Venezuela has plunged into a very deep economic and political crisis with a default on its sovereign debt becoming an ever more likely event. Many Wall Street firms already are sharpening their pencils to calculate potential recovery values for Venezuelan bonds. Against this background we thought it would be helpful to provide an update on a little noticed, but very significant, development relating to the infamous pari passu clause under New York law.
Que es “Pari Passu”…?
As we explained in our blog “Don’t Cry for the Holdouts” in February 2016, some hedge funds, led by Paul Singer’s Elliott Associates (through a vehicle called NML Capital), sought full repayment on unrestructured Argentine government bonds on a contractual clause in bond documentation that said that these bonds would rank pari passu (or “on equal footing”) with all other present and future external debt obligations of the government. The general market understanding of this clause was that there would be a breach of the pari passu clause only if the debtor subordinates the protected debt by some measure which lowers the legal ranking. The hedge funds argued that the clause had a wider meaning of “equal payment”, implying that Argentina should pay all creditors ratably or pay none at all. In 2012, Thomas Griesa, a senior U.S. district judge that took the case (as Latin American international bonds generally are documented under New York law), sided with the hedge funds and ordered Argentina to refrain from paying restructured bondholders without making a simultaneous ratable payment to holdout creditors. The ratable payment was meant to be full payment of interest and principal. Again, this was a somewhat surprising interpretation of “equal payment” as in 2005 (and, after the re-opening of the swap, in 2010) restructured bondholders took a 65% haircut and only because of this severe haircut and high participation rate in the restructuring (93% after the 2010 swap), as well as a lucky run in commodity markets, Argentina was in the position to pay up. Despite many challenges, Argentina, under the new government of Maurico Macri, finally gave in and paid off the hedge funds in early 2016. Judge Griesa lifted the injunctions that prohibited Argentina to make payments to restructured bondholders after Macri’s government, on Griesa’s instructions, paid the holdouts before the end of February 2016 and repealed the Lock law that was adopted by Macri’s predecessor, Cristina Fernández de Kirchner, in 2005 to prohibit reopening of the debt swap (at improved terms) after the 2005 exchange offer. The rest is history…
Sovereign debt specialists at international law firms and development finance institutions, like the IMF, were shocked by Griesa’s verdict as agreeing debt restructurings, not only for sovereigns but also for corporates, would be much more complicated (e.g. it would not be possible for a corporate to pay lease/rent or trade suppliers to keep the company alive) knowing that holding out could result in full repayment. It would also be questionable if a sovereign could subsequent to a default take IMF money, which generally receives preference status (i.e. ranks ahead of other debt).
However, Griesa’s tale did have a tail. Basically, Griesa made a 180 degree U-turn when another group of hedge fund investors (collectively referred to as White Hawthorne) filed suit in February 2016, invoking the same pari passu clause, demanding payment on Argentine sovereign debt they held. In December 2016, Judge Griesa issued an opinion dismissing claims against Argentina for breach of the pari passu clause (and any claims accruing outside of the six-year statute of limitations). Now he said that Argentina violated the pari passu clause only because of extraordinary, recalcitrant, conduct (i.e. Cristina’s continuous rants against Griesa and hedge funds) and harmful legislation (the Lock law). Helpfully, he clarified that payment to some creditors and not to others was not a breach of the pari passu clause. A simple translation would have been: Judge Griesa did not like Cristina and that is why Argentina had to pay up! The whole saga has been a bonanza for law firms which were asked to rewrite pari passu clauses and to insert new clauses, like collective action clauses, to diminish the power of holdouts. In any case, it is clear that in future restructurings pari passu may not hold the same sway over sovereign debt negotiators as in Argentina’s case.
Pari Passu is for sissies …
This does not mean that Venezuela has an easy task to restructure its debt, should the government decide or be forced to default on sovereign debt. For example, two bonds (one maturing on 15 August next year and the other on 15 September 2027) have no collective action clauses. Collective action clauses permit a supermajority of bondholders (generally 75% but in the case of Venezuela 85% for some bonds) to agree to a restructuring with that agreement binding all holders of the bonds. Further, as sovereign bonds under New York law typically use a fiscal agency agreement (as in the case of Venezuela) instead of a trustee structure, each creditor retains the right to contractual remedies in the event of a default, including the right to accelerate their claims and to initiate legal proceedings against the borrower. Hedge funds could buy up these two bonds and engage in protracted negotiations to get a high pay-out. Indeed, the two bonds in question already trade at a higher price than similar bonds with collective action clauses. For example, the 2027 bond trades at a premium of 3 points. However, buying these bonds is not a slam dunk. For example, exit consents (amendment to the terms of bonds upon acceptance of an exchange offer) could be agreed by a simple majority as opposed to the higher 75% threshold for bonds with collective action clauses.
Restructuring Venezuela’s debt probably will result in new legal challenges and twists, although pari passu is probably off the table as an important negotiation chip. Nevertheless, a long, protracted battle with holdouts awaits…
