the

matter. First of all, she argues that both debtors and creditors will suffer from this decision in

future restructurings.485 Countries that are not capable of enduring prolonged litigation and

reputational costs, will be ‘temped to settle’, while creditors will have to consider the

possibility that they will not see any money if they agree to an exchange offer.486 Thus,

restructuring negotiations will henceforth be even more of a chore. Secondly, third parties

such as trustees, fiscal agents and clearing systems, become vulnerable to injunctions.487

Lastly, the so-called official sector (i.e. the ECB, the IMF and the World bank) might lose its

de facto preferential status. Thus far vulture funds have not attacked such payments, but

477 ‘Argentina offers $6.5 billion cash deal to end debt battle’ (Reuters, 5 February 2016)

<http://www.reuters.com/article/argentina-debt-idUSL2N15K2KB> accessed 6 February 2016. 478 Daniel Bases, Richard Lough and Sarah Marsh, ‘Argentina, lead creditors settle 14-year debt battle for $4.65

billion’ (Reuters, 1 March 2016) <http://www.reuters.com/article/us-argentina-debt-idUSKCN0W2249>

accessed 2 March 2016. 479 EMTA, ‘Preliminary Analysis of Creditor Litigation (n 94) 3. 480 Gelpern, ‘Sovereign Damage Control’ (n 187) 9. 481 Brief for the United States of America as Amicus Curiae in Support of Argentina’s Petition for Panel

Rehearing and Rehearing En Banc, NML Capital, Ltd. v. Republic of Argentina, No. 12-105 (2d Cir. Dec. 28,

2012) at 9. 482 Ibid 10. 483 Ibid. 484 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 3. 485 Gelpern, ‘Sovereign Damage Control’ (n 187) 10. 486 Ibid. 487 Ibid.


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theory might yet become practice. The preferential status is not a matter of law, so courts can

decide to disregard it at any time.

However, not everyone seems to think that this decision constitutes the ‘end of sovereign debt

restructuring as we know it’.488 ZAMOUR justly emphasises the fact that this case is all about a

remedial issue and that such issues are highly fact based.489 Consequently, since the outcome

of this case was hugely dependant on the facts, its impact on future cases should be

minimal.490

ZAMOUR does not stand alone in this. A lot of authors support his view.491 Even GELPERN

provides some support, since she points out that the pari passu remedy is arbitrary and that

courts will ‘need to flesh out when a good apple turns bad’.492

Nevertheless, GELPERN’s comment also shows that NML case proves an excellent feeding

ground for speculation, since the Court of Appeals did not provide any guidance as to what a

pari passu breach entails.493 It merely said:

[It] prohibits Argentina, as bond payor, from paying on other bonds without paying on the

FAA Bonds.494 We simply affirm the district court's conclusion that Argentina's

extraordinary behavior was a violation of the particular pari passu clause found in the

FAA.495

However, what does that mean? Does that preclude a ‘payment’ interpretation, or not? In fact,

all that NML v Argentina did, was create even more confusion in an already chaotic discussion

concerning the pari passu clause.

In sum, this decision may or may not disrupt future sovereign debt restructuring. It all

depends on the market’s reaction and each sovereign debt situation should best be approached

488 Zamour, ‘NML v. Argentina’ (n 473) 56. 489 Ibid 65. 490 Ibid 56. 491 H Weisburg H, A E Stolper and S Marzen, ‘Don’t Cry for Me Argentine Bondholders: the Second Circuit

Decides NML Capital v Argentina’ (Shearman & Sterling LLP Client Briefings, 29 October 2012)

<www.emta.org> accessed 26 September 2015; EMTA, ‘Second Circuit Adheres Strictly to the Rules of

Contract in Sovereign Debt Restructuring’ <www.emta.org> accessed 26 September 2015; H Weisburg H, A E

Stolper, S Marzen and Clancy P, ‘Don’t Cry for Me Argentine Bondholders: The Second Circuit Rules’

(Shearman & Sterling LLP Client Briefings, 27 August 2013) <www.emta.org> accessed 26 September 2015;

Day, ‘Market Failure’ (n 11) 246; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 403. 492 Gelpern, ‘Sovereign Damage Control’ (n 187) 12. 493 Zamour, ‘NML v. Argentina’ (n 473) 64; Day, ‘Market Failure’ (n 11) 245. 494 NML Capital, Ltd. v. Argentina, 699 F.3d 246, 259 (2d Cir. 2012). 495 NML Capital, Ltd. v. Argentina 727 F.3d 230, 247 (2d Cir. 2013).


74

on a case-by-case basis.496 Besides, it should be noted that the ‘Exchange Bonds’ of 2005 and

2010 already included a new provision, namely a CAC. This type of clause ensures that

dissenting bondholders are also bound, if a sufficiently large number of bondholders agrees to

an offer. Supposedly, the inclusion of such a clause was intended to prevent any holdout

litigation from occurring under the Exchange Bonds.497 This seems to indicate that sovereign

debtors now think they can prevent holdout litigation by way of CACs. The Court of Appeals

also seemed to think so.498 The question therefore becomes: ‘Will CACs save the day?’. A

more detailed overview on this topic can be found below in Chapter 4 Drafting Is Key to the

Pari Passu-Holdout Issue.

3.3.2.4. Conclusion

Under New York law, the ‘payment’ interpretation is now a fact. It appeared in Elliott, took a

step back in LNC, but was ‘revived’ in NML. Although it is purely fact-depended at the

moment that does not take away the fact that it is out there and that holdouts can rely on it.

However, can the same be said about the other dominant applicable law in a sovereign debt

context? Would English courts reach the same conclusion as their US counterparts?

3.3.3. English Law Litigation

So far, we have focussed on litigation under New York law. However, as stated before,

English law is also of paramount importance when discussing the governing law of debt

instruments. Therefore, the pari passu litigation before the English courts also merits some

attention. Would the English courts rule the same way as their American brethren? Would an

Argentinian ‘Lock Law’ scenario have the same result, or not?

Unfortunately, the answers are nowhere near crystal clear.499 As a matter of fact, there is only

one case with any pari passu relevance, namely Kensington International Ltd v. Republic of

The Congo.500 Other than that, legal doctrine is forced to rely on basic contract interpretation

496 Michael M Chamberlin, ‘Argentina–Implications for the Marketplace?’ (EMTA, November 2012),

<www.emta.org> accessed 26 September 2015. 497 NML Capital, Ltd. v. Argentina, 699 F.3d 246, 253 (2d Cir. 2012). 498 Ibid 264. 499 IMF, ‘Strengthening the Contractual Framework’ (n 279) 13. 500 Kensington International Ltd v. Republic of The Congo ComC (Bailii) [2003] EWHC 2331 (Comm). Upheld

on appeal in Kensington International Ltd. v. Republic of the Congo, [2003] EWCA Civ 709, A3/2003/1036.

(hereinafter: ‘Kensington Ltd v. Congo’).


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principles and –frankly– educated guesses. The whys and wherefores of this situation are

discussed below.

3.3.3.1. Kensington International Ltd v. Republic of The Congo

RELEVANT FACTS

In 1984, a consortium of banks provided the Peoples Republic of Congo with a loan of US$

20 million. This loan, governed by English law, had to be fully repaid by the end of 1988.

However, Congo never managed to repay any principal and from 1985 onwards it did not

even pay any interest. Thus, Congo defaulted on its loan agreement and the creditors decided

to sell the debt. 501

Enter Kensington International Ltd (‘Kensington’). This fund, affiliated with Elliott, bought

the distressed debt at a steep discount and immediately sued Congo seeking a summary

judgement.502 Its claims were as follows: (i) order Congo to pay US$ 56.5 million of principal

and interest, (ii) restrain Congo or its agents from paying any other creditors, (iii) unless

Kensington is paid pro rata and (iv) prevent Congo from granting any other securities over its

assets. Congo, however, never showed up in court, nor did it ever acknowledge the existence

of the lawsuit. So, Judge CRESSWELL was forced to consider the claims without any

counterarguments from Congo.503

Unfortunately for Kensington, Judge CRESSWELL only granted a summary judgment on the

money claim.504 The remaining claims were left unanswered and were simply directed to a

speedy trial. However, was the assignee entitled to the injunctive relief it claimed, or not?

This question required the interpretation of the pari passu clause contained in the loan

agreement. Clause 9(d) read: ‘To procure that the claims of all other parties under this

agreement will rank as general obligations of the People’s Republic of the Congo, at least pari

passu in right and priority of payment with the claims of all other creditors of the People’s

Republic of the Congo […]’.505

Finally, it should be noted that the injunctive relief sought was completely novel and

unprecedented, especially in the light of the facts. Firstly, it concerned an assignee rather than

501 Ibid §1-2 and 4. 502 For more info on summary judgements see note 96. 503 Ibid §10, 11. 504 Ibid §15. 505 Ibid §15.


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an original party. Secondly, the relief was sought in 2002 for an event of default which dated

from 1984 and lastly, the claimant did not have any interest in the case until the assignment in

2000, whereas the loan should have been fully repaid by 1988.506 These facts do explain why

Judge CRESSWELL was unwilling to grant a full summary judgement.

RELEVANT ARGUMENTS

In essence, Kensington tried to convince the court to grant specific performance of both the

negative pledge clause and the pari passu clause. According to Kensington, Congo had

breached these clauses on multiple occasions and therefore, the enforcement of these clauses

by way of injunctive relief was both adequate and proportionate.507

In support of these allegations, Mr MCQUARTER, counsel for Kensington, produced the

following arguments. For a start, he asserted that Congo had a history of violating negative

pledge clauses and that this case was not any different, especially since the negative pledge

clause in question was clear and unambiguous.508 Furthermore, he admitted that the pari

passu clause had been the subject of considerable discussion and that English law lacked any

direct authority on this point. To clarify he pointed out that there were two rival

interpretations. One considered the pari passu clause to be more or less a sharing clause.509

The other said that it had to do with ‘ranking’, meaning an ‘agreement that the debtor will not

create a class of debt or unsecured debt that ranks ahead of the debt created by the particular

loan agreement’.510 Ultimately, he concluded that the pari passu clause could not be anything

else than a pro rata sharing clause511, because:

(i). Pari passu literally means ‘by equal step’.512

(ii). The decision in Bowen v Brecon Railway Company513’strongly suggests that the pari

passu clause means that money to be distributed should be distributed or paid on a pari

passu basis’.514

(iii). The wording of the clause clearly puts emphasis on ‘payment’.515

506 Ibid §14. 507 Ibid §25-26. 508 Ibid §27-28. 509 A pro rata sharing clause guarantees that if one creditor receives a greater (i.e. disproportionate) payment, it

has to share it rateably with the others. 510 Kensington Ltd v. Congo (n 500) §53. 511 Ibid §54. 512 Ibid §56. 513 Bowen v Brecon Railway Company (1867) LR 3 Eq 541. 514 Kensington Ltd v. Congo (n 500) §57.


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(iv). A ranking interpretation makes little sense in a sovereign context. In a corporate

context the pari passu clause might preserve a creditor’s ranking in an insolvency

situation. However, in a sovereign context there is no insolvency, so the clause must

have another meaning altogether. More specifically, extra creditor protection in the

form of a pro rata payment rule.516

(v). Foreign authority may have some (indirect) bearing, because in Merchant Bills

Corporation Limited v Permanent Nominees Australia Limited517, Red Mountain

Finance v The Democratic Republic of Congo518 and Elliott v. Peru519 three separate

jurisdictions supported a ‘payment’ interpretation of the pari passu.


