Source: https://www.creditslips.org/creditslips/2018/01/the-pari-passu-strategy-in-venezuela.html
Timestamp: 2019-04-25 10:51:58+00:00

Document:
Almost all of Venezuela’s bond debt is governed by New York law; much of it includes pari passu language that essentially mirrors that used by Argentina. At first glance, one would think these bonds perfectly tailored to the pari passu strategy. But in the middle of 2017, in response to another holdout’s attempt to replicate NML’s strategy, Judge Griesa seemed to change course. In this case (White Hawthorne v. Argentina), he explained that selective nonpayment did not constitute a breach of the pari passu clause unless it was paired with additional “extraordinary conduct.” In Argentina’s case, he explained, that conduct included the passage of a statute barring negotiations with or payments to holdouts and a series of inflammatory comments made by Argentine officials. Argentina had been a “uniquely recalcitrant debtor,” the judge reasoned, and this had constituted a violation of the pari passu clause. Because much had changed by the time of the White Hawthorne case, including the government in Argentina, he ruled that there was no longer a violation.
Given this apparent change in course, Lee and Andrés argue that the pari passu strategy is essentially dead. The reason is that the White Hawthorne case (and a later case also decided in the Southern District of New York) allows governments to stiff holdouts as long as they do not formally disavow liability for the debt, as Argentina seemingly did.
We are a bit less confident. Certainly Judge Griesa appeared to walk back his interpretation of the pari passu clause in the White Hawthorne case. But he did so in ways that leave us utterly perplexed about what the clause is supposed to mean. At a fundamental level, we simply do not understand the logic of interpreting the words “payment obligations … will at all times rank at least equally” to mean that selective nonpayment is fine except when done in a “uniquely recalcitrant” manner. To an investor, isn’t deliberate non-payment… well, deliberate non-payment? As one of us has written previously about the White Hawthorne case, it would have made perfect sense to say that an injunction was no longer an appropriate remedy given the change in circumstances. Injunctions aren’t automatic; they are equitable remedies reserved for exceptional cases. But it makes very little sense to interpret the clause to provide some protection against selective nonpayment, only to confine that protection to such a vague and ill-defined set of cases.
More generally, we’re completely at a loss about what kinds of behavior will constitute “egregious” additional conduct and thus turn selective nonpayment into a violation. From Argentina’s experience, it appears that enshrining the decision not to pay in a statute would be bad. Presumably, government officials should not publicly avow never to pay holdouts. But if a government experiences a bit of recovery and still doesn’t pay, what will really distinguish it from Argentina? Certainly Lee and Andrés are right that the pari passu strategy has become harder to pursue, but time will tell how completely the genie goes back into the bottle.
As a final note, query how much actual contract language matters to the meaning of the pari passu clause. There has been much debate over whether the Argentina-style version of the clause, which refers expressly to the government’s “payment obligations,” means something different from another extant version of the clause, which refers simply to the “ranking” of the debt. But then again, nothing about Argentina’s clause said that the clause only protected against “recalcitrant” governments.
It is utterly obvious that Griesa embraced ratable payments for "uniquely recalcitrant sovereigns". If you thought Kirchnerian Argentina proved to be a fiery defiant of contractual obligations and US law, wait till you see how Chavista Venezuela behaves. So even the now seemingly very restrictive rulings of "flip-flopping" Griesa would-will aply in spades to Venezuela.
The main reason why a pari passu strategy could also succeed here is that rather than undergo a formal debt restructuring, Venezuela is simply going to selectively default (they´ll probably continue paying some few bonds and the Russians-Chinese). That is, no new bonds with ratabality-unfriendly new pari passu clauses.
Venezuela could try to pass domestic laws to undo pari passu from within (taking advantage of "odd" version of the clause in most bonds) but would NY courts see that as legitimate?
So you could get a pari passu judgment a la Argentina. But do you actually need it? Couldn´t you just seize oil shipments-facilities and get made good on monies owed? And if not, how do you make Chavismo pay you? If Cristina Kirchner refused to pay a cent, imagine what Maduro would do. And regime change seems far less likely in Venezuela than was the case in Argentina. You may get a pari passu injunction, but you may not get a Macri any time soon if at all. Just ask the Cubans where their Macri is, sixty years later.
I think it would be useful if the "opponents" of ratable payments would explain why such ratability would be so impossibly unseemly in sovereign debt land when, for instance, all the Eurozone countries insisted on being promised pro-rata payments when they lent money to Greece starting in 2010.
Seems rather odd to conclude that pro-rata payments should never and would never happen in sovereign land while at the same time Germany, Italy, France, Spain et al are in practice saying that pro-rata payments by a sovereign debtor should be a must.
And there are many other such examples out there of creditors contractually demanding ratability from sovereign borrowers.
It is unclear how the White Hathorne v. Argentina case completely killed the pari passu strategy unless Argentina provides the sole example of "extraordinary conduct" that leads to them being considered a "uniquely recalcitrant debtor." The distinction seems to boil down to whether a country desires to repay a debt even if the end result is the same.
Could Venezuela be categorized as a "uniquely recalcitrant debtor"? Government officials have been undermining the country's recovery by obtaining US dollars that are meant for productive institutions and selling them on the black market for personal gain. Failure to address this type of behavior is not the same as passing a statute barring payments to holdouts, but it does not inspire confidence in the country's ability to recover and pay its debts.
Would Venezuela, like Argentina, be forgiven for "extraordinary conduct" as a result of a regime change? International law has said the nature of the regime is irrelevant. Will the lack of predictability in these cases make borrowers less likely to invest in sovereign nations?
As Lee Buchheit said, there will need to be more than non-payment to certain creditors to establish a breach of the pari passu clause. However, I am bothered by the lack of clarity resulting from the Second Circuit's reluctance to clarify what constitutes such a breach. Judge Griesa dealt with some bondholders restructuring their debt, while other bondholders were holding out; how relevant would it be if payments of other Public External Debt (which the bonds rank at least equally with) were clearly preferred over the bonds? Are there other situations (other than a "Lock Law" or comments by public officials) that would be considered enough to meet Judge Griesa's test, thereby resulting in a breach of the pari passu clause?
Moreover, in the event a clause in a Fiscal Agency Agreement doesn't parallel that in the note's prospectus (i.e. the July 2001 FAA and the Venezuelan bond maturing 12/1/18), it is worth considering which version of the clause courts are likely to enforce. On one hand, the FAA is the bond's contract. On the other hand, the bondholders likely relied on the prospectus, not the FAA. In the prospectus of the Venezuelan bond maturing 12/1/18, for example, the payment obligations are subject to a negative pledge covenant and subject to "exceptions as may be provided by applicable legislation." These limitations are absent in the FAA. If courts allow the clause in the prospectus to be used, it may be significant if "applicable legislation" is interpreted by the courts to mean Venezuelan law, allowing the enactment of certain laws to drive a restructuring.
To me, it seems that based off of the current case law on the Pari Passu clause, that it is hard to predict the outcome of the cases since as soon as there seems to be some direction as to the correct interpretation of the clause, that the court uses the complete opposite interpretation with a nifty justification to create the allusion that their decision seem based on logic. And I think that this variance in outcome is motivated by the court trying to impute their view of what they perceive is the correct outcome opposed to their decision being rooted in law or contract terms, and that they often do this by using the contract terms to make it appear that the parties bargained for such an outcome. They appear to do this by strategically deciding whether they want to interpret the contract terms with a functional or formalist approach.
For instance, in Marblegate (not a Pari Passu case, but about payment terms), the District Court said that the "practical ability" to collect payment was taken away, so there was a violation - hence, a "functional" approach. Whereas based off of the same contract terms, the Second Circuit focused on the fact that the transaction did not formally amend the payment terms, so there was no violation. Its hard to reconcile the difference in interpretation - of course, the Second Circuit did the classic "plain meaning" and "Congressional intent" analysis - but those never convince me since as 1Ls, we are taught to manipulate those devices to further our argument. I think that the Second Circuit's decision was driven by what they perceived as opportunistic behavior (Marblegate was the only creditor that held out, and so was now the only creditor that could receive the full payout based off of the original Notes), and the court wanted to disincentive holdouters from hindering restructuring transactions.
