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HARVARD LAW SCHOOL
International Finance Seminar
Professor Hal Scott and Professor Howell Jackson
SOVEREIGN DEBT RESTRUCTURING:
SHOULD WE BE WORRIED ABOUT ELLIOTT?
EDUARDO LUIS LOPEZ SANDOVAL
Cambridge - Massachussets
May 2002
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TABLE OF CONTENTS
I. INTRODUCTION...3
II. THE ELLIOTT CASE: FACTUAL BACKGROