Later on Thursday, the US Supreme Court may decide whether to accept or reject Argentina’s pari passu case. Rejection could mean a swift end to the saga. Argentina would be left to decide whether to comply with paying bond holdouts alongside its restructured debt, or defaulting on both, or settling with the holdouts.
It’s always possible however that the court decides another day, or just asks the US Solicitor General to advise. That can take months. Hey. It’s the pari passu saga. (Update: no decision after all from the court on Thursday, it seems.)
Still, this is a moment for the enforcement of sovereign debt, supposedly the least enforceable of financial instruments. That’s a fascinating subject in itself. In fact we argued in a paper forthcoming in the Capital Markets Law Journal that the originsof pari passu may lie in enforcement. What pari passu ‘means’ in sovereign debt may not matter so much as its use.
We wrote it as one of many responses to Mitu Gulati and Benjamin Chabot’s great study of one possible origin for pari passu, in a Mexican bond of the 1840s, the ‘Black Eagle’. We’ve placed an expanded and version below. Warning, it’s 2,500 words and is in an academic style. But we hope it’s some context for the saga…
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1. Introduction
“Well, but doesn’t that seem pretty extraordinary?” said Chief Justice John Roberts of the Supreme Court of the United States halfway through the oral argument on a Monday late in April, 2014. And in a way, it was.
The case before the justices that morning pitted the Republic of Argentina against NML Capital, a hedge fund which has collected defaulted debts of Argentina over the years and won several judgments upon them. Monday’s hearing was about what often comes after judgment day: enforcement, via powers in the Federal Rules of Civil Procedure to discover debtors’ assets.
Often, but not always. When a sovereign debtor’s assets might be spread worldwide, covering fighter jets as well as bank accounts, embassy cars as well as beachfront property, then enforcement can become tricky. When the debtor argues that Congress also fully intended its passage of the Foreign Sovereign Immunities Act in 1976 to mean that judgment debts should not always be enforced, it gets trickier still.
And yet, the justices had a hugely expansive request before them that day. Just before Justice Roberts spoke, Ted Olson, counsel for the respondent, had conceded that his client was indeed, as Justice Sonia Sotomayor had put it, “asking for an accounting of everything that Argentina owns regardless of what its purpose is.”
2. We begin this meeting of Scripophilists’ Anonymous…
This case about discovery is not the one which Argentina and NML might yet also fight at the Supreme Court in 2014: the pari passu saga. That case might appear to provide far more rocket-fuel for enforcing claims against sovereign debtors than mere discovery. The injunction on Argentina to pay holdouts and restructured creditors ratably would not only enforce pre-judgment debt, but also implicate third parties (including payments systems, trustees, bondholders who have accepted Argentina’s restructuring terms) wherever they would be deemed to be helping Argentina to avoid the injunction.
Nor does the Chief Justice’s perplexity appear to have much to do with a decree signed 171 years earlier by General Antonio Lopez de Santa Anna, ‘Napoleon of the West’, eighth President of Mexico, villain of the Alamo — AKA the Black Eagle. That’s him, pictured right.
The decree promised “just equality amongst the creditors” in newly-restructured bonds of Mexico after yet another of its defaults in the nineteenth century. The caudillo’s signature followed a less than subtle complaint by the British ambassador about fair treatment for his bondholder countrymen.
Nevertheless something had, somehow, changed in sovereign debt enforcement. The 1843 Black Eagle bond to which the decree applied is today a yellowing stalwart of Ebay, some seedy scripophilist forums on the internet, and Cecil Court in London. Mitu Gulati and Benjamin Chabot, however, believe it to be the first instance of pari passu protection in sovereign bonds.
This means that the origin of one of the weirdest clauses in bond contract history would predate a promise of equal treatment which Gulati previously found in revenue-backed debt issued by Bolivia in the 1870s. Bolivia’s bond was to finance an American charlatan’s expedition to open up a route to the Atlantic through the Amazon jungle. (Long story.) However the 1870s were near the start of the first age of financial globalisation, when creditors were already well used to forming committees in order to police far-flung sovereign borrowers — often, several rival committees. This increasingly required anti-discrimination provisions in debt. It would make sense to find the birth of pari passu here then, as one such provision.
Rewind pari passu’s origin story back another thirty years into the nineteenth century, however, and it might instead be a response to a baser problem. As Gulati and Chabot note:
If one concludes (a) that the pari passu concept is indeed one that has existed for centuries in sovereign bonds and (b) that this history might be able to illuminate how we understand the clause, there is still one large leap that needs to be made. That is that the origins of the clause seem to lie in a period when there was no real possibility of legal enforcement. The clause had value, we suspect, because its violation provided a justification for the gunboats to be sent in. Today, there are no gunboats that will enforce debt contracts, but there are courts that will at least try. Question is: How does this old clause, devised for an entirely different era, get translated into the modern era.