Similarly, in these recent Pari Passu cases, I think that the court uses vague, fancy adjectives so that they have the wiggle room to make the decision based off of what they perceive is the correct outcome. For instance, in NML v. Argentina, the court felt that the bad behavior was that Argentina created a Lock Law and made public statements that they would not honor obligations to holdout bondholders, so the court focused on the formalist legal subordination of the bonds. Whereas in White Hawhorne and Ajdler v. Mendoza, the courts probably felt as though the holdouters were being opportunistic, so found against them.
As Mr. Buchheit writes in his paper, "the fallacy [of implicit mandatory ratable payments due to pari passu clauses] caused considerable mischief in the sovereign debt market"--Argentina being the most poignant example. But, what if Judge Griesa's interpretation and then seeming "undoing" of his own creation was an attempt at equity, trying to make the most out of a bad situation. Restructuring has two main goals: (1) to prevent an impending default by the sovereign and (2) get creditors as much of their money back as possible while avoiding consequences caused by (1). Though Judge Griesa's two opinions seem to muddy the waters of what will trigger a ruling mandating ratable payment, it also could be seen to provide considerable guidance to just avoid egregious behavior like trying to affirmatively burn some creditors. Perhaps the rulings are more helpful to accomplish the two goals of restructuring and could result in less "considerable mischief" in the future than Mr. Buchheit worries about.
From a contractual point of view the White Hawthorne case effectively makes the applicability of the pari-passu clause into a contingent remedy. Further, since it requires courts to make political determinations regarding the willingness of sovereign countries to restructure and since this new rule formulated by the court has no basis in the actual contract, will it survive judicial scrutiny upon appeal?
Also, from a restructuring perspective the judgement basically converts the pari-passu clause into a carrot-stick type of provision which does lend some flexibility to the restructuring process. So despite the seemingly contradictory nature of the Judge Griesa’s judgement, it probably gives sovereigns some incentives to negotiate and restructure albiet at the cost of legal clarity. If Venezuela goes the Argentina route and implements lock law legislations then pari-passu clause works against them, if they attempt to negotiate with the creditors it works in their favour making them less susceptible to hold-out based injunctions.
The 2d Circuit seems to have its hands tied. On the one hand, it wants to disincentivize holdouts and incentivize investments. On the other hand, the court also likely realizes it is tenuously fudging simple tenets of contract law. Perhaps Judge Griesa’s rationale just points to the accretive nature of the common law. He might have realized that his previous pari passu interpretation was unworkable and discouraged debt restructurings—it certainly got flak from the investment community—and decided to scale it back a bit. He saw an opportunity to do so in White Hawthorne and applied an arbitrary standard to achieve this end. Perhaps important to the interpretation that Professors W & G render above is that payment obligations do rank at least equally among those who do not hold out—which is to say, at least in the mind of the court it seems, the clause is less germane to a holdout creditor. Whether right or wrong, comporting with contract law or not, I can't say; but I think that, at least descriptively, this is the rationale behind these checkered rulings.
That said, to speak sweepingly about an area of law with which I am just becoming familiar, sovereign debt restructuring seems to be a make-shift, cutthroat, enigmatic area for lawyers and jurists, making it very interesting for academic discussion but equally unclear/unsettled for judicial decisionmaking. Ad hoc, magisterial functionalism might be convenient for a judge who feels that s/he knows what is the correct outcome in an idiosyncratic factual context; but it doesn’t foster clarity in pari passu interpretation and, perhaps more importantly, it doesn’t foster confidence in investors. Judge Griesa’s ruling therefore seems to me to be little more than an ad hoc judgment —a judgment made because, well, it was sensible in the new circumstances under which White Hawthorne arose. It does seem to be arbitrary to say, “Ok, you may refrain from paying certain creditors so long as you’ve been on your best behavior,” but then again, so do several features of restructuring a sovereign’s debt. Whatever the case may be, the fact that pari passu interpretation seems to be in flux—or at the very least unsettled—means that this might need to be a strategy in which Venezuela and creditors are willing to push the envelope in order to leverage the most favorable outcome for themselves. In other words, I don’t think that the White Hawthorne v. Argentina case has eviscerated the pari passu strategy, but tentatively revived it depending on how VZ goes about the restructuring process.
Regarding corruption from the Maduro regime, the question should be whether the behavior of the “uniquely recalcitrant debtor” has been recalcitrant with respect to matters material to the payment of its creditors. So, it seems to me that corrupt government activity need not bar the pari passu strategy either, as was noted by Stephanie in her final paragraph. I also appreciated Charlie’s commentary from above re which pari passu provision courts are more likely to enforce. It seems to me that it would be the FAA and that a duty to read (more than the prospectus) arises for bondholders; but I don’t know if there’s anything to substantiate my suspicion there. I’ll do a bit more research and, if I don’t find an answer, we can ask the profs about it in class.
Redressing creditor equality should not be a matter of debtor behaviour. Would I feel better if a sovereign defaults on me with an open smile and an invitation to have supper on Sundays? Hey, the Minister of Finance may be my lover and I would still feel harmed and demand redress.
It is plain silly to argue that creditor equality should not include payments equality. The number one reason people lend money is to get repaid, not to keep the same legal rank. The only equality a creditor cares about is payment equality.
Buchheit et al have tended to side with sovereigns and not with creditors (let alone holdouts) so it´s not surprising that they would detest ratable payments rulings. But I find their arguments lacking, mostly because they don´t take account of the ample historical evidence favouring ratable payments in sovereign debt land. With all due respect, I don´t think it very solid to argue that the presence of pari passu in sovereign debt contracts is due and should be due entirely to concerns that Philippine law would allow subordination of certain creditors.
There is good headwind in New York courts in favor of requiring an egregious course of conduct for a sovereign to have violated the pari passu clause. However, given the Second Circuit's failure to explicitly reject the pro rata/intercreditor agreement interpretation, vulture funds will likely continue to litigate in hopes of reaching a more favorable court or enlarging the category of egregious conduct. However, the Venezuela and PDVSA clauses contain different language than the Argentina clauses and significant players in the financial and legal community have reacted negatively to the pro rata/intercreditor interpretation since Elliot v. Peru.
Although the language of the clause is similar between the Venezuela and Argentina bonds (especially regarding the Republic bonds - "rank at least equally with all its other payment obligations" relating to external indebtedness; PDVSA bonds also carry high litigation risk with prospectus language - "rank equally in right of payment"), there are two important differences. First, the Venezuela & PDVSA pari passu clauses contain additional language seemingly allowing subordination pursuant to Venezuelan law (like many English law bonds). Assuming, as Elliot Associates has established, that investors read and rely on the substance of these clauses, courts must take this difference into account. If the parties agreed to the statutory subordination possibility (of which the Argentinian Lock-Law was one type), it might make harder the argument that they also agreed to an expansive pro rata interpretation. Second, the negative reaction to the pro rata interpretation following Elliot and NML is evidence that the financial community did not perceive the pari passu clauses to carry the meaning that Judge Griesa, in 2012, seemed to give them. ICMA, as just one example, has put forth a new model explicitly ruling out the expansive interpretation. Both of these points suggest that investors in these bonds did not expect to be investing bonds containing a pro rata/intercreditor clause.
Moreover, the PDVSA bonds do not include the pari passu clause in their Unanimous Consent Amendment procedure (at least, not explicitly), instead possibly leaving it open to deletion by a majority of each series. And the Republic bonds include them within a 75% or 85% CAC structure. This is more evidence that investors did not enter into the contracts expecting the pari passu clause to carry such great weight, even if they did rely on them as substantive protection, and not simply a relic from the corporate context. Nonetheless, even if only "egregious course of conduct" defines the meaning of the clause, this adds uncertainty and potential judicial discretion into the world of emerging market debt.