Judge TOMLINSON considered the claim for specific performance and came to the following

conclusions. The negative pledge clause had indeed been breached. The clause was clear and

unambiguous and Congo had become notorious for violating it in all its agreements.520 The

pari passu clause arguments, however, did not convince the court. According to TOMLISON

‘little weight’ could be attached to the foreign authorities, because the state in question were

not part of the procedures or the decision itself lacked in reasoning.521 Besides, he also

doubted the legal correctness of the broader interpretation and cited the Encyclopaedia of

Banking Law to support his view:

It should also be observed that the pari passu clause has nothing to do with the time of

payment of unsecured indebtedness, since this depends upon contractual maturities. The

undertaking is not broken merely because one creditor is, in fact, paid before another. In

the case of a state borrower, the pari passu clause must bear a different construction, since

a government cannot be liquidated […] Hence, a statutorily enforced hierarchy on forced

dissolution is not in point. It is suggested that a pari passu clause in state creditors is

primarily intended to prevent the legislative ear-marking of revenues of the government,

or the legislative allocation of inadequate foreign currency reserves to a single creditor

and is generally directed against legal measures which have the effect of preferring one

515 Ibid §59. 516 Ibid § 60. 517 Bowen v Brecon Railway Company (1867) LR 3 Eq 541. 518 Red Mountain Finance v The Democratic Republic of Congo, Case No. CV 00-0164 R (C.D. Cal. 29th May,

2001). 519 Brussel, 26 September 2000, 8e Kamer, AR nr. 2000/QR/92. 520 Kensington Ltd v. Congo (n 500) §30 and 43. 521 Ibid §62-63.


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set of creditors over the others or discriminating between creditors at a time when the

state is unable to pay its debts as they fall due.522

Whatever the case, TOMLISON decided that interpreting the pari passu clause was

unnecessary.523 In the end, he simply refused to grant injunctive relief because Kensington

could not tell the court what its considerations were when it acquired the debt, especially since

the breaches had been continuing for at least 18 years.524


Most authors consider Kensington a landmark case for pari passu interpretation under English

law.525 While the court did not choose one interpretation over the other, it clearly showed

reservations regarding the legal correctness of a ‘payment’ interpretation. In other words, the

court implicitly rejected the ‘payment’ interpretation set forth in Elliott v. Peru.526 Moreover,

these authors opine that this line of reasoning is complementary to the ‘ICS principles’ found

in Investors Compensation Scheme Ltd v West Bromwich Building Society (the ‘ICS case’).527

More specifically, they refer to the principle of ‘business common sense’ and the market

understanding of the word ‘rank’.528

In fact, when considering ambiguous contract clauses, the starting point under English law is

the so-called ‘five canons’ approach or the ‘ICS principles’ of Lord Hoffmann.529 In his

ground-breaking ICS judgement, he briefly summarized all contract interpretation rules in the

following five guidelines: 530

(i). The Intention of the Parties Is Objective.

(ii). The ‘Matrix of Facts’.

(iii). The Exclusions From the ‘Matrix of Facts’.

522 Ibid §67 (emphasis added). 523 Ibid §91. 524 Ibid §92. 525 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 10; Olivares-Caminal,

‘Understanding the Pari Passu’ (n 7) 1229; Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n

27) 12. Andrew Shaw, however, does not see this case as a persuasive authority. (See Shaw, ’Ways to get paid in

a sovereign default’ (n 234) 631). 526 United States Court of Appeals_NML, p 45. 527 Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] AC 896. 528 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 9 and 12. 529 H Harris, ‘Contractual Interpretation: the "Five Canons"’ < http://www.crippslink.com/index.php?option=

com_content&view=article&id=1176:contractual-interpretation-the-qfive-canonsq&catid=88:commercial-

law&Itemid=626> accessed 21 February 2016; JW Carter, The Construction of Commercial Contracts (Hart

Publishing 2013); Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 267. 530 S Steiger, ‘Burning Question: Contract interpretation’ <http://www.lawcareers.net/Information/

BurningQuestion/Ince-Co-LLP-Contract-interpretation> accessed 21 February 2016.


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(iv). The words used in a contract do not have to be taken literally.

(v). Something Must Have Gone Wrong With the Language.

What these guidelines actually try to convey, is that English courts need to interpret contract

clauses in a purposive way, rather than a literal way.531 So, when a court is faced with an

ambiguous clause it has to consider the following question: What does the clause mean to a

reasonable person having access to all background knowledge that was available to the

parties? If the clause, read literally, leads to an absurdity in the light of the background

information, then the court should be able to assign a more appropriate meaning to it.

The latter is actually the principle of ‘business common sense’, which was first set forth by

the House of Lords in the Antaios532 case and was later endorsed by following case law533. At

the time, Lord DIPLOCK said ‘if detailed semantic and syntactical analysis of a written contract

lead to a conclusion that flouts business commonsense the contract must be made to yield to

business commonsense.’534 So, while the ‘payment’ interpretation might seem correct at first

glance, one cannot disregard the fact that the parties could never have intended it, especially

because of the far-reaching consequences such an interpretation entails.535 Besides, the legal

history of the clause is also relevant.536 Therefore, the ‘ranking’ interpretation is the correct

interpretation under English law.

This conclusion is held by reputable authorities. Chief among these is the Financial Markets

Law Committee (‘FMLC’). This independent committee, affiliated with the Bank of England,

identifies legal issues, uncertainties and misunderstandings on the financial market and it

opined that ‘the payment interpretation of the pari passu clause is unsupportable as a matter

of English law except where the clause is very clearly drafted to achieve this effect.’537

Also practitioners, such as renowned law firms Allen & Overy and Clifford Chance, opined

that the ‘ranking’ interpretation is the only correct one under English Law.538 In fact, lawyers

531 Ibid. 532 Antaios Compania Naviera S.A. v. Salen Rederierna A.B. 1 [1985] A.C. 191. 533 Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] AC 896, Rainy Sky SA and

others v Kookim Bank [2011] UKSC 50; BMA Special Opportunity Hub Fund Ltd and others v African

Minerals Finance Ltd (2013). 534 Ibid at 201. 535 See supra 3.3.2.2.6 Elliott Associates v. Banco de la Nacion. 536 Tolek N Petch, ‘NML v Argentina in an English legal setting’ (2014) 9 (3) CMPLJ 266, 268. 537 FMLC, ‘Analysis of the role, use and meaning of pari passu clauses’ (n 234) 12; Allen & Overy Global

Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 12. 538 Allen & Overy Global Intelligence Unit, ‘The Pari Passu Clause’ (n 27) 13.


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at Allen & Overy go one step further and doubt that even a ‘Lock Law’ scenario (cf.

Argentina) would change an English Court’s view on the matter. Though it would be seen as a

breach of the (ranking) pari passu, it probably would not lead to pro rata payments as a

remedy. 539 It should be noted that Allen & Overy does not stand alone on this matter. Other

authors, such as SHAW and PETCH have voiced similar opinions.540

3.3.3.2. Conclusion: The English Differ From the Americans

Although there is no direct (judicial) authority on the matter, it is safe to assume that under

English law the ‘payment’ interpretation of the pari passu would not fly, not even in a ‘Lock

Law’ scenario. The prime reason being that such an interpretation flouts basic contractual

interpretation principles under English law, namely the business common sense principle.

Indeed, the consequences of such an interpretation are simply to far-reaching and no

sovereign borrower would ever agree to such terms. Therefore, contractual mechanisms are

the only way –short of a statutory approach– to prevent future disputes with holdouts.

539 Ibid. 540 Shaw, ’Ways to get paid in a sovereign default’ (n 234) 63; Tolek N Petch, ‘NML v Argentina in an English

legal setting’ (2014) 9 (3) CMPLJ 266, 271.

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3.3.4. Conclusion: Where Did the Waves of Litigation Lead Us?

The presence of ‘payment’ language541 in certain pari passu clauses has resulted in quite a bit

of litigation in the sovereign debt context. Where once the ‘ranking’ interpretation was the

only interpretation, vulture funds now adhere to a second, ‘payment’, interpretation.

Although a literal read of some pari passu clauses might lead one to believe that the

‘payment’ interpretation is indeed valid, one cannot simply disregard all other possible

explanations. However, in the Elliott case, where the ‘payment’ interpretation made its debut,

the Belgian Court of Appeals did just that. It mindlessly followed a misguided declaration by

professor LOWENFIELD and plunged the sovereign debt sector into chaos.

Unfortunately, the NML case only added to that chaos and created a ‘new’ opening for vulture

funds. If the facts allow it, vulture funds can now request a ‘rateable payment’ remedy for a

breach of a pari passu clause. Although this is more of a remedy issue than an interpretation

issue, the result is more or less the same. Sovereign debtors are no longer be able to pay the

milk man. Instead, they are forced to settle.

However, it must be noted that this course of action is highly fact-based, so the significance of

NML is rather limited. Besides, the ‘payment’ interpretation only flies under New York law.

English courts (would) completely disregard it.

In essence, the ‘payment’ interpretation is the result of mindless copy paste behaviour and

complete disregard of the historical background of the pari passu clause. Obviously, the

advocates of the ‘payment’ interpretation choose to disregard this fact. Little wonder, since

this theory provides vulture funds with a lot of leverage over their sovereign debtor. The

consequences are simply not their problem. From their perspective, they have finally found a

way to force sovereign debtors to settle and get paid, even though it might take them a while

to obtain the desired judgement.

3.4. CONCLUSION: DRAFTING IS KEY?

The analysis of the pari passu clause’s history and litigation has revealed one thing. There is a

distinct lack of judicial clarity and no real market understanding concerning the clause. In

fact, two interpretations are possible, though both are largely a matter of perspective.

541 E.g. rank at least pari passu in priority of payment.


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Historically, there is only one real interpretation, namely anything that has to do with legal

‘ranking’, meaning sovereign debtors should not create preference with regard to collateral,

nor earmark certain revenues, nor involuntary subordinate certain creditors by law. However,

ever since the Elliott case a new interpretation has surfaced. According to its advocates, the

‘payment’ interpretation precludes a sovereign debtor from paying any unsecured creditors,

without concurrently paying other unsecured creditors pro rata.

In addition, both these interpretations have their own sets of consequences. As mentioned

before the ‘ranking’ interpretation tries to uphold equality between creditors by preventing

any form of subordination. The ‘payment’ interpretation, on the other hand, has far-reaching

consequences. In a nutshell, it provides holdout creditors with leverage, but in doing so, it

creates all kinds of potential absurdities such as (i) being unable to prioritise payments, thus

jeopardizing the official sector’s preferential status, (ii) rendering real equality clauses useless

(i.e. sharing clauses, acceleration clauses…), (iii) destabilising sovereign debt restructuring

and (iv) affecting third parties which renders exchange bondholders hostages. Basically, it

would even make paying the milkman impossible.

Evidently, both the authors and parties involved argue back and forth about these

interpretations and their consequences. However, neither of them have any neutrality

regarding the meaning of the clause. In the end, it all boils down to a matter of perspective.

Sovereign debtors and exchange bondholders seek to block any payments to holdouts and try

to force them to participate in debt-restructuring, while holdouts endeavour to use the pari

passu as leverage to force sovereign states into settlements.

In any event, the cases referred to above have shown that litigation is definitely not an

efficient mechanism to address the sovereign immunity-bankruptcy standoff. Even though

holdouts always prevailed in the end by managing to force a sovereign state to settle, the time

and extreme effort it takes to obtain that goal hardly bodes well for an efficient approach.

One thing is for sure, BRATTON was right when he said that the ex post ‘payment’

interpretation highlighted the vulnerability of a purely contractual debt framework.542

However, lacking any statutory regime, the only other option is looking for the best way

mitigate the holdout issue or prevent it altogether. Therefore, construing the pari passu clause

542 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 867; Wong, ‘NML Capital, Ltd. v. Republic of

Argentina’ (n 287) 403.

C o n c l u s i o n : D r a f t i n g i s K e y ?

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as clearly as possible and inserting certain other clauses such as CACs and exit consents,

might preclude or at least prevent holdouts from forcing a settlement via litigation.