It’s a good question.
2. Enforcement is everywhere
And that is why the 2014 discovery case is useful to begin with. It is a simple reminder that the enforcement of sovereign debt can take many forms. Pari passu is one strategy among many others. In particular, whatever the relevant clauses ‘mean’ in the Argentine bonds in the two cases, it seems more important that they are flexible enough to be plugged into the broader modern machinery of the US legal system: the discovery of assets, injunctions, and ultimately, courts’ powers of equity.
Holdout investors would argue that access to this machinery is exactly what the waiver of immunity and pari passu clause in their bonds entitle them to. This is undergirded by the fact that Argentina has long shown scant respect for US courts despite its waiver of immunity in its bonds, and has long since become a byword for how not to restructure sovereign debt in good faith. There are few other remedies available to holdouts.
This does not mean that the machinery is well-ordered or should extend this far, however. In both Argentina cases, the holdouts have argued that lower courts are best placed to judge the permissible scope of enforcement, even when this may have extraterritorial reach. They have also argued in the pari passu case specifically that the lower courts are similarly well enough equipped to weigh enforcement’s impact on third parties. The onus appears to lie on the latter to show to a federal judge why they should not be so affected. This is a rather debatable way to regulate the twin forces of sovereign immunity and international finance.
Consider NML’s last brief to the Supreme Court before justices imminently decide whether to take up the pari passu case. It makes mincemeat of a petition by Argentina to refer the interpretation of the pari passu clause to New York state courts: the request is too late and too general. No use dredging up the Black Eagle history here.
But the brief also sweeps past complaints that the injunctive relief granted to the holdouts is effectively a catch-all enforcement device of just the kind which the FSIA prevents. “Allowing Argentina to choose whether to honour its obligations and with what resources looks nothing like an order seizing assets,” according to NML.
Really? If Argentina alternatively chooses to pay just one set of creditors, recourse could be had not just against Argentina but against any entities that handle the payment. These might feel that their assets are being seized instead.
Thus, while it is fun to also debate what pari passu ‘really’ means and where it may come from, it is not so important to the pari passu case now. Nor is it where the history uncovered by Gulati and Chabot has the most interest. In fact, the Black Eagle bond embodies a rather haphazard enforcement regime itself.
3. The ‘Napoleon of the West’ as a recalcitrant debtor
Illinois museum has Santa Anna’s leg, and Texas site wants it— Dallas Morning News headline, May 2014
Consider the kind of sovereign which Gulati and Chabot have dug up alongside the Black Eagle. Not least, General Santa Anna’s Mexico came to be the target of intense enforcement efforts by creditors of two empires: France and Britain.
The key word is recalcitrance, although on a scale at which even Argentina would balk. Between the 1830s and 1840s, Mexican governments practically made restructuring of sovereign debt into a business model. It had to pay for crushing internal rebellion somehow, including sending General Santa Anna to a date at the Alamo. This is probably not an advisable approach to sound public debt management. Still, as a primordial soup for the pari passu clause, it is interesting for two reasons.
First, whether by accident or design, each time it restructured, Mexico played off different creditors against each other. This was principally by shuffling a major source of income, customs house revenue, between its old and new debts. A January 1836 law is especially notable for this three-card Monte, according to Gulati and Chabot. It is perhaps the fact that Mexico gradually began to charge fees for the privilege of having claims on it dismembered and reassembled each time which shows the most commercial spirit.
Secondly however, there was the problem which this hyperactivity created. By attaching ever more elaborate gradations of revenue to each fresh restructuring, Mexico was thereby opening up the structure of its debt to render claims upon its bonds more and more enforceable. Worse, in place of domestic investors, Mexico was inviting in creditors who were patient, and connected, enough to go the extra mile with enforcement: internationally-active distressed debt trading houses.
This is not an outlandish predicament even for sovereign debtors today, although the creditor list can differ, and may not always include private-sector holdouts. The Caribbean island of Grenada turned a semi-official Taiwanese creditor into a holdout in the 2000s by withholding diplomatic recognition, but also through tweaking restructuring terms. Ukraine remains at risk in 2014 of discovering that it was a bad idea for it to issue eurobonds with special terms to Russia as its (then) friendly creditor.
But at the very least, the two points show that an entanglement of intercreditor equity and enforcement provided the backdrop to the emergence of pari passu in Mexico in the 1840s. The sheer speed of development is noteworthy. Arguably the Mexico of General Santa Anna was engaging in the “constant recontracting” of its debt, as opposed to committing for very long to the payment terms of its latest restructuring. This is an artefact of an age more relaxed about recurrent defaults. The practice of recontracting is at least as old as modern sovereign finance as a means to future repayment capacity, including at the court of Philip II of Spain.
