World Wise: Judges, High Finance and Sovereign Nations

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Mark Weidemaier

In 2012, the U.S. Court of Appeals for the Second Circuit issued a ruling in a legal battle over payments to bondholders who owned debt issued by Argentina. The court’s ruling hinged on how to interpret a widely used “pari passu”clause that was part of the bond agreement for debt issued by Argentina in 1994. Research by Ralph M. Stockton Jr. Distinguished Scholar and Associate Professor Mark Weidemaier on this issue has been cited by parties before the Supreme Court, and he has been quoted frequently in major national and international financial media because of his expertise on the issue.

Argentina defaulted on that debt more than a decade ago, and has since issued new bonds in exchange for the old ones. In effect, it asked bondholders of the 1994 debt to refinance because it couldn’t — and wouldn’t — pay the original debt. Most bondholders agreed, taking a loss on their original investment with the understanding they would get at least some of their money back this way.

But there were a few holdouts.

As Argentina sought to pay interest to the holders of the new bonds, the holdouts took the country to court in Manhattan, arguing that if Argentina was going to pay the new bondholders, it also must pay them.

The Second Circuit’s decision ultimately rested on the interpretation of the pari passu clause. Traditionally, that clause in contracts is taken to mean, roughly, that everyone should be treated equally and without one party favored over another.

The holdouts argued, and the Second Circuit agreed, that if Argentina was going to pay the new bondholders interest, the country also had to pay them the full amount owed on their original bonds — an amount in the billions of dollars — otherwise their debt would be treated as subordinate to the new bonds, violating the equal treatment clause. To enforce its order, the court blocked financial institutions from processing payments to holders of the new bonds until Argentina pays the holdouts in full.

But for Argentina and the holders of the new bonds, it looks as though the holders of the original bonds are getting preferential treatment. They are not only being paid more than owners of the new bonds, they are being allowed to block payments to others.

So what does equal treatment mean in this case? And can a U.S. court ruling on a contract even bind a sovereign nation?
These questions hinge in part on what exactly pari passu clauses really mean. And that, it turns out, is not nearly as clear as many lawyers once thought it was.

“All you’re left with is kind of a widespread rejection of the interpretation the Second Circuit gave it, without a compelling explanation of what the clause is,” Weidemaier says.
The Argentine case (as of this writing) is ongoing, but there are signs that nations that issue debt and their lawyers are taking heed.

“We’ve seen a few countries start to modify the pari passu clause in new debt they issue,” Weidemaier says. “Or they issue debt accompanied by disclosure documents that explicitly reject the Second Circuit interpretation for the pari passu clause.”

What makes Weidemaier’s research so important, though, is that scores of countries around the world routinely issue bonds like Argentina did. That debt, and how it’s received in the market, can have a major impact on the wealth of a nation.

How the pari passu clause is interpreted could also affect what financial markets countries choose to issue debt in, whether they continue to use New York or move their business to other financial capitals, such as London or Tokyo.

Weidemaier also notes that the Argentina case, and the research he’s done generally on contacts and sovereign debt, point to how powerful contracts are. Even though no court has explicit authority over the actions of another nation, and so enforcement of contracts could be difficult, if not impossible, these contracts are still taken very seriously by bond investors and debt-issuing nations.

How the laws of one country — or even agreements between countries — are actually enforced is also a key subject in human rights law.

This article was originally published in the Fall-Winter 2014 issue of Carolina Law.

-December 1, 2014

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