Meanwhile, in the absence of clear contractual provisions, courts would do best to approach

each sovereign debt restructuring on a case-by-case basis.

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DRAFTING IS KEY TO THE PARI PASSU-HOLDOUT ISSUE

Holdouts are faced with a sovereign immunity-bankruptcy situation. Lacking any other

recourse, they use whatever strategy available to achieve their goal of full repayment. As was

shown in the previous chapter, one of those tactics includes using the pari passu clause as an

enforcement device in sovereign debt litigation. Although its use is heavily debated and courts

do not give any crystal-clear indications on the matter, sovereigns still risk to encounter this

enforcement technique. Unfortunately, tackling the pari passu issue would merely be a

symptomatic solution. Holdouts, or more specially, the lack of creditor coordination, are the

root of the problem.

This chapter will therefore shed some light on the possible ways to mitigate the parri passu

conundrum and the holdout issue in general. First of all, this chapter will address the pari

passu clause. Secondly, it will discuss the legislative and contractual techniques to mitigate

the holdout issue –determining the pros and cons of each solution. Finally, it will provide a

possible approach to solve or at least mitigate the holdout issue.

However, it should be noted up front that these techniques are merely theoretical. No one

knows how the market or the courts will interpret them.543 Even the slightest hint of a

potentially profitable way to sue a sovereign debtor for full payment will entice creditors to

opt for litigation.544 As a result, introducing these measures creates ‘uncertainty’ costs.545

Besides, every issuance of bonds is unique and the terms differ accordingly. Consequently,

there is no all-round solution to the holdout issue.

4.1. TACKLING THE PARI PASSU ISSUE

Sovereign states have not been blind to the dangers a pari passu clause poses to potential

restructuring efforts.546 Cases such as Elliott v. Peru and NML v. Argentina have led to all

kinds of changes in the sovereign debt landscape, ranging from legislative to contractual

solutions.

543 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2501. 544 Broomfield, ‘Subduing the Vultures’ (n 204) 502. 545 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2501. 546 IMF, ‘Strengthening the Contractual Framework’ (n 279) 14.

D r a f t i n g i s K e y t o t h e P a r i P a s s u - H o l d o u t I s s u e

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As mentioned before, LNC Investment v. Nicaragua led to a change in Belgian law. In fact,

the Settlement Finality Law was amended in such a way that it would prevent any future

attempt to intercept payments at Euroclear via the pari passu clause. However, this action

only tackled the symptoms, not the root of the problem.

Apart from a legislative approach, some contractual modifications are possible that might

mitigate or solve the pari passu issue.

The most radical approach is probably the one hinted at by GULATI and SCOTT.547 They

implied that drafters could simply do away with the pari passu clause entirely. Since no one

really knows what this clause actually means, why bother to insert it in the debt instrument at

all? However, this idea completely disregards the fact that a pari passu clause prevents

involuntary subordination of the debt by the sovereign debtor. Thus, this approach is hardly a

viable option.

On the other hand, some sovereigns –e.g. Ecuador, Honduras and Mexico– adopted a less

radical approach. Instead of eliminating the pari passu clause entirely, they either changed the

language of the clause, clarified its meaning in the offering memorandum, or identified the

risk in the prospectus.548 Even though their methods differed, the end result was the same: a

specific exclusion of the ‘payment’ interpretation and the rateable payment remedy.549

The International Capital Markets Association (the ‘ICMA’) took note of this development

and proposed a model pari passu clause to facilitate any future sovereign debt restructurings.

It reads as follows:

The Notes are the direct, unconditional and unsecured obligations of the Issuer and rank

and will rank pari passu, without preference among themselves, with all other unsecured

External Indebtedness of the Issuer, from time to time outstanding, provided, however,

that the Issuer shall have no obligation to effect equal or rateable payment(s) at any time

with respect to any such other External Indebtedness and, in particular, shall have no

547 Gulati and Scott, The Three and a Half Minute Transaction (n 40) 157; (See also Mark L J Wright, ‘The Pari

Passu Clause in Sovereign Bond Contracts: Evolution or Intelligent Design?’ (2014) 40 Hofstra L. Rev. 103,

103-104). 548 IMF, ‘Strengthening the Contractual Framework’ (n 279) 14. 549 Ibid.

H o l d i n g t h e H o l d o u t s

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obligation to pay other External Indebtedness at the same time or as a condition of paying

sums due on the Notes and vice versa.550

This model has received wide support from both the IMF and practitioners.551 Similarly to

Ecuador, this clause chose to directly exclude any ‘payment’ interpretation or rateable

payment remedy. However, perhaps the most important thing to note, is that there is no

evidence to suggest that inserting this clause in bond documentation causes ‘uncertainty

costs’.552 Apparently, the market thinks its meaning is quite straightforward.

Be that as it may, the ICMA’s approach targets only the (mis)use of the pari passu clause. As

shown by NML v Argentina, 553 some courts might allow the breach of a pari passu clause to

be remedied by a rateable payment –albeit under very specific circumstances. Therefore, to

prevent the use of yet another far-fetched remedy, it might be advisable to include a remedy

other than ‘acceleration’. For instance, a specific pool of assets that can be attached upon

breach. That, coupled with the ICMA’s model pari passu clause, might be enough to put an

end to the misuse of the pari passu once and for all.

All things considered, solving the pari passu issue itself is not that hard from a drafter’s

perspective. It only takes some diligent drafting and careful wording of the clause,

supplemented with clauses that remedy breaches of the pari passu. Conversely, solving the

actual problem –the holdout issue in general– is a whole other matter.

4.2. HOLDING THE HOLDOUTS

Sovereign debt restructuring is voluntary by nature. As a result, bondholders are free to opt in

or opt out of an exchange offer. In addition, the increased atomisation of bondholders and the

resulting divergence of interests only enhance the creditor coordination issue. Hence, holdout

creditors are definitely the major stumbling block of a sovereign debt restructuring and

finding a solution to the holdout issue is paramount. Therefore, this section provides a brief

overview of (primarily) contractual techniques that address this participation issue. To

550 ICMA, ‘Standard Collective Actions Clauses, Pari Passu and Creditor Engagement Provisions for the Terms

and Conditions of Sovereign Notes’ <http://www.icmagroup.org/resources/Sovereign-Debt-Information/>

accessed 21 April 2016, (hereinafter: ICMA, ‘Standard Provisions’) (emphasis added). 551 IMF, ‘Strengthening the Contractual Framework’ (n 279) 15; Stephen Moverley QC Smith and Heather

Murphy, ‘Sovereign Bond Collective Action Clauses: Issues Arising’ [2015] 2 JIBFL 128A 2. 552 IMF, ‘Strengthening the Contractual Framework’ (n 279) 15. 553 See supra 3.3.2.3.8 NML Capital Ltd. v Argentina.


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conclude, this section will also provide a possible approach to solve or at least mitigate the

holdout issue.

4.2.1. Three Approaches to Curb Holdout Power

Generally speaking, there are three ways to tackle the holdout issue: (i) a statutory approach,

which proffers a sovereign insolvency regime (e.g. the SDRM) or limits vulture funds’

activities, (ii) a market-based approach, which uses corporate restructuring techniques such as

CACs and exit consents to emulate features of bankruptcy, and (iii) a contractual approach,

which focuses on contractual provisions that facilitate a restructuring.554

4.2.2. The Statutory Approach

As mentioned before, a statutory approach is politically impossible. The IMF tried, but failed

to implement the SDRM due to the tremendous amount of criticism it received. Moreover,

there is even evidence to suggest that the market intentionally came up with contractual

alternatives to block the SDRM initiative.555 However, this raises another question entirely:

What if that was the IMF’s intention all along –getting the market to address the holdout issue

itself?556

In addition to the SDRM failure, some countries have adopted legislation that curbs vulture

fund activity.557 Pioneering this initiative, was Belgium.558 In 2007 the Belgian market was

flooded with vulture fund litigation.559 For instance, Kensington International Ltd. managed to

seize money earmarked by the Belgian government for development aid projects in the

554 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1094; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;

Warren and Avery, ‘Investors of Prey’ (n 204) 225-226.

555 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1643, 1649 and 1674; Gelpern, ’Contract Hope’ (n 20) 143. 556 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1650. 557 Broomfield, ‘Subduing the Vultures’ (n 204) 503; Sookun, Stop Vulture Fund Lawsuits (n 191) 87-91;

Warren and Avery, ‘Investors of Prey’ (n 204) 225-226; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507. 558 Patrick Wautelet, ‘Vulture funds, creditors and sovereign debtors: how to find a balance?’ (2011) 20

<https://orbi.ulg.ac.be/bitstream/2268/87549/1/Vulture%20funds%20and%20sovereign%20debtors%20Wautelet

.pdf> accessed 24 April 2016, (hereinafter: Wautelet,’Vulture Funds’); Human Rights Council Advisory

Committee, ‘Draft progress report on the activities of vulture funds and the impact on human rights’ (OHCHR

2015) 14 <http://www.ohchr.org/Documents/HRBodies/HRCouncil/AdvisoryCom/Session15/A_HRC_AC_15_

CRP_1.doc> accessed 24 April 2016, (hereinafter: OHCHR,’Draft Progress Report’). 559 Warren and Avery, ‘Investors of Prey’ (n 204) 225.


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Democratic Republic of the Congo.560 Consequently, a new law561 was passed to keep future

development aid money out of the clutches of vulture funds.562

However, the scope of the Belgian law is rather limited.563 It reads: ‘[T]he funds and assets

which are earmarked for international cooperation as well as the funds and assets earmarked

for public development aid, other than those of the international cooperation, cannot be

attached nor assigned.’564 The law specifically safeguards money intended for development

and international cooperation, but it does not provide a general prohibition on vulture funds

activity in Belgium.

In 2014, another attempt was made to curtail vulture funds in Belgium.565 This time, the law

proposal provided a detailed legal framework and included indicative criteria to identify

vulture funds.566 The aim of the law was to help the judges determine if a creditor’s actions

were contrary to public interest and ‘immoral’.567 Unfortunately, the law proposal was

retracted in May 2015.568

Following Belgium’s example, the United Kingdom enacted the ‘Debt Relief (Developing

Countries) Act in 2010.569 However, its approach was a little more aggressive vis-à-vis

vulture funds than the Belgian initiative. In essence, the act sought to clip the wings of

vulture funds by (i) putting a cap on vulture fund repayment, (ii) demanding disclosure of

secret vulture fund activity when bringing a lawsuit, (iii) imposing transparency rules and (iv)

banning corrupt payments.570 Be that as it may, its scope was still limited since it only

560 Sookun, Stop Vulture Fund Lawsuits (n 191) 88; OHCHR,’Draft Progress Report’ (n 558) 14. 561 Wet van 6 maart 2008 die ertoe strekt de inbeslagneming of de overdracht te verhinderen van overheidsgeld

besteed voor de internationale samenwerking, met name via de techniek van de aasgierfondsen. In fact, this law

inserted a new provision in the law of 25 May 1999. (Art. 11bis Wet van 25 mei 1999 betreffende de Belgische

internationale samenwerking). 562 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507; OHCHR,’Draft Progress Report’ (n 558) 14. 563 Broomfield, ‘Subduing the Vultures’ (n 204) 503; Warren and Avery, ‘Investors of Prey’ (n 204) 225. 564 Unofficial translation of art. 11bis Wet van 25 mei 1999 betreffende de Belgische internationale

samenwerking by Patrick Wautelet (See Wautelet,’Vulture Funds’ (n 558) 21). 565 OHCHR,’Draft Progress Report’ (n 558) 15. 566 Ibid. 567 Ibid. 568<https://www.dekamer.be/kvvcr/showpage.cfm?section=/flwb&language=nl&cfm=flwbn.cfm?lang=N&legisl

at=54&dossierID=0394> accessed 26 April 2016. 569 Broomfield, ‘Subduing the Vultures’ (n 204) 507; Warren and Avery, ‘Investors of Prey’ (n 204) 226; Ryan,

‘Sovereign Bankruptcy’ (n 3) 2507. 570 Sookun, Stop Vulture Fund Lawsuits (n 191) 89; OHCHR,’Draft Progress Report’ (n 558) 14.


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protected so-called ‘Heavily Indebted Poor Countries’ (‘HIPCs’) countries from vulture fund

activity in the UK.571

Similarly, the United States of America attempted to aggressively curtail vulture fund

activity.572 The bill was known as the Stop Vulture Funds Bill and it imposed a maximum

recoverable amount for vulture funds, namely the purchase price plus 6% interest.573 Under

this bill, a limited number of countries, qualifying as poor countries574, would have been

protected from vulture fund activity. Unfortunately, this bill never made it into law.575

On the whole, several states do take steps to enact legislation that curtails vulture fund

activity. Nevertheless, their initiatives lack the power to address the holdout situation

effectively.576 It is quite clear that more (aggressive) legislation is necessary.577 Unfortunately,

political traction for a more aggressive stance –genre SDRM– is absent.

4.2.3. The Market-Based Approach: Exit Consents and Collective Action Clauses

Lacking an effective legislative solution, some authors proclaim a market-based approach as

the way forward.578 According to them, the solution to the holdout issue might be found in

corporate restructuring techniques such as collective action clauses (‘CACs’) and exit

consents.

571 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507. 572 Broomfield, ‘Subduing the Vultures’ (n 204) 507; Warren and Avery, ‘Investors of Prey’ (n 204) 226-227. 573 Ibid; Sookun, Stop Vulture Fund Lawsuits (n 191) 90-91. 574 I.e. those countries that can borrow from the International Development Association (see Broomfield,

‘Subduing the Vultures’ (n 204) 507). 575 Sookun, Stop Vulture Fund Lawsuits (n 191) 90-91; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2507. 576 Wautelet,’Vulture Funds’ (n Wautelet,’Vulture Funds’) 22; OHCHR,’Draft Progress Report’ (n 558) 16. 577 Ibid. 578 See in general Barry Eichengreen and Richard Portes, Crisis, What Crisis? Orderly Workouts for Sovereign

Debtors (Center for Economic Policy Research, 1995); Lee C Buchheit and G Mitu Gulati, ‘Exit Consents in

Sovereign Bond Echanges’ (2000) 48 UCLA L. Rev. 59, (hereinafter: Buchheit and Gulati, ‘Exit Consents’); Lee

C Buchheit and G Mitu Gulati, ’Sovereign Bonds and the Collective Will’ (2002) 51 Emory L J 1318

(hereinafter: Buchheit and Gulati, ‘Sovereign Bonds’); Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639;

Olivares-Caminal, ‘Is There a Need’ (n 2) 21; Gelpern, ’Contract Hope’ (n 20) 132; W Mark C Weidemaier and

G Mitu Gulati, ‘A People’s History of Collective Action Clauses’ (2013) 54 Va. J. Int'l L. 52, (hereinafter:

Weidemaier and Gulati, ‘A People’s History’); Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt

Instruments’ (n 25) 121; Naoki Ishikawa, ‘Towards the Holy Grail of Orderly Sovereign Debt Restructuring Part

I: The Use of CACs in Sovereign Debt Financing’ (2007) 6 JIBFL 333, (hereinafter: Ishikawa ‘Towards the

Holy Grail Part I’); Naoki Ishikawa ‘Towards the Holy Grail of Orderly Sovereign Debt Restructuring Part II:

Optimum Architecture of Collective Action Clauses’ (2007) 7 JIBFL 404, (hereinafter: Ishikawa ‘Towards the

Holy Grail Part II’).


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4.2.3.1. Collective Action Clauses or CACs

Sovereign debt restructuring is voluntary by nature. As a result, individual bondholders can

choose to holdout rather than participate, even though it might be in the creditors’ collective

best interests to do so.579 Moreover, the shift from bank lending to bond issuance led to an

increased atomisation of bondholders, which only strengthened the coordination issue.580 In a

corporate context such creditor coordination issues are resolved via the bankruptcy regime.581

Unfortunately, no such framework exists for sovereigns. Therefore, CACs can be used to fix

this problem in a sovereign debt context.582

4.2.3.1.1. What Are Collective Action Clauses?

In the broad sense of the word, CACs are clauses specifically designed to remedy bondholder

coordination issues.583 However, CACs can take on many forms. For instance, (i) majority

action clauses or modification clauses enable a defined percentage of bondholders –usually

75 per cent in principal amount– to amend any of the terms and conditions of the bonds in a

vote that is binding for all holders of that bond, (ii) aggregation clauses enable cross-border

bond-modification votes, (iii) collective representation or engagement clauses coordinate the

representation of the bondholders as a group by appointing a representative or a committee to

negotiate on their behalf upon default, (iv) majority enforcement or acceleration clauses

prevent an individual creditor from demanding full payment or suing the sovereign debtor

after a default, unless a predetermined percentage of bondholders approves it and (v) sharing

clauses force creditors who obtain (litigation) proceeds from the sovereign debtor to share

them among all creditors on a pro rata basis.584

Within this myriad assortment of CACs there are two types of clauses that form the

centrepiece of the CAC discourse.585 The first is a majority action clause, the second a

579 IMF, ‘Strengthening the Contractual Framework’ (n 279) 16. 580 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1320; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84)

43. 581 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639. 582 Gelpern, ’Contract Hope’ (n 20) 143. 583 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639; Weidemaier and Gulati, ‘A People’s History’ (n 578) 64;

Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502; Samples, ‘Rogue Trends’ (n 13) 83; Turchi, ‘Restructuring a

Sovereign Bond Pari Passu Work Around’ (n 25) 2183. 584 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1641; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43;

Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 46; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;

Weidemaier and Gulati, ‘A People’s History’ (n 578) 53. 585 International Monetary Fund, ‘The Design and Effectiveness of Collective Action Clauses’ (2002) 2

<https://www.imf.org/external/np/psi/2002/eng/060602.pdf> accessed 30 April 2016, (hereinafter: IMF, ‘The


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majority enforcement clause. In fact, the other types of CACs586 merely have a supportive

role.587

It is generally understood that modification of (payment) terms and the ability to curtail

individual enforcement rights, could facilitate sovereign debt restructuring significantly.588

Indeed, bonds can be restructured via CACs despite the objections of the minority

bondholders.589 However, if that is truly the case, why did it take until 2003 for CACs to

become widespread in bonds issued under New York law? Besides, are these clauses even

legal?

4.2.3.1.2. The History of CACs

CACs are not something new or innovative. On the contrary, they have been around for more

than a century –just not in sovereign debt instruments issued under New York law.590 In fact,

the origin of CACs can be traced back to 1879.591 Ever since, they have been a ‘regular

feature’ of English bonds.592

In the early nineteenth century, English corporate bonds were characterised by unanimous

action clauses or ‘UACs’.593 This meant that the terms could not be changed without the

consent of all bondholders.594 In addition, English law lacked a US Chapter 11 bankruptcy

regime that allowed debtors to reorganise debt in order to avoid liquidation.595 As a result, a

minority of creditors, unwilling to cooperate in voluntary debt restructurings, could force

distressed corporate debtors into bankruptcy and subsequently liquidation.596 Needless to say,

Design’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43; Olivares-Caminal, ‘Is There a Need’ (n 2)

30; Gelpern, ’Contract Hope’ (n 20) 143; Weidemaier and Gulati, ‘A People’s History’ (n 578) 53. 586 Such as trustee clauses, information provision clauses, representation clauses… 587 Ishikawa ‘Towards the Holy Grail Part II’ (n 578). 588 International Monetary Fund, ’Collective Action Clauses in Sovereign Bond Contracts—Encouraging Greater

Use’ (2002) 3 <https://www.imf.org/external/np/psi/2002/eng/060602a.htm> accessed 30 April 2016,

(hereinafter: IMF, ‘Collective Action Clauses’); Das and others, ‘Sovereign Debt Restructurings’ (n 25) 44;

Ishikawa ‘Towards the Holy Grail Part I’ (n 578); Olivares-Caminal, ‘Is There a Need’ (n 2) 33; Weidemaier and

Gulati, ‘A People’s History’ (n 578) 53. 589 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1097. 590 Ibid. Das and others, ‘Sovereign Debt Restructurings’ (n 25) 44. 591 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325; Olivares-Caminal, ‘Is There a Need’ (n 2) 30; 592 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1321, IMF, ‘Collective Action Clauses’ (n 588) 3; Fisch and

Gentile, ‘Vultures or Vanguards’ (n 42) 1097; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work

Around’ (n 25) 2183. 593 IMF, ‘Collective Action Clauses’ (n 588) 3. 594 Ibid. Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324. 595 IMF, ‘Collective Action Clauses’ (n 588) 3; Olivares-Caminal, ‘Is There a Need’ (n 2) 30. 596 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324.


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some creditors (i.e. holdouts) used this ‘threat of liquidation’ to obtain preferential

treatment.597

After years of enduring this structural flaw in corporate debt, the London market reacted and

introduced CACs to fix the issue.598 The father of this new clause was Sir Francis B.

Palmer.599 In his opus Company Precedents, he briefly explained the use of CACs:

It is by no means uncommon [anno1881] to insert [majority action clauses] in a debenture

trust deed, enabling the majority to bind the minority in respect of various matters. […]

Now it sometimes happens that a company which has raised a large sum on debentures

[i.e. bonds] falls into temporary difficulties, and, though a large majority of its debenture

holders may be willing to give time or make some reasonable arrangement, a minority

decline to concur, and, in the result, the company is forced into liquidation. The insertion

of [majority action] provisions […] meets this inconvenience, and may save the majority

from the tyranny of the minority.600

Apparently, CACs were the London market’s reaction to the so-called ‘tyranny of the

minority’.601 Ever since they have been present in both sovereign and corporate bonds issued

under English Law.602 Oddly enough, prior to 2003 CACs were absent from the New York

market.603 This raises the question: why?

In the late nineteenth century, US bond issuers were plagued by the same issues as their

English brethren.604 When a US debtor had troubles servicing his debt, he was also faced with

the ‘threat of liquidation’.605 Indeed, it was not until 1934 that a ‘US Chapter 11

reorganisation’ became possible.606 Meanwhile, creditors had to endure the ‘tyranny of the

minority’ in the event of restructuring negotiations. Surprisingly, the US market did not react

with CACs to resolve this issue, instead they opted for equity receivership, UACs and exit

597 Ibid. 598 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1324; IMF, ‘Collective Action Clauses’ (n 588) 3. 599 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325. 600 Francis B Palmer, Company Precedents 271 (2nd ed., Stevens and Sons, 1881), (emphasis added). 601 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1325. 602 Ibid. 603 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 43; Gelpern and Gulati, ‘Public Symbol’ (n 90) 1639;

Broomfield, ‘Subduing the Vultures’ (n 204) 498; Gelpern, ’Contract Hope’ (n 20) 143; Turchi, ‘Restructuring a

Sovereign Bond Pari Passu Work Around’ (n 25) 2183. 604 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1326. 605 Ibid. 606 Ibid.


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consents.607 Needless to say, this makes one wonder why two similar situations were solved

differently.