And yet, in Mexico, in the 1830s and 1840s, it clearly went wrong, turning creditors against each other instead. Mexico was also ‘recontracting’ ever more recognisably modern devices to placate this or that bondholder. Gulati and Chabot uncover both an acceleration clause and a rudimentary waiver of immunity, for example.
Of course, there was also plenty of violence. Mexico’s drafters had a strong incentive to break a leg (as the saying goes) in contractual innovation, in that their caudillo had lost his. Extra-contractual enforcement was also an option for Mexico’s international creditors. In 1838 it appeared off the coast of Veracruz in the form of the trigger-happy French naval squadron that gave General Santa Anna the prosthesis which he would later lose in Texas.
In that regard, the Black Eagle may have little to tell the present. Liberal application of cannon-fire is less welcome in cross-border creditor negotiations nowadays. Even so, the chaotic nature of how even legal enforcement became embedded within Mexico’s debt may be a lesson worth remembering.
Pari passu clearly was born as one such enforcement device, with a meaning that slipped and slid from one letter of the British ambassador to another as expediency demanded. The British did not want full equality for everyone, but to protect their own claims and would have sought preferred status if possible.
Lastly then, it is worth looking more closely at the inter-creditor problems which recurred throughout the process that eventually led to this pari passu origin.
4. Gunboats then and Rule 65(d)(2)(c) now
This partly depends on who Mexico’s foreign creditors were at the time: citizens of two empires which had few qualms about violating the sovereignty of a country recently liberated from a third. This fact could also be argued to lessen the Black Eagle’s relevance in a post-imperial age. NML, while politically connected, cannot call upon the services of the US Navy’s Fifth Fleet at tricky points in litigation in the same way.
But actually the Black Eagle history may show the opposite. It highlights that more recent precedents set in establishing enforcement over sovereign immunity are being driven by a comparative handful of holdout creditors, using a relatively minimalist, but powerful, legal framework to obtain redress.
The ultimate dividing line between creditors in the Black Eagle incident was nothing less than imperial prestige, after all: French versus British interests. This is opposed to a more functional, modern division of those who accept a debt restructuring and those (invariably a minority) who do not. Moreover, within each national group, the enforcement efforts were driven by organised committees of mainstream creditors; in the British case, the Committee of South American and Mexican bondholders. With access to policymakers in their respective imperial metropoles, these groups were therefore already large dogs when it came to waving their tails and threatening their debtor with official intervention.
By contrast a modern holdout is a tail waving the dog. Argentina’s lawyer in the 2014 discovery case’s oral argument even went so far as to argue that “you have a tail that’s cut off from the dog”: the discovery order would force his client to divulge even assets that could never be executed upon. It is not necessary to agree fully with that statement to acknowledge that holdouts have indeed been able to gain expansive powers of enforcement through judicial discretion.
This is not least disquieting news for the dog. Consider the substructure of how third parties may become bound by the injunction on Argentina to pay all creditors ratably. This is through Rule 65(d)(2)(c) of the Federal Rules of Civil Procedure — in other words, binding those who might be Argentina’s agent, or in active concert and participation with it in order to avoid the injunction.
This rule is hardly a gunboat in itself: it is required to make any injunction effective. A hint of the rule’s power is already inherent in the response to an extraordinary memo by Argentina’s lawyers. The memo advised the republic on the options to default in response to the ratable payment order and reroute bond payments. The lawyers soonfound themselves facing tough questions in court, although Judge Thomas P. Griesaruled that the memo remains privileged. But when the rule has appeared on the shores of cross-border finance during the Argentina case, it has been met with no less indignation between creditors.
Euroclear Bank has called the courts’ offers of “clarification” of its status (as a system used to channel Argentine bond payments — not via New York, it says) “a hollow promise at best, and a frivolous promise at worst” given that it does not believe it is even bound by US court decisions as a foreign-based entity.
Similarly, holders of Argentina’s euro-denominated, English-law restructured bonds refer to an “onslaught of foreign litigation and inconsistent judgments,” if the payment system on their debt falls under the injunction. Here’s how they represented that payment system to the justices… (click to enlarge)
This again is where post-pari passu enforcement — that is, in significant measure via third parties — might also prove unlike the gunboat era. The third parties can fire back. The euro bondholders have commenced Belgian litigation already, to ensure they are paid there. In New York itself, Citibank has asked Judge Griesa to rule on consequences from his order (if any) for paying local-law bonds.
Judge Griesa is hardly Viscount Palmerston. Nevertheless, the discretion given to the courts here is ad hoc enforcement of a kind not dissimilar to the troubles that led to the Black Eagle and to the creation of pari passu language. That is what makes the reconstruction of the Black Eagle history by Gulati and Chabot so useful. Even as we wait for the Supreme Court, pari passu has already almost gone full circle.
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