NML Capital v Argentina: a lesson in
indenture interpretation
Howard S Steel*
Elnaz Zarrini
Arkady A Goldinstein
Brown Rudnick, New York
Brown Rudnick, New York
Brown Rudnick, New York
hsteel@brownrudnick.com ezarrini@brownrudnick.comagoldinstein@brownrudnick.com
O
n 16 June 2014, the United States Supreme
Court denied Argentina’s petition for certiorari
in an ongoing dispute between Argentina and certain
holders of Fiscal Agency Agreement (FAA) bonds
(on which Argentina defaulted in 2001), who did not
agree to exchange their bonds in two earlier offers by
Argentina in 2005 and 2010.1 Argentina and certain
commentators have criticised the denial of certiorari as
a victory for ‘vulture’ hedge funds and a blow to ‘New
York’s status as the law of choice for sovereign debt.2
This article provides an overview of the case and
concludes that the outcome was not a result of any
bias in New York law but a well-reasoned exercise in
contract interpretation. Courts applying New York law
recognise that efficient capital markets can only exist
if freedom of contract and the expectations of the
parties embodied within the contract are predictably
enforced. A legal regime that enforces the terms of a
contract as written is one that ‘dignifies’ both parties
to a bond indenture.3 Thus, the denial of certiorari
does not yield a one-sided victory for hedge funds, but
instead provides future sovereign issuers and investors
with support that bargained-for terms of indentures
will be upheld.
Background: NML Capital Limited v Republic
of Argentina
In 1994, Argentina began issuing FAA debt securities,
some of which were purchased by hedge funds and
other distressed debt investors.4 The FAA bonds were
governed by New York law and included the following
‘pari passu’ clause:
‘[T]he securities will constitute… direct,
unconditional, unsecured and unsubordinated
obligations of the Republic and shall at all times rank
pari passu without any preference among themselves.
The payment obligations of the Republic under
the Securities shall at all times rank at least equally
with all its other present and future unsecured and
unsubordinated External Indebtedness.’5
The Second Circuit referred to the last sentence of the
pari passu clause as the ‘Equal Treatment Provision’.6
The events that followed have received substantial
publicity. In 2001, Argentina defaulted on the
FAA bonds. That same year, Argentina’s president
declared a ‘temporary moratorium’ on payments of
public external debt, including the FAA bonds. The
moratorium has been renewed every year since, and
no payments have been made on the FAA bonds since
the 2001 default. In 2005, Argentina offered the FAA
bondholders an opportunity to exchange their bonds
for new unsecured debt at a rate of 25 to 29 cents on
the dollar. That same year, the Argentine legislature,
presumably to pressure FAA bondholders to accept
the exchange, enacted a ‘Lock Law’ preventing
Argentina from conducting any type of settlement
with respect to the FAA bonds.7 In 2010, Argentina
temporarily suspended the Lock Law and extended
another exchange offer to the FAA bondholders
that did not participate in the 2005 exchange. At
the close of the 2010 exchange offer, 91 per cent of
the original FAA bondholders had participated in
an exchange. To date, Argentina has not made any
payments to the holdout bondholders.8
Between 2009 and 2011, a number of holdout FAA
bondholders sued Argentina in the Southern District
of New York, alleging, inter alia, breach of the equal
treatment provision of the FAA bond indenture,
and seeking injunctive relief, including specific
performance of the contract terms. Judge Thomas
Griesa found that Argentina had breached the equal
treatment provision when it effectively lowered the
rank of the FAA bonds by making payments on the
bonds exchanged in 2005 and 2010 but not the FAA
bonds, and enjoined Argentina from further doing so.9
Argentina unsuccessfully appealed the decision to the
Second Circuit.10 On 30 June 2014, enjoined by Judge
Griesa’s order, Argentina missed an interest payment
on the exchange bonds.11 The 30-day grace period
expired on 30 July 2014.12
Insolvency and Restructuring International Vol 8 No 2 September 2014 31
NML Capital v Argentina: a lesson in indenture interpretation
Interpretation of Pari Passu clauses under
New York law
Under New York law, bargained-for contractual
provisions are enforced as they are written.13 Indeed,
New York courts are hesitant to look beyond the ‘four
corners’ of a contract to determine the meaning of
contractual provisions.14
Indentures follow form and are uniformly enforced
as written under New York law, and for good reason.15
In Sharon Steel, the Second Circuit explained that
‘uniformity in interpretation is important to the
efficiency of the capital markets’, such that uncertainties
as to the meaning of indenture provisions ‘would
decrease the value of all debenture issues’ and ‘increase
the risks and, therefore, the costs of borrowing with no
offsetting benefits either in the capital market or in
administrative justice’.16
Thus, New York courts are reluctant to find
implied indenture terms that parties did not bargain
for or to interpret common indenture terms in an
unconventional fashion because doing so ‘on a case-bycase basis threatens to inject an impermissible degree
of uncertainty into the bond market’.17
Although pari passu clauses have become an
increasingly common provision in bond indentures over
the past few decades, these clauses are rarely litigated
and case law construing these clauses is minimal.18 In
one South American sovereign debt case, a court in
Brussels, interpreting New York law, found a pari passu
clause to provide for equal payment rights. In 2000,
Elliott Associates, a holder of Peruvian debt (and one
of the holdout FAA bondholders), successfully enjoined
the payment on Peru’s Brady Bonds on the basis of a
1983 New York law-governed agreement containing
a pari passu clause.19 Elliott had obtained a judgment
in an unrelated matter against Peru and a Peruvian
bank in the Southern District of New York, and sought
to redirect the payments on Peru’s external Brady
Bonds to pay the judgment creditors.20 Elliott filed an
ex parte motion with the President of the Commercial
Court in Brussels seeking to enjoin the operator of the
Euroclear System from processing the payments to the
Brady Bonds holders.21 On appeal, the Brussels Court of
Appeals granted Elliot’s motion to enjoin, stating that
a pari passu clause ‘in effect provide[d] that the debt
must be repaid pro rata among all creditors[,]… and no
creditor can be deprived of its proportionate share’.22
After the Peru case, bondholders recognised the
leverage embedded in pari passu clauses, and many
initiated legal action seeking injunctive relief on the
basis that funds ought to be distributed pro rata to
other debt holders.23 The majority of these actions
were brought in New York courts, but ver y few
32
cases demanded a judgment under New York law to
determine whether the pari passu clause had actually
been breached.24 Thus, NML Capital v Argentina would
be principally decided by contract interpretation.
The Second Circuit did not cite any cases that
involved pari passu clauses to support its holding
in NML Capital v Argentina, but rather looked at
the language of the pari passu clause and applied
basic principles of contract interpretation. The
Second Circuit reasoned that the first sentence of
the pari passu clause prohibited Argentina from
legally subordinating the FAA bonds. 25 The Court
then reasoned that the second sentence, the
equal treatment provision, must have prohibited
something else. 26 The Second Circuit concluded
that the equal treatment provision prohibited
Argentina from ‘paying on other bonds without
paying on the FAA [b]onds’. 27 The Second Circuit
thus found that Argentina breached the pari passu
clause by making payments on the exchange bonds
but not the FAA bonds.28
Freedom of contract and the free market
Contrar y to the contentions of certain legal
commentators, the Southern District of New York’s
interpretation of the FAA bonds’ pari passu clause does
not create a lender-friendly legal regime at the expense
of borrowers. The outcome in this case happened to
be a victory for the holdout FAA bondholders, but this
victory was a result of a clean textual interpretation of
the indenture terms as they were drafted, and not as a
result of any preference in New York law.
At least three things in the FAA bond indentures
could have been different – and more in line with
comparable indentures – and may have changed the
outcome for Argentina. First, Argentina could have
removed – or bargained to remove – the ‘payment
obligation’ language that lent itself to be interpreted
as providing pro rata payments to all similarly
situated bondholders.29 Second, many sovereign bond
indentures allow the borrower’s legislative acts to
override equal rank provisions of pari passu clauses.30
Had such a provision been present in the FAA bond
indenture, the Lock Law would have accomplished its
desired goal without breaching the pari passu clause.
Third, and more fundamentally, the holdout FAA
bondholders were able to succeed partly because the
FAA bond indenture lacked a collective action clause.
Had such a clause been present, the majority of the FAA
bondholders that accepted Argentina’s exchange offers
would have been able to bind the holdout bondholders
and prevent any further litigation.31 Thus, it was not
that New York law was bondholder-friendly; rather the
Insolvency and Restructuring International Vol 8 No 2 September 2014
courts happened to have applied New York law to a
bondholder-friendly indenture.
