A riddle, wrapped in a mystery, inside an enigma, inside a pari passu clause.
Here are some terms from Italy’s 2015 US dollar bond, which it issued under New York law in 2010. It is a pari passu clause, even though you won’t find the words ‘pari passu’.
The debt securities will be the direct, unconditional, unsecured and general obligations of Italy. They will rank equally with all of our present and future unsecured and unsubordinated general borrowing. The full faith and credit of Italy will be pledged for the due and punctual payment of the debt securities and for the due and timely performance of all of our obligations under the debt securities. We will pay principal and interest on the debt securities out of the Ministry of Economy and Finance of Italy.We will pay amounts due on the debt securities equally and ratably with all general loan obligations of Italy.
You will, however, find an explicit promise of ratable payment.
And that is a very, very strange thing to find in a sovereign debt contract. It is not the only Italian bond bearing this language: other ones, issued throughout the 2000s, have it. William W Bratton noted Italy’s unusual choice of terms all the way back in 2004.
It just happens to stick out now, amidst Argentina’s pari passu saga.
That’s all it is, one sentence. But what a sentence. “We will pay amounts due on the debt securities equally and ratably with all general loan obligations of Italy.” That is ratable payment, the idea of paying bondholders on exactly the same basis (not, for example, paying one bondholder, then the next one).
Everything in the long saga of defaulted sovereigns trying to fend off holdouts bringing pari passu suits against them, has involved those sovereigns arguing that they do not – and do not ever intend to – pay bondholders ratably.
Meanwhile the most notorious holdout victories — Elliott v Peru back at the turn of the century, and now the Second Circuit ruling in NML v Argentina — have involved judgements interpreting the pari passu clause as meaning ratable payment.
So what on earth was Italy doing putting this language out there?
Just to give an idea of the stakes – and the rancour – it’s really worth reading Professor Andreas Lowenfeld’s original “Tom, Dick and Harry” memo for Elliott v Peru, which set out the ratable payments interpretation. The memo is still being argued over today:
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…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 most 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 remains 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.
We’ve bolded that last sentence too, because it carries possibly the most mind-blowing implication of ratable payment for the financial system. Defaulted sovereign bondholders might one day sue other bondholders to get their money. Crazy! Not so crazy any more. NML v Argentina resulted in an order for third parties not to assist Argentina in any plan to avoid making ratable payments. The order did not put Argentina’s restructured bondholders directly in the frame. But the bondholders have certainly been left rattled.
Anyway, that’s why the Second Circuit’s affirmation of ratable payment has ruffled feathers.
In an application to rehear the case, Argentina declared that the court “effectively held that the provision is a promise by a sovereign to never restructure its debt… no sovereign debtor or creditor would ever agree to such a prohibition.” (Emphasis ours.)
Well it would appear one sovereign has agreed to it.
So why haven’t the holdouts seized on this Italian bond contract? It’s been around for ages. It apparently blows a hole in Argentina’s argument that ratable payments belong in cloud cuckoo land.
But then, one thing has been pointed out to us. Argentina might well counter-argue this point: Italy’s bond actually shows sovereigns expect to specifically spell out when they agree to ratable payments. Argentina’s vexatious pari passu clause and others like it (a brief list of recent ones is here) do not similarly spell it out. Therefore, courts should not be finding that the boilerplate clause inherently means ratable payment.
An interesting point to drop into proceedings when NML v Argentina comes back for oral argument next year, maybe?
Related link:
Putting the E(lliot) in Sovereign Debt Enforcement… – Credit Slips
Putting the E(lliot) in Sovereign Debt Enforcement… – Credit Slips
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