The origin of the market’s reluctance lay in the Negotiable Instruments Law (‘NIL’).608

Apparently, the market feared that the use of CACs would damage a bond’s status as

negotiable instrument.609 The NIL regarded negotiable instruments as unconditional promises

or orders to pay at a fixed or determinable time.610 The ability to modify terms via CACs

would undermine that. Therefore, the market had to come up with another solution: ‘equity

receivership’.611

In essence, equity receivership constituted a court-supervised restructuring.612 However, it

was soon replaced by a Chapter 11-style reorganisation in 1934.613 Although some voices

cried out for the use of CACs, the –newly created– Securities and Exchange Commission

(‘SEC’) was not a fan.614 The SEC’s research had shown that CACs did mitigate the ‘tyranny

of the minority’, but at the cost of creating a ‘tyranny of the majority’.615 Besides, the SEC

feared corporate insiders might abuse the CACs for their personal gain. For instance, equity

owners could buy up distressed debt of their company, only to reduce or forgive the debt

through the use of CACs.616

Since this practice was completely contrary to normal bankruptcy proceedings, the United

states inserted a new section in the Trust Indenture Act of 1939 (‘TIA’).617 Under section

316(b) of the TIA –the so-called ‘voting prohibition’– the use of CACs to modify payment

terms of publicly traded corporate bonds was expressly prohibited.618 It should be noted that

modification of payment terms was still possible, but it required the consent of every

bondholder (i.e. UAC).619 Oddly enough, almost all bond issuances followed the TIA-driven

607 See infra 4.2.3.2 Exit Consents. 608 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1326. 609 Ibid. 610 Ibid. 611 Ibid. 612 Ibid 1327; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 71; Olivares-Caminal, ‘Is There a Need’ (n 2)

29. 613 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1327. 614 Ibid. 615 Ibid 1328. 616 Ibid. 617 Ibid; Gelpern and Gulati, ‘Public Symbol’ (n 90) 1705; Weidemaier and Gulati, ‘A People’s History’ (n 578)

59. 618 Ibid; Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 53; Olivares-Caminal, ‘Is There a Need’ (n 2) 30. 619 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1705; Olivares-Caminal, ‘Is There a Need’ (n 2) 30.


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approach of UACs, even though the TIA contained an exception and was not applicable to

foreign sovereign bonds issued in the US. 620

In 2003 the ‘CAC shift’ occurred.621 After years of promoting by the IMF, G7 and the US

Treasury, Mexico was the first to adopt CACs in its issue of New York bonds.622 This

breakthrough led to a rapid shift from UACs to CACs and ever since, CACs have been a

‘regular feature’ in bonds issued under New York law.623

In sum, CACs have been around for more than a century, especially in the UK. Most authors

agree that the absence of CACs in the US prior to 2003 was ‘market convention’ rather than

legal requirement.624 However, some authors claim that the ‘pro-CAC movement’ focuses too

much on the history of majority action clauses and dismisses every scrap of contrary evidence

that suggests that other types of CACs were present in the US prior to 2003.625

4.2.3.1.3. Legal Actions Against CACs

As mentioned before, CACs can be used to address the so-called ‘tyranny of the minority’.

However, what about the tyranny of majority? Is there nothing an individual bondholder can

do against the collusion of a sovereign debtor and the majority of creditors?626 In other words,

is there something akin to ‘good faith’ or ‘intercreditor’ duties in sovereign debt instruments?

In the US, good faith duty operates as a ‘gap filler’.627 If parties do not specifically prohibit an

action such as debtor-creditor collusion, then good faith can be called upon to prohibit it.

However, in order to do so, the action must be unforeseeable, meaning, had parties known

they would have prohibited it.628 Besides, even if this condition is met, US judges often

refrain from intervening because that will force parties to draft better contracts.629

Consequently, good faith duties are therefore virtually non-existent in the corporate bond

620 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1097; Olivares-Caminal, ‘Is There a Need’ (n 2) 30-31. 621 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1641; Gelpern, ’Contract Hope’ (n 20) 142. 622 IMF, ‘Collective Action Clauses’ (n 588) 3; Das and others, ‘Sovereign Debt Restructurings’ (n 25) 45. 623 Gelpern, ’Contract Hope’ (n 20) 142-143; Weidemaier and Gulati, ‘A People’s History’ (n 578) 57; Samples,

‘Rogue Trends’ (n 13) 83; Turchi, ‘Restructuring a Sovereign Bond Pari Passu Work Around’ (n 25) 2183. 624 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 45. 625 See Weidemaier and Gulati, ‘A People’s History’ (n 578) and Bratton and Gulati, ‘Sovereign Debt Reform’ (n

84) for a deeper analysis on the rise of CACs. 626 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 62. 627 Ibid. 628 Ibid. 629 Ibid.


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context, let alone in a sovereign bond context.630 Luckily, in case of corporate bonds

individual creditors can still rely on Chapter 11 to offer some protection.631 Sovereign

creditors, however, do not have that luxury.

In sum, ‘judicial policing of the opportunistic use of CACs in restructurings’ is highly

unlikely in the US, even though it would help to prevent a tyranny of the majority.632 Hence,

there is little an individual bondholder can do against misuse of a CAC.

Under English law, however, intercreditor duties do exist.633 For instance, in Redwood Master

Fund Ltd. v. TD Bank Europe Ltd, the High Court specifically stated that CACs should be

exercised in good faith.634 Although, it must be noted that the court did not extend this duty so

far that it amounted to a minority veto right.635 In any event, contrary to their American

brethren, English courts will scrutinize the use of CACs.636

4.2.3.1.4. The Value of CACs and Their Limitations

Most agree that –in theory– the value of CACs lies in solving creditor coordination

problems.637 Indeed, the ability to modify key (financial) terms and limit individual

enforcement rights can prevent or reduce the risk of holdouts.638 In that sense, CACs actually

emulate US bankruptcy features such as a ‘cramdown’ and an ‘automatic stay’.639 A

cramdown mimics a majority action clause, since it entails a reorganisation plan that binds a

dissenting class of creditors, whereas an automatic stay mirrors a majority enforcement clause

given that it prevents individual creditors from undertaking legal actions against the sovereign

debtor.640 Hence, it is generally understood that CACs could significantly facilitate sovereign

debt restructuring.

Nevertheless, there are some downsides to using ‘plain vanilla’ majority action or

enforcement CACs in sovereign debt workouts.641 For instance, without any additional

630 Ibid 64. 631 Ibid 70. 632 Ibid 65. 633 Ibid 72; IMF, ‘Strengthening the Contractual Framework’ (n 279) 29. 634 [2002] EWHC 2703 (Ch) English High Court. 635 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 63. 636 Ibid 74. 637 Ibid 48; IMF, ‘Strengthening the Contractual Framework’ (n 279) 29. 638 IMF, ‘Collective Action Clauses’ (n 588) 3. 639 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1345 and 1347; Gelpern, ’Contract Hope’ (n 20) 143. 640 Ibid. 641 Ibid 1344.


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features CACs only operate within individual bond series.642 This results in a coordination

problem across bonds, especially when a sovereign debtor is trying to restructure dozens of

bond issues involving different currencies and governing laws.643

Closely related to this issue are so-called ‘blocking stakes’.644 Voting thresholds might be the

core of collective action decision-making, but they also show holdouts how much bonds they

need to acquire in order to effectively block any decision.645 For instance, in 2012 holdouts

managed to block a restructuring in Greece despite the presence of CACs.646 Luckily,

aggregation clauses647 might mitigate both the cross-issuance issue and the risk of blocking

stakes.648

Finally, sovereign debtors might abuse the CAC mechanism by buying up or controlling the

distressed debt. Therefore, an additional feature called ‘disenfranchisement’ is required to

exclude those bonds from the bondholder votes.649

Nowadays, aggregation features are heavily promoted or obligatory in bond issuances. For

instance, the ICMA model CAC includes such a clause and all Eurobonds650 are required to

use a standardised aggregation provision.651

It must be noted, however, that an aggregation feature poses problems of its own. In some

instances, such clauses rely on a double majority or ‘two limb’ voting structure.652 This means

that a minimum threshold of support is required in both the individual series and across all

642 Ibid; Gelpern, ’Contract Hope’ (n 20) 143; Samples, ‘Rogue Trends’ (n 13) 83; Wong, ‘NML Capital, Ltd. v.

Republic of Argentina’ (n 287) 421. 643 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1098. 644 Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421. 645 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1344; IMF, ‘Strengthening the Contractual Framework’ (n

279) 18; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287)

421. 646 IMF, ‘Strengthening the Contractual Framework’ (n 279) 18; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502;

Samples, ‘Rogue Trends’ (n 13) 83. 647 Aggregation clauses enable cross-border bond-modification votes, where multiple series of bonds can be

amended with a double majority threshold. (See Gelpern, ’Contract Hope’ (n 20) 143). 648 IMF, ‘Strengthening the Contractual Framework’ (n 279) 18; Gelpern, ’Contract Hope’ (n 20) 143; Samples,

‘Rogue Trends’ (n 13) 83; Wong, ‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421. 649 Gelpern, ’Contract Hope’ (n 20) 143. 650 i.e. Domestic and foreign bonds in the euro area (See IMF, ‘Strengthening the Contractual Framework’ (n

279) 19). 651 ICMA, ‘Standard Provisions’ (n 550) 4; IMF, ‘Strengthening the Contractual Framework’ (n 279) 19;

Gelpern, ’Contract Hope’ (n 20) 143; 652 IMF, ‘Strengthening the Contractual Framework’ (n 279) 19; Gelpern, ’Contract Hope’ (n 20) 143; Wong,

‘NML Capital, Ltd. v. Republic of Argentina’ (n 287) 421.


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series as a whole.653 When an individual series fails to back a modification, it drops out and

the other bond series go forward.654 Usually the voting threshold is lower for individual series

than the minimum level of support required across all bonds (e.g. 66 ⅔ versus 75 per cent).655

The lower threshold makes it more difficult for holdouts to acquire a blocking stake, but not

impossible.656 That is why the ICMA model CAC provides a feature called ‘single limb’

voting, which essentially calculates the vote on aggregated basis across all affected bond

series.657

Moreover, aggregation clauses do not help ‘non-bond debt’, nor does it solve broader

information-sharing issues.658 Again, these problems can be resolved by inserting additional

clauses, but it does show that simply including an aggregation feature is not enough.659

In sum, CACs essentially eliminate holdout activity and in doing so, facilitate sovereign debt

restructuring. There is more to it than merely inserting a majority action/enforcement clause.

Some meticulous drafting is required to make the CAC mechanism effective. This includes

adding features such as aggregation or disenfranchisement. That is why some authors argue

that CACs were inserted not because of their –theoretical– value, but rather as an attempt to

pre-empt the IMF’s SDRM proposal.660

4.2.3.2. Exit Consents

CACs are not the only contractual technique to address creditor coordination issues.661 As

mentioned before, prior to 2003 bonds issued under New York law were subject to unanimous

action clauses (‘UACs’) rather than CACs.662 Due to the TIA-driven drafting approach, the

only way to amend payment terms was the consent of all bondholders.663 Given the dispersed

ownership of sovereign bonds, this was well-nigh impossible.664 Therefore, the market

653 IMF, ‘Strengthening the Contractual Framework’ (n 279) 19. 654 Gelpern, ’Contract Hope’ (n 20) 143. 655 IMF, ‘Strengthening the Contractual Framework’ (n 279) 19. 656 Ibid. 657 ICMA, ‘Standard Provisions’ (n 550) 1; IMF, ‘Strengthening the Contractual Framework’ (n 279) 20. 658 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503. 659 Ishikawa ‘Towards the Holy Grail Part II’ (n 578). 660 Gelpern and Gulati, ‘Public Symbol’ (n 90) 1643, 1649 and 1674; Fisch and Gentile, ‘Vultures or Vanguards’

(n 42) 1097; Gelpern, ’Contract Hope’ (n 20) 143; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2502. 661 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503. 662 See supra 4.2.3.1.2 The History of CACs. 663 Ibid. 664 Olivares-Caminal, ‘Is There a Need’ (n 2) 33.