The enforcement of the FAA bond indenture terms
as written provides assurance to all participants in the
capital markets that the bargained for terms of their
agreements will be upheld. Indeed, Judge Griesa
explicitly justified issuing the injunction against
Argentina on this very rationale. In the injunction,
he explained:
‘The public interest of enforcing contracts and
upholding the rule of law will be served by the issuance
of this Order, particularly here, where creditors of the
Republic have no recourse to bankruptcy regimes
to protect their interests and must rely on courts to
enforce contractual promises. No less than any other
entity entering into a commercial transaction, there
is a strong public interest in holding the Republic to
its contractual obligation.’32
Greater certainty that contractual terms will be
enforced encourages participation in the debt markets
by both lenders and borrowers, and may increase access
to capital for borrowers. Investors will be less willing to
lend or will demand greater returns in a legal regime
that increases their financial risks by failing to uphold
bargained for investment protections.33
Thus, contrary to certain commentators’ conclusions,
the Supreme Court’s denial of certiorari does not
undermine the status of New York law in the sovereign
debt market. In fact, it strengthens it. Future borrowers
and lenders may continue to rely upon foundational
principals of contract construction under New York law
when evaluating the terms of their indentures without
fear of undue interpretative bias.
Notes
* Howard Steel is a partner in Brown Rudnick’s corporate restructuring
group. Elnaz Zarrini and Arkady Goldinstein are associates in Brown
Rudnick’s litigation group and corporate restructuring group,
respectively. The views and opinions expressed in this article are those
of the authors and shall not be attributed to Brown Rudnick.
1 Republic of Argentina v NML Capital, Ltd, 134 S Ct 2819 (2014); NML
Capital, Ltd v Republic of Argentina, 727 F.3d 230, 237 (2d Cir 2013).
2 Petition for Writ of Certiorari at 22, NML Capital Ltd, 134 S Ct 2819
(2014) (No 13-990); Nicholas L Georgakopoulos, ‘Opinion: A Victory
for Vulture Funds’ (10 July 2014) Law360, available at: www.law360.
com/articles/556124.
3 Brief for the Aurelius Respondents in Opposition to Argentina’s
Petition for Certiorari at 17, NML Capital Ltd, 134 S Ct 2819 (2014)
(No 13-990) [hereinafter Aurelius Brief].
4 NML Capital, Ltd v Republic of Argentina, 699 F.3d 246, 251 (2d Cir
2012).
5 NML Capital, Ltd, 699 F.3d at 251.
6 Ibid.
7 Ibid.
8 Ibid.
9 Ibid at 254.
10 Republic of Argentina v NML Capital, Ltd, 134 S Ct 2819 (2014)
(affirming judgment of the district court).
11Nicole Hong, ‘US Judge Says Argentina Can’t Pay Some
Bondholders’ (27 June 2014) Wall Street Journal, available at:
http://online.wsj.com/articles/u-s-judge-says-argentinas-attemptto-pay-holders-of-restructured-bonds-is-illegal-1403884702.
12 Ibid.
13 See, for example, Riverside S Planning Corp v CRP/Extell Riverside, LP,
13 NY 3d 398, 403–04 (2009).
14 See, for example, Sharon Steel Corp v Chase Manhattan Bank, NA, 691
F.2d 1039, 1048–49 (2d Cir 1982) (looking to the contract language as
‘the starting point in the search for meaning’); Vermont Teddy Bear Co
Inc v 538 Madison Realty Co, 1 NY 3d 470, 475 (2004) (‘In the absence
of any ambiguity, we look solely to the language used by the parties
to discern the contract’s meaning’).
15 See, for example, Sharon Steel, 691 F.2d at 1048–51; cf Hartford Fire Ins
Co v Federated Dep’t Stores, Inc, 723 F Supp. 976, 992 (SDNY 1989).
16 Sharon Steel, 691 F.2d at 1048; see also Hartford Fire Ins, 723 F Supp at
992 (citing Sharon Steel).
17See Hartford Fire Ins, 723 F Supp at 992; see also Broad v Rockwell
Int’l Corp, 642 F.2d 929, 943 (5th Cir 1981) (interpreting New York
law in finding that the parties ‘who must comply with or refer to
the indenture’ are the members of the investing public and their
investment advisors. A large degree of uniformity in the language of
debenture indentures is essential to the effective functioning of the
financial markets: uniformity of the indentures that govern competing
debenture issues is what makes it possible to meaningfully compare
one debenture issue with another, focusing only on the business
provisions of the issue….’); In re Bank Atlantic Bancorp, 39 A.3d 824,
837–38 (Del 2012) (applying a successor obligor clause in accordance
with Sharon Steel).