If Maduro stays in power, he is likely to use rhetoric similar to that condemned by Judge Griesa in NML. And will any law passed by the Constitutent Assembly be viewed as egregious conduct? The added language regarding a statutory subordination possibility will help Venezuela in this interpretation, but it is not clear what a given judge will do. I believe that Venezuela should be confident that a court will not employ an explicit pro rata/intercreditor interpretation, but it should be wary of its stance towards holdouts. A Maduro government may have little shot at escaping liability per the clause, even with an egregious course of conduct analysis. But, even a more benign successor government will have to tread lightly and be prepared to make significant concessions to holdouts.
The Province of Mendoza case has more to do with statute of limitations than with the meaning of pari passu, so not that relevant in that sense.
By the way, who represented Mendoza and argued that paying some creditors but not others should not be seen as a breach of pari passu? That´s right, Argentina´s lawyers during the NML saga.
Don´t ask a barber if you need a haircut.
Let’s face it - when a country is in financial distress, it won't submit wholesale to the demands of its creditors. Instead, it will act evasively - with a positive spin, it will take “creative actions;” when painted in a darker light, it acts “evasively” or “underhandedly.” Regardless, the country may (and likely will) take actions that fall somewhere on the spectrum between perfect behavior and “extraordinary conduct” that would allow a judge to characterize it as a “uniquely recalcitrant debtor.” Questions also remain about what constitutes this “extraordinary conduct” - does it refer to actions specifically relating to the bonds, or instead general improper actions taken by the regime in power (or the overlap, as is the case with Venezuela’s hunger bonds)? Like Mark and Mitu, I’m frustrated by this vagueness and current lack of clarity.
I’m currently in “Contract Drafting for the Finance Lawyer” at Duke Law, and yesterday’s class covered the fundamentals of drafting. One of the main points that my professor stressed was that the contract has to hold up over time and for other audiences than the initial parties to the agreement (including judges; cough, cough); another point was that consistency is key unlike in casual or informal writing, as changing a single word or term throughout the agreement or set of agreements will change the interpretation.
Blame my naiveté as a 2L, but I thought perhaps I could find some distinctions in the agreement terms that could distinguish Venezuela’s pari passu language from that contested in previous litigation and provide an alternative reasoning (besides the nebulous “recalcitrance” approach) for the discrepancy between the outcomes in NML v. Argentina and Ajdler v. Province of Mendoza.
The Province of Mendoza issuances lack the “without any preference” language that Argentina’s issuances contain. However, Venezuela’s issuances do contain this language.
The Province of Mendoza language stays consistent before and after the contested exchange offer, save for adding “unsecured” to the last part of the clause. In contrast, Venezuela’s issuance from October 2004 says that it is an unsecured obligation, but “unsecured” was dropped from the issuance from October 2011 (although they are both issued under the same 2001 FAA).
In Argentina’s issuances, the ranking is linked to the payment twice, whereas in Venezuela it is not. Does this help Venezuela?
Unlike Argentina, the 2001 Venezuelan FAA language makes a distinction between Notes (“[the Republic’s] notes, bonds, debentures, and/ or other unsecured evidence of indebtedness) and Series (such series of Notes); Series are linked to ranking, whereas Notes are linked to payment. In contrast, Argentina’s FAA uses more general language.
In October of 2004, Venezuela issued a bond referring to the 2001 FAA; however, in December of the same year, it issued a bond going back to the 1998 FAA. I am not sure of the implications, because I was not able to get the 1998 FAA.
What is the role of pari passu clauses in sovereign international debt? Professor Lowenfeld says that pari passu clauses "means what it says" that is, that a "given debt will rank equally with other debt of the borrower." These clauses are meant to protect bondholders from any actions that the sovereign can take to prioritize the debt of another equally rank creditor.
The contract language of pari passu clauses can vary in many different ways. After the NML case, some bond contracts have been drafted stating that the pari passu clause does not give a right to bondholders to a ratable payment. This new language tries to protect issuers from remedies that holdouts can use to be paid, by blocking a debt restructuring. But, could a borrower say to a creditor "you are equal rank with other debt, but I can decide not to pay you and pay another equal creditor? Wouldn't that ultimately erase the purpose of the pari passu clause and its effects?
I believe the main issue is not the language of the pari passu clause, but the rights it gives to bondholders. If I am ranked equally with other debt of the borrower, what borrower's actions will constitute a violation of this condition? Indeed, selective nonpayment will be a violation; regardless it has been done in a uniquely recalcitrant manner.
White Hawthorne case makes it harder for a creditor to pursue remedies based on a pari passu clause violations. However, in the Venezuela case, considering Maduros past actions, is likely that his officials would publicly avow selective nonpayment.
Taken at face value, pari passu clauses award protection for bondholders in a straightforward manner--you will rank equally to others-- and a violation/breach (such as selective payments) of this clause entitles you to a remedy. This provides a substantial assurance to bondholders, particularly those who are investing in a high risk bond such as Venezuela, to prevent the sovereign from prioritizing its debt. Unfortunately, according to the late Judge Griesa, this is not the case because a remedy is only available if in addition to selective nonpayment the sovereign acts in a"uniquely recalcitrant manner." To me, this seems illogical.
I believe with Andres above, the whole point of the pari passu clause is to award equal rights to bondholders. Otherwise, what is the point of the clause? I believe "equal rank" is quite clear and selecting which bondholders to pay is not awarding "equal rank." If I choose to pay someone and choose not to pay another bondholder, I am implicitly saying that I am paying the bondholder because I rank them over you. Regardless of whether this is uniquely recalcitrant or not, I believe it is a blatant violation of what the clause is supposed to be used for.
Another problem that is raised is the lack of guidance on what constitutes aggravating factors or acting in a "uniquely recalcitrant manner." Sure there is guidance on Argentina, but that can only be used as a comparison, and it is certainly not an exhaustive list of what a sovereign should or should not do. With this lack of guidance, I would feel a little uneasy about my assurance if I was a bondholder. Should there be a problem of selective payment, it is uncertain whether the government of Venezuela has already acted in a way that could constitute a violation of the pari passu clauses that would entitle bondholders to an equal payout.
As stated in the post, injunctions “aren’t automatic; they are equitable remedies reserved for exceptional cases.” While there was certainly some hyperbole as well as fancy—and vague—language employed by the judges in the previous cases, it would appear that the decisions and perhaps the precedent would boil down to a couple of more fundamental legal concepts—the punishment of “wrongdoing,” and protecting the integrity of the system. In the NML case, it was clear that governmental behavior both with the Lock Law and public repudiation of the debts owed were “egregious” violations of both principles. In White Hawthorne, which followed a change in government (and repeal of the Lock Law), there were no continued actions by Argentina, and thus perhaps the hold out legal action taken was decided to be outside the best interests of the system, and equitable results. This could be looked at as a trend to disincentivize the groups who buy with the intention of holding out, and a potential nod to the support of restructuring efforts when done in good faith. I certainly don’t see the nail being placed in the coffin of the NML pari passu strategy just yet…However, we will have to await the Second Circuit decision that will almost certainly be involved in the Venezuela crisis, provided they are willing to step to the plate.
The countless movements of questionable character (egregious? recalcitrant?) already made by the Maduro regime aside, they are already engaged in nonpayment, movement of assets, and what could only be called “interesting” attempts to circumvent sanctions and capital markets entirely (the Petro). One additional move that could be coming down the pipe (oil pun not intended) that could potentially trigger the Judge Griesa NML-style ire—Venezuelan attempts to insulate PDVSA with friendly bankruptcy legislation. Get the popcorn, this will be must-see TV…the lives of millions and an entire sovereign nation’s economy hangs in the balance, while countless legal and financial entities are looking for an opening to recovery.

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