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devised a new technique called ‘exit consents’ to coerce (potential) holdouts into participating

in a sovereign debt swap.665

4.2.3.2.1. What Are Exit Consents?

Exit consents or exit amendments are a legal technique that makes the acceptance of an

exchange offer conditional on a bondholders’ consent to amend certain non-payment terms of

the old bonds.666 Upon acquiring a predetermined threshold, the targeted non-payment terms

are amended and as a result, the value of the bonds is reduced.667 More specifically, these

amendments include the removal of key (financial) covenants668 such as a sovereign

immunity waiver, listing requirements or even the pari passu clause.669 By stripping away the

bonds’ favourable features670, the bonds become less attractive or illiquid.671 In other words,

the consenting bondholders are ‘poisoning the well behind them’ and forcing other

bondholders to participate in the exchange offer.672 If not, holdouts are left with impaired or

useless bonds.673 Small wonder that Bratton refers to this as a ‘starvation tactic’.674

Over the course of years, exit consents have evolved. They were first used in 2000 after

Ecuador defaulted on its bonds in 1999.675 At that time, the exchange offer constituted a ‘take-

it-or-leave-it’ strategy.676 Only by consenting to a list of amendments were bondholders able

to participate. The stripped out features of the bond included a cross-default clause, a negative

pledge covenant and the rescission of acceleration of the bonds.677 A few years later, Uruguay

followed Ecuador’s lead and made use of the exit consent technique.678 However, as opposed

to Ecuador, Uruguay opted for ‘consensual exit consents’, meaning bondholders willing to

665 Goldman, ‘Mavericks in the Market’ (n 130) 175; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1095. 666 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46; Olivares-Caminal, ‘Is There a Need’ (n 2) 30;

Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122; Turchi, ‘Restructuring a

Sovereign Bond Pari Passu Work Around’ (n 25) 2183. 667 Ibid. 668 E.g. Cross-default clauses, negative pledge clauses, acceleration clauses, governing law clauses… 669 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46; Bratton, ‘Pari Passu and a Distressed Sovereign’

(n 75) 830; Olivares-Caminal, ‘Is There a Need’ (n 2) 30; Wheeler and Attaran, ‘Declawing the Vulture Funds’

(n 133) 265. 670 Including those securing seniority. 671 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 46. 672 Ibid; Olivares-Caminal, ‘Is There a Need’ (n 2) 30. 673 Olivares-Caminal, ‘The Pari Passu Clause in Sovereign Debt Instruments’ (n 25) 122. 674 Bratton, ‘Pari Passu and a Distressed Sovereign’ (n 75) 830-831. 675 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331; Das and others, ‘Sovereign Debt Restructurings’ (n 25)

46; Olivares-Caminal, ‘Is There a Need’ (n 2) 31; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504. 676 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 47. 677 Olivares-Caminal, ‘Is There a Need’ (n 2) 31-32. 678 Ibid 32; Broomfield, ‘Subduing the Vultures’ (n 204) 497; Turchi, ‘Restructuring a Sovereign Bond Pari

Passu Work Around’ (n 25) 2183.


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participate in the exchange offer could choose to grant their exit consent or not.679 Moreover,

Uruguay’s exit amendments were the first to include a waiver immunity clause.680 In sum, exit

consents have evolved from a ‘take-it-or-leave-it’ tactic to a ‘consensual’ approach instead.

Prior to 2003, three categories of bond terms could be distinguished: (i) terms that were

subject to a UAC (i.e. ‘unanimous consent matters’), for instance payment terms; (ii) terms

that, if amended, had an effect on unanimous consent matters; and (iii) all other provisions,

including pari passu clauses, negative pledges and immunity waivers.681 Consequently, only

terms of the third category were available for exit amendments, as long as the required

majority of 66 ⅔ was reached and the issuer consented.682

Nowadays, however, CACs are allowed in sovereign bonds issued under New York law.

Consequently, all terms can be amended with the consent of a specified majority of

bondholders.

4.2.3.2.2. Legal Actions Against Exit Consents

Exit consents try to coerce dissenting creditors into participating in an exchange offer. As

such, they are an effective tool to address the so-called ‘tyranny of the minority’ (cf.

CACs).683 However, some authors and market participants argue that the coercion of non-

participating bondholders constitutes a ‘tyranny on the minority’.684 Nevertheless, the cases

on the subject of intercreditor duties are rather limited in number. In fact, there are but a few

cases in the corporate context and none with regard to sovereign debt.685

In the late nineteenth century, majority action clauses were first introduced as an alternative to

the holdout’s ‘threat of liquidation’.686 At that time, the creditors were subject to some kind of

fiduciary duty, namely a duty to act in the best interest of all bondholders.687 This was

confirmed in Hackettstown National Bank v. D.G. Yuengling Brewing Co688, when an attempt

679 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 47; Olivares-Caminal, ‘Is There a Need’ (n 2) 32. 680 Olivares-Caminal, ‘Is There a Need’ (n 2) 32. 681 Buchheit and Gulati, ‘Exit Consents’ (n 578) 79-80. 682 Ibid 82; Olivares-Caminal, ‘Is There a Need’ (n 2) 33. 683 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1336. 684 Goldman, ‘Mavericks in the Market’ (n 130) 175; Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1335. 685 Buchheit and Gulati, ‘Exit Consents’ (n 578) 78-82. 686 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1336. 687 Ibid. 688 74 F. 110 (2d Cir. 1896) <https://law.resource.org/pub/us/case/reporter/F/0074/0074.f1.0110.pdf> accessed 6

May 2016.


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to use a majority action clause was deemed ‘a corrupt and unwarranted exercise of the power

of the majority’.689 Consequently, later cases were subject to scrutiny by US courts.690

As mentioned above, majority actions did not ‘take hold’ in the US market.691 Besides, with

the enactment of Chapter 11 and the TIA’s ‘voting prohibition’, majority actions soon

disappeared along with the fiduciary duties.692 Instead, US law turned and became quite

hostile towards the notion of implied intercreditor duties.693

However, in the landmark case of Katz v. Oak Industries Inc694 the door was opened to more

judicial discretion.695 In that case the plaintiff asserted that the removal of all financial

covenants binding the issuer constituted a breach of the issuer’s obligation to act in good

faith.696 Although Chancellor Allen ultimately rejected the plaintiff’s reasoning, he did

introduce a ‘test’ to determine if there was a breach of an implied contractual obligation (i.e. a

duty to act in good faith):

Because it is an implied contractual obligation that is asserted […] the appropriate legal

test is […] this: is it clear from what was expressly agreed upon that the parties who

negotiated the express terms of the contract would have agreed to proscribe the act later

complained of as a breach of the implied covenant of good faith – had they thought to

negotiate with respect to that matter. If […] yes, then […] such [an] act constitutes a

breach of the implied covenant of good faith.697

In other words, this test determines that if drafters had foreseen the (mis)conduct in question,

they would have barred it via contract, meaning they would have increased the number of the

‘unanimous consent matters’.698

Furthermore, in Federated Strategic Income Fund v. Mechala Group Jamaica, Ltd.699 a New

York court did rule in favour of a bondholder minority and blocked the use of an exit

689 Ibid at 114. 690 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1337. 691 See supra 4.2.3.1.2 The History of CACs. 692 Ibid. 693 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1339. 694 508 A.2d 873 (Del.Ch. 1986). 695 Buchheit and Gulati, ‘Exit Consents’ (n 578) 80; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1095. 696 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504. 697 Katz v. Oak Industries Inc 508 A.2d 873, 880 (Del.Ch. 1986), (emphasis added). 698 Buchheit and Gulati, ‘Exit Consents’ (n 578) 80. 699 No. 99 CIV 105 1 7 HB, 1999 WL 993648 (S.D.N.Y. Nov. 2, 1999).


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amendment.700 In casu, the amendment would have completely impaired the minority

bondholders’ enforcement rights, given that the issuer would have been left without any assets

to attach.701 Hence, the court found that the exit consent went too far.702

In addition, in Assénagon Asset Management S.A. v. Irish Bank Resolution Corp.703 an

English court rejected the validity of an exit consent, reasoning that ‘the only function [of the

exit consent] is the intimidation of a potential minority, based upon the fear […] that, by

rejecting the exchange and voting against the resolution, he (or it) will be left out in the

cold.’704

In sum, unlike CACs, exit consents are scrutinized by US courts as well as by their English

counterparts. Consequently, depending on the circumstances, minority bondholders will be

able to do something about the abuse of this technique. Nevertheless, this fact must not be

overrated, because exit consents have been deployed successfully in quite a number of cases

(e.g. Ecuador in 2000, Uruguay in 2003 and Belize in 2004).705

4.2.3.2.3. Benefits and Downsides of Using Exit Consents

The objective of an exit consent is to encourage a minority of bondholders to accept an

exchange offer once the majority has accepted the offer. In other words, this technique tries to

address the holdout issue. So far, there have been quite a few cases in which this technique

has been successfully deployed, with participation rates ranging from 72% in Dominica to

98% in Belize.706 Besides, compared to CACs, the average threshold of an exit amendment is

lower, which makes it easier to use.707 Consequently, this ‘starvation tactic’ does seem to have

its merits with regard to mitigating the holdout issue.

Despite these advantages it is unlikely that this approach will be viable in all circumstances.708

First of all, an exchange offer might not always be economically feasible.709 Sometimes the

changes required are of such a magnitude that none of the bondholders will be willing to

700 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 68; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504. 701 Buchheit and Gulati, ‘Exit Consents’ (n 578) 73. 702 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2504. 703 [2012] EWHC 2090 (Ch). 704 Ibid at 84. 705 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2503. 706 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 49. 707 Olivares-Caminal, ‘Is There a Need’ (n 2) 34. 708 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096 709 Ibid; Broomfield, ‘Subduing the Vultures’ (n 204) 497; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505.


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accept them.710 Secondly, sovereign debtors always run the risk of a ruling against the use of

exit consents.711 Depending on the circumstances, a court can always find that the use of exit

consents constitutes a ‘tyranny of the majority’. Finally, when using exit consents one must

beware of the so-called ‘buoying-up’ effect.712 While it is so that exit consents initially reduce

the value of bonds, there is also an increase in value following the completion of the

restructuring.713 Consequently, it is possible that the ‘buoying-up’ effect outweighs the

negative effects of exit consents.714

In sum, similarly to CACs, exit consents essentially eliminate holdout activity and in doing

so, they facilitate sovereign debt restructuring. Their major downside, however, is their

inability to amend every bond term. Nevertheless, sometimes their lower thresholds make

them more convenient than CACs. Consequently, it rather depends on the circumstances

which of the two approaches is best.

4.2.4. The Contractual Approach: A Trust Structure, MDV and Restructuring Triggers

Other than the corporate restructuring techniques mentioned above, there are contractual

techniques –proclaimed by several authors– that might facilitate sovereign restructuring and in

doing so, prevent or mitigate holdouts. Amongst others, these provisions include a trust

structure, an MDV and restructuring ‘triggers’. This section will give a basic overview of

these techniques and highlight their merits in the sovereign debt context.

4.2.4.1. A Trust Structure

When sovereigns issue debt, they either choose to use a fiscal agent structure or a trust

structure.715 Generally speaking, bonds issued under New York law will take the form of a

fiscal agency agreement, while bonds issued under English law will take the form of a trust

deed.716 However, what is the significance of that choice, especially in the light of the holdout

issue?

710 Ibid. 711 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096. 712 Ibid. Broomfield, ‘Subduing the Vultures’ (n 204) 498; Wheeler and Attaran, ‘Declawing the Vulture Funds’

(n 133) 265; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505. 713 Broomfield, ‘Subduing the Vultures’ (n 204) 497-498. 714 Fisch and Gentile, ‘Vultures or Vanguards’ (n 42) 1096; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2505. 715 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221. 716 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1332; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506.


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Under a fiscal agency agreement, the issuer appoints a ‘fiscal’ agent, meaning someone who

will handle matters such as the redeeming of bonds and coupons upon maturity.717 Moreover,

said agent will act as representative of the issuer and funds held by the fiscal agent will remain

the sovereign’s funds until they are deposited in each creditor’s account.718 Besides, since the

agent does not act for the bondholders, each bondholder typically retains individual

enforcement rights, including the right to call for acceleration.719

On the other hand, a trust structure differs in three ways. First of all, under a trust structure, a

trustee is appointed as a fiduciary representative of the bondholders who takes on a

monitoring role to ensure that the issuer meets all the terms and conditions of the issuance.720

Secondly, any payments done through a trustee cannot be attached.721 From the moment the

funds are deposited on the trustee’s account they are no longer the sovereign’s property.722 In

fact, the trustee merely holds on to them on behalf of the creditors.723 Finally, a trust structure

entails that the enforcement powers are centralised on the trustee.724 Consequently, there are

no individual enforcement rights for the bondholders.725 The only way726 to sue a sovereign

debtor is via the trustee acting upon instructions given by a specific percentage of

bondholders.727 Besides, any recoveries made by the trustee must be shared pro rata among

the bondholders.728

In sum, a trust structure essentially eliminates individual bondholder litigation and prevents

funds from being seized by recalcitrant creditors. As such, it is a great way to address the

holdout issue, but it requires a sovereign to issue bonds pursuant to such a structure.

717 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221; Fisch and Gentile, ‘Vultures or Vanguards’ (n

42) 1106. 718 Ibid; Broomfield, ‘Subduing the Vultures’ (n 204) 499. 719 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1332; Fisch and Gentile, ‘Vultures or Vanguards’ (n 42)

1106; Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506. 720 Ishikawa ‘Towards the Holy Grail Part II’ (n 578). 721 Olivares-Caminal, ‘Understanding the Pari Passu’ (n 7) 1221. 722 Ibid. Broomfield, ‘Subduing the Vultures’ (n 204) 500. 723 Ibid. 724 Ishikawa ‘Towards the Holy Grail Part II’ (n 578). 725 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331. 726 It should be noted that a bondholder can act individually, if only when a trustee fails to follow the instructions

of the bondholders. (See Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331). 727 Buchheit and Gulati, ‘Sovereign Bonds’ (n 578) 1331; Broomfield, ‘Subduing the Vultures’ (n 204) 499. 728 Ibid.


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4.2.4.2. MDV: Minimum Default Value

GREGORY DAY has come up with an innovative idea to solve the sovereign debt issue. He

argues that a solution can be found in a technique similar to that of a ‘crop lien’, namely in a

‘minimal default value’ or ‘MDV’.729

During the nineteenth century, farmers were unable to obtain a loan because they lacked the

property to secure it.730 Luckily, this issue was solved in many countries by farmers who

pledged a portion of the next seasons’ harvest as security, hence a ‘crop lien’.731

Consequently, banks obtained a mechanism that enabled them to remedy a default, while

farmers were incentivized to make regular payments.732

DAY argues that a similar solution is possible in a sovereign debt context.733 If all parties

agreed ex ante to include an MDV in the debt instrument, it could provide them with a more

efficient way to remedy a default. In essence an MDV constitutes a provision clause that when

a default event or material breach occurs, a creditor may claim a predetermined percentage of

the original investment.734 An example clarifies:

[I]f a sovereign bond listed an MDV as 20% of a $1 million loan, then, upon a

nonpayment, the creditor could demand $200,000 from the bond's fiscal agent to be

drawn from the debtor nation's foreign central bank account, immediately terminating the

contract.735

Ostensibly, such a mechanism would entail certain advantages.736 First of all, an MDV

constitutes a termination clause of sorts.737 However, and MDV would not be a creditor’s

preferred route, because it would only allow him to mitigate losses and avoid lengthy

restructuring negotiations or litigation. In other words, an MDV merely provides a

prearranged settlement.738 Secondly, an MDV would neutralize vulture funds.739 It increases

the bonds’ minimal value, thereby reducing profits for vulture funds and making their

729 Day, ‘Market Failure’ (n 11) 256. 730 Ibid 255. 731 Ibid 256. 732 Ibid. 733 Ibid. 734 Ibid 257. 735 Ibid 258. 736 Ibid 258-261. 737 Ibid 258. 738 Ibid. 739 Ibid 259.


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business strategy less attractive. Moreover, creditors will be less inclined to dump bonds with

vulture funds, since their prices might be lower than the prearranged settlement.740 Thirdly,

this system would be more equitable than the current ‘winner-takes-all’ framework.741

Nowadays only reputation precludes sovereign debtors from an opportunistic default. An

MDV might prevent it altogether, since it raises the minimum costs of a default. Finally, DAY

is convinced that MDVs would work, because they bypass courts.742 Consequently, they

provide creditors with a self-executing remedy and succeed in solving the holdout issue.

However, the MDV system is not without its flaws. From a business perspective, borrowing

money only to block a percentage of it on a bank account is far from an attractive a plan. In

fact, it is weird, to say the least. Moreover, to effectively block vulture funds activity, the

MDV would have to constitute a very large prearranged settlement. Otherwise it might not be

that much of a disincentive to vulture funds or creditors. DAY, however, claims that creditors

will opt for a 20% settlement rather than risk being faced with a debt swap at 2 cents on the

dollar.743 While I can agree with that logic, his example is a bit extreme. For instance,

Argentina’s debt swap included an exchange of 25 cents on the dollar.744 How would a 20%

MDV then stop creditors from engaging in vulture fund activity?

On the whole, MDVs are certainly an innovative approach, yet theoretical at best. Given their

disadvantages, they will never see the light of day.

4.2.4.3. Restructuring Triggers

Inherent to restructuring negotiations are a wide array of costs, including reputational costs,

lawyer fees, administrative costs and so on.745 Moreover there is evidence to suggest that

restructurings destabilise a country’s economy, while the outcome of the negotiations is

always uncertain.746 Consequently, sovereign debtors are often reluctant to start restructuring

negotiations, even though it might be in their best interests to do so early on.747

740 Ibid. 741 Ibid. 742 Ibid 260. 743 Ibid 259. 744 See supra 3.3.2.3.8. NML capital Ltd v Argentina. 745 Das and others, ‘Sovereign Debt Restructurings’ (n 25) 65-66; Crispi, ‘Not Just the Luck of the Irish’ (n 1)

1873. 746 A. Mechele Dickerson, ‘A Politically Viable Approach to Sovereign Debt Restructuring’ (2004) 53 EMORY

L.J. 997, 1007, (hereinafter: Dickerson, ‘A Politically Viable Approach’); Das and others, ‘Sovereign Debt

Restructurings’ (n 25) 65-66. 747 Dickerson, ‘A Politically Viable Approach’ (n 746) 1006-1007.


107

According to KATHERINE CRISPI, sovereign debt instruments should therefore dictate when a

restructuring will begin.748 More specifically, contracts should include a provision that

identifies an economic indicator to automatically triggers restructuring negotiations.749 As a

result, such a ‘trigger’ would make the whole restructuring scenario a well-organised, efficient

process and allow sovereigns to regain access to capital markets more easily.750

Furthermore, CRISPI asserts that such a trigger will entail certain benefits for the restructuring

process.751 First of all, she claims it would tackle holdouts, because the provision would also

include a time limit during which restructurings need to take place.752 In other words, if

creditors refuse to cooperate, they lose their right of repayment. Consequently, any holdout

behaviour would result in a loss of legal right of repayment.753 Secondly, she claims that a

predetermined economic trigger will reduce the risk of an opportunistic default.754 If the

trigger event occurs, a sovereign will have to initiate restructuring negotiations. Indeed,

economic indicators such as the GDP, export-to-import ratio and debt-to-equity ratio are

objective.755 Hence, they will do away with the discretionary element that characterises

restructurings today. Finally, she argues that including triggers will reduce costs of

negotiations and preclude drawn-out negotiations.756 All of that will expedite and facilitate

future access to the market.

At first glance, triggers appear to be a great mechanism to ensure that sovereign debtors do

not wait too long to restructure their debt. In that sense, they might indeed prevent some

reputational damage and quicken the restructuring process. However, claiming that a trigger

would reduce costs in general is overly optimistic. Though triggers might prevent drawn out

negotiations, lawyer fees might reflect the rushing of the process. Indeed, it is not because

negotiations are instigated automatically and constrained by a time limit that they will be any

less complicated. Triggers do not help with regard to

748 Crispi, ‘Not Just the Luck of the Irish’ (n 1) 1889. 749 Ibid. 750 Ibid. 751 Ibid 1889-1891. 752 Ibid 1889-1890. 753 Ibid. 754 Ibid 1890. 755 Ibid. 756 Ibid 1891.


108

finding ‘balanced’ terms and conditions. So, they might prove to be more time efficient, but at

the risk of increasing legal costs.

Besides, triggers only postpone the issue of debtor moral hazard. For instance, to strengthen

his bargaining position, a sovereign debtor could play hardball during the negotiations.

Consequently, when time runs out, the creditors would be left with no legal rights to

repayment, while the sovereign will have eliminated the risk of litigation. Thus, it might be

prudent to take note of this possibility and rule it out via another provision.

On the whole, there might be some merit to triggers, but they certainly raise another set of

questions as well. If one chose to use them, it would be advisable to include complementary

provisions to address issues such as (postponed) debtor moral hazard. Triggers as such are

insufficient to effectively create a flawless restructuring.

4.3. CONCLUSION: A POSSIBLE APPROACH TO ADDRESS THE ISSUE

Lacking a sovereign insolvency regime and given the limited scope of legislation to curtail

excessive holdout behaviour, creditors and sovereign debtors are left with the contractual tools

to solve the pari passu-holdout issue. However, while designing the new clauses is quite easy,

the hard part is getting the debtors and creditors to accept them.757 Besides, all contract tools

have their limitations.758 This raises the question: Which drafting solution is best?

For starters, adjusting the pari passu clause is a must. There is no judicial clarity nor any real

market understanding regarding pari passu interpretation.759 The clause is simply too big a

litigation risk to escape a contractual reform unscathed. Therefore, it would be advisable to

change the language of the clause in such a way that it precludes both the payment

interpretation and the rateable payment remedy. Moreover, the new clause should also be

accompanied by a new remedy. As shown in NML v Argentina, the current acceleration

remedy simply does not cut it.760

Secondly, the holdout issue in general should be addressed in an effective way. CACs are an

excellent tool to address the holdout issue. However, their voting thresholds can be quite

difficult to achieve. Exit consents, on the other hand, are easier to deploy, but they lack the

757 Bratton and Gulati, ‘Sovereign Debt Reform’ (n 84) 46. 758 Broomfield, ‘Subduing the Vultures’ (n 204) 496-497. 759 See supra 3 Pari Passu Clauses: The Root of the Problem? 760 See supra 3.3.2.3 The Third Wave: The Return of the Pari Passu?

C o n c l u s i o n : A P o s s i b l e A p p r o a c h t o A d d r e s s t h e I s s u e

109

ability to amend payment terms. In brief, none of the contractual mechanisms mentioned

above will solve the holdout issue on its own. Therefore, it would be advisable to use a

combination of a few techniques instead.

The combination of contractual tools should include a trust structure, CACs and exit consents.

A trust structure is needed, given that it provides multiple benefits at once: (i) it provides

representation by a fiduciary trustee of the bondholders who will take on a monitoring role

and make any restructuring easier to coordinate, (ii) any payments done through a trustee

cannot be attached, which will definitely hamper holdouts and (iii) a trustee structure does not

provide individual enforcement rights for bondholders, which will hamper holdout activity

even more. Furthermore, CACs should be included to facilitate any restructuring. Similar to

the ICMA model, the CACs should be drafted with all the bells and whistles. More

specifically, they should include a modification clause with an aggregation feature,

supplemented with a disenfranchisement feature and a provision on the sharing of information

to mitigate any coordination issues. Lastly, the contractual tools also encompass exit consents.