18 Scott and Mitu Gulati, ‘Origin Myths, Contracts, and the Hunt for
Pari Passu’ (2013) 38 Law & Soc Inquiry 72, 101.
19Lee C Buchheit and Jeremiah S Pam, ‘The Pari Passu Clause in
Sovereign Debt Instruments’ (2004) 53 Emory L J 869, 877–79; see
also Elliot Assocs, LP v Banco de la Nacion, General Docket No 2000/
QR/92 (Ct App Brussels, 8th Chamber, 26 September 2000).
20See Elliot Assocs., LP v Banco de Nacion, No 96 Civ 7916, 2000 WL
1449862 at *1 (SDNY 29 September 2000); Buchheit, n19 above, 877.
21 Buchheit, n 19 above, 877.
22 Elliot Assocs, LP v Banco de la Nacion, General Docket No 2000/
QR/92 (Ct App Brussels, 8th Chamber, 26 September 2000)
(emphasis added).
23 See, for example, Export-Import Bank of the Republic of China v Grenada,
2013 WL 4414875 at *1 (SDNY 19 August 2013) (lenders assert breach
of pari passu clause in loan agreements and seeking injunctive relief);
Nacional Financiera, SNC v Chase Manhattan Bank, NA, No 00 Civ 1571,
2003 WL 1878415 at *1 (SDNY 14 April 2003) (bondholders assert a
breach of contract claim against external bondholders that received
bond payments in violation of a pari passu clause); Pereira v Equitable
Life Ins Soc’y of the US (In re Trace Int’l Holdings, Inc), 289 BR 548, 552
(Bankr SDNY 2003) (class of shareholders invoke pari passu clause
in certificate of designation to receive dividend payments pari passu
with other class of shareholders).
24 See, for example, Pons v People’s Republic of China, 666 F Supp 2d 406,
409 (SDNY 2009) (dismissing plaintiffs’ complaint alleging breach
of a pari passu clause in a bond indenture for lack of subject matter
jurisdiction); Nacional Financiera, 2003 WL 1878415 at *2 (pari passu
clause in a bond indenture did not create contractual rights and
obligations between holders of unsecured notes); Pereira, 289 BR
at 559 (finding the application of a pari passu clause in certificate
of designation to be ambiguous because of the failure to provide a
comparable provision for other stockholder classes).
25See NML Capital, Ltd v Republic of Argentina, 699 F.3d 246, 258–59 (2d
Cir 2012) (construing the first sentence of the pari passu clause that
read as follows: ‘The securities will… constitute direct, unconditional,
unsecured, and unsubordinated obligations...).
26 Ibid, 258 (citing Singh v Atakhanian, 818 NYS 2d 524, 526 (App Div
2006)) (applying the interpretive principle that a contract should not
be interpreted to leave one of its provisions without effect).
27 Ibid, 258–59 (construing the second sentence of the pari passu clause
that read as follows: ‘The payment obligations… shall at all times rank
Insolvency and Restructuring International Vol 8 No 2 September 2014 33
Liabilities that survive insolvencies and restructurings in Brazil
at least equally with all its other present and future unsecured and
unsubordinated External Indebtedness’).
28 Ibid, 259–60.
29 See Aurelius Brief, n3 above, 4.
30 See Scott and Mitu Gulati, n18 above, 87. The language of such a
‘modified’ pari passu clause would, for example, read: ‘The payment
obligations of the Issuer under the Notes shall rank at least pari passu
with all other unsecured and unsubordinated obligations of the Issuer,
present and future, save only for such obligations as may be preferred
by mandatory provisions of applicable law.’ Ibid.
34
31See NML Capital, Ltd v Republic of Argentina, 727 F.3d 230, 247 (2d
Cir 2013).
32 NML Capital, Ltd v Republic of Argentina, No 1:08-cv-06978 (SDNY
23 February 2012).
33 See Aurelius Brief, n3 above, 16–17; see also Sharon Steel Corp v Chase
Manhattan Bank, NA, 691 F.2d 1039, 1048 (2d Cir 1982) (explaining
that uncertainties in the meaning of indenture provisions ‘would
vastly increase the risk and, therefore, the cost of borrowing with no
offsetting benefit either in the capital market or in the administration
of justice’).
Insolvency and Restructuring International Vol 8 No 2 September 2014