As OLIVARES put it, there might be instances where the supermajority of a CAC cannot be

achieved. Then, it might be convenient to use an exit consent –with a lower threshold– to

persuade recalcitrant creditors.

Finally, even though it might not be a ‘contractual’ approach, it would be beneficial to

promote legislation that curtails excessive vulture fund activity. Indeed, current legislative

approaches are too feeble. The scope of the Belgian law does not encompass a lot of vulture

fund activity and the United Kingdoms’ law is limited to HIPCs. Therefore, it would be

beneficial to the market if major actors such as the IMF, the G-10 or the World Bank decided

to promote the enactment of similar –though more elaborate– legislation.

In Sum, GELPERN was right when she proposed a contractual approach in tandem with a

statutory one.761 However, given that a sovereign insolvency regime is currently politically

impossible, national legislation to curtail excessive vulture fund activity is the next best thing.

So, the holdout issue can definitely be mitigated by way of contract, but it should be noted

that the larger issue of over-borrowing still remains.762

761 Gelpern, ’Contract Hope’ (n 20) 148. 762 Ryan, ‘Sovereign Bankruptcy’ (n 3) 2506-2507.

111

GENERAL CONCLUSION: WHAT TO EXPECT IN THE FUTURE?

From the outset, this thesis has tried to shed some light on the pari passu-holdout issue in a

sovereign debt restructuring. It started with some essential background information on the

subject and determined that in a sovereign default scenario creditors are faced with a so-called

‘sovereign immunity-bankruptcy standoff’.

Lacking a sovereign insolvency regime, creditors are forced to restructure their debt by way of

negotiations. Usually this leads to a debt swap or an exchange offer, whereby creditors have

the opportunity to exchange their old debt for new debt at inferior terms. However, due to the

voluntary nature of those restructurings, some recalcitrant creditors might refuse to

participate. Instead, these ‘holdouts’ try to achieve better terms or even sue the sovereign

debtor for full repayment of the debt. To their dismay, they are often faced with sovereign

immunity and find themselves in a veritable hunt for sovereign assets to attach. Hence, they

look for creative ways to pierce or circumvent a sovereign’s defences, but that approach is

both costly and time consuming.

Enter vulture funds. These investment funds buy up distressed debt of countries at a steep

discount with the sole intention of suing the sovereign debtors for repayment at par value.

Unlike regular holdout creditors they have the time and money to do so. Needless to say, are

often criticised for being the major stumbling block in a sovereign debt restructuring, because

they disrupt negotiations and cause lengthy sovereign debt litigation.

Still, it must be noted that vulture funds are not always a bad thing. Sometimes they provide

liquidity to the market or keep sovereign debtors from engaging in opportunistic defaults.

Nevertheless, in most cases, they are purely intent on high returns and merely bleed a country

dry.

Furthermore, this thesis examined landmark sovereign debt cases and showed how vultures

make use of a pari passu clause to force a sovereign debtor to settle.

Ever since the Elliott v. Peru case vulture funds have been proclaiming the ‘payment’

interpretation of the pari passu clause as the correct one, meaning that sovereign debtors

cannot pay exchange bondholders without paying the holdouts pro rata. In other words, only

paying the exchange bondholders constitutes a breach of the pari passu clause. Thus, this

tactic forces sovereign debtors to choose between defaulting on exchanged bonds or paying

G e n e r a l C o n c l u s i o n : W h a t t o E x p e c t i n t h e F u t u r e ?

112

the holdouts. In essence, it completely bypasses the issue of ‘asset hunting’ and therefore, it

has been a favourite of vulture funds ever since its first appearance.

By way of contrast, the historical analysis of the pari passu has shown that another

interpretation prevails, namely anything that has to do with legal ‘ranking’. Sovereign debtors

should not create preference with regard to collateral, nor earmark certain revenues, nor

involuntary subordinate certain creditors by law. In other words, the ‘ranking’ interpretation

tries to uphold equality between creditors by preventing any form of subordination.

Besides, the ‘ranking’ interpretation deserves support because of the extreme consequences

the ‘payment’ interpretation entails. In a nutshell, those potential absurdities include (i) being

unable to prioritise payments, thus jeopardizing the official sector’s preferential status, (ii)

rendering real equality clauses useless, (iii) destabilising sovereign debt restructuring and (iv)

affecting third parties which renders exchange bondholders hostages. Basically, it would even

make paying the milkman impossible.

To make matters worse, NML Catpital Ltd –a vulture fund affiliated with Elliott– has devised

yet another use for the pari passu clause. When Argentina subordinated debt by enacting the

‘Lock Law’, NML proposed ‘rateable payment’ as remedy for the breach of the pari passu

clause. Although it must be noted that Argentina’s behaviour in court played a big role in this

case, that does not take away the fact that this new pari passu approach is out there and poses

a risk to orderly sovereign debt restructuring.

Oddly enough, English Courts do not agree with their American brethren when it comes to

pari passu interpretations. Instead, they claim that the ‘payment’ interpretation flouts basic

contractual interpretation principles under English law, namely the business common sense

principle. Indeed, given the absurd consequences of the ‘payment’ interpretation sovereign

borrowers would never agree to such terms.

In sum, both English and American litigation has shown that there is no judicial clarity, nor

any real market understanding regarding the pari passu clause. Therefore, it would be

advisable for debtors and creditors alike to prevent or mitigate the holdout issue ex ante in the

debt instrument. In the absence of clear contractual provisions, courts would do well to

approach each sovereign debt restructuring on a case-by-case basis.

Finally, this thesis discussed some legislative and contractual techniques to prevent or at least

mitigate the pari passu-holdout issue and it suggested which approach should be endorsed.

G e n e r a l C o n c l u s i o n : W h a t t o E x p e c t i n t h e F u t u r e ?

113

Apparently, there are various techniques to address the pari passu-holdout issue. For instance,

changing the language of the pari passu clause. However, pari passu clauses are only part of

the problem in a distressed sovereign debt scenario. Limiting behaviour of holdouts,

especially vulture funds, is the actual issue. They will use whatever strategy available to

prevent a restructuring from ever taking place or force a sovereign debtor into a settlement.

Unfortunately, a sovereign insolvency regime remains politically impossible and legislative

attempts at ‘curtailing’ vulture fund activity are too limited to be effective. Consequently, the

contractual approach should –for now– be the main focus of issuers and creditors alike.

Meticulously drafting a combination of anti-holdout techniques could at least mitigate the

issue.

Given that contractual tools are never air-tight, this thesis suggested that sovereign debt

instruments should take on the form of a trust structure and insert both CACs and exit

consents. This, combined with legislation –promoted by actors such as the IMF or the G-10–

that curtails excessive vulture fund activity, should enable sovereign debtors to minimise

holdout litigation.

As a final note, it should be pointed out that the larger issue of over-borrowing and tardy

restructuring will still remain. Moreover, the contractual solutions mentioned above are purely

theoretical. Only time will tell if they are effective in a default scenario. In any event, one

thing is for certain. As long as there is even the slightest hint of a potentially profitable way to

sue a sovereign debtor for full repayment, holdouts will try and obtain settlements. Therefore,

further research on these subjects and on the prospect of an SDRM 2.0 might be interesting.

115

REFERENCES

TABLE OF CASES

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Merchant Bills Corporation Limited v Permanent Nominees Australia Limited (1972-73)

Australian Law Reports 565.

Belgium

Brussel 26 September 2000, 8e Kamer, AR nr. 2000/QR/92.

Brussel (9e Kamer) 19 maart 2004, Republiek Nicaragua t/ LNC Investments LLC en NV

Euroclear Bank, A.R. nr. 2003/KR/334 – A.R. nr. 2004/1831.

United Kingdom

Assénagon Asset Management S.A. v. Irish Bank Resolution Corp [2012] EWHC 2090 (Ch).

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Kensington International Ltd. v Republic of the Congo [2005] EWHC 2684 Queen’s Bench

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Redwood Master Fund Ltd & Others v TD Bank Europe Limited & Others [2002] EWHC

2703 (Ch) English High Court.

United States of America

Bluebird Partners, L.P. v. First Fidelity Bank, N.A., 94 N.Y.2d 726 (2000).

Connecticut Bank of Commerce v. Republic of Congo 309 F.3d 240.

Elliott Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363 (2d. Cir. 1999).

R e f e r e n c e s

116

Federated Strategic Income Fund v. Mechala Group Jamaica, Ltd. No. 99 CIV 105 1 7 HB,

1999 WL 993648 (S.D.N.Y. Nov. 2, 1999).

Hackettstown National Bank v. D.G. Yuengling Brewing Co 74 F. 110 (2d Cir. 1896).

Katz v. Oak Industries Inc. 508 A.2d 873 (Del.Ch. 1986).

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NML Capital, Ltd. v. Argentina, 699 F.3d 246 (2d Cir. 2012).

NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978 (S.D.N.Y. Nov. 21, 2012).

NML Capital, Ltd. v. Republic of Argentina 727 F.3d 230 (2d Cir. 2013).

MHR Capital Partners LP v. Presstek, Inc., 912 N.E.2d 43 (N.Y. 2009).

Pravin Banker Associates v. Banco Popular Del Peru, 109 F.3d 850 (2nd Circuit 1997).

Red Mountain Finance v. The Democratic Republic of Congo, Case No. CV 00-0164 R (C.D.

Cal. 29th May, 2001).

Republic of Argentina v. Weltover 504 U.S. 607 (1992).

Republic of Argentina v. NML Capital Ltd, 573 U. S. (2014).

Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F2d 1039 (2d Cir. 1982).

Case Documents

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Affidavit in support of motion for permission to file letter brief as amicus curiae, NML

Capital Ltd. v. Republic of Argentina, No. 12-105 (2d Cir. 2012).

Brief of amici curiae Argentine law professors in support of affirmance, NML Capital Ltd. v.

Republic of Argentina, No. 12-105 (2d Cir. 2012).


R e f e r e n c e s

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Brief for the United States of America as Amicus Curiae in Support of Argentina’s Petition

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Transcript of Court Hearing, NML Capital Ltd. v. Republic of Argentina, No. 08-cv-6978

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TABLE OF LEGISLATION

Australia

Section 11 Foreign States Immunities Act 1985 (the FSI Act).

Argentina

Ley 26.017 de fecha 9 de febrero de 2005 [30.590] B.O.

Belgium

Art. 1165 BW.

Art. 584 and 1412quinquies Ger. W.

Art. 9 Wet van 28 april 1999 houdende omzetting van Richtlijn 98/26/EG van 19 mei 1998

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in betalings- en afwikkelingssystemen (de ‘finaliteitswet’).

Art. 11bis Wet van 25 mei 1999 betreffende de Belgische internationale samenwerking.

Wet van 6 maart 2008 die ertoe strekt de inbeslagneming of de overdracht te verhinderen van

overheidsgeld bested voor de internationale samenwerking, met name via de techniek van de

aasgierfondsen.

United Kingdom

The Debt Relief (Developing Countries) Act 2010.

Section 3(1) State Immunity Act 1978.

Section 31 of the Civil Jurisdiction and Judgments Act 1982.

R e f e r e n c e s

118

United States of America

New York Judiciary Law §489.

Federal Rules Appellate Procedure 35.

Federal Rules of Civil Procedure 56(a), 65(d)(2) and 69.

Foreign Sovereign Immunities Act of 1976, 28 U.S.C. § 1604-1610.

Trust Indenture Act of 1939, 15 U.S.C. §77aaa.

11 U.S.C.

Article 4A U.C.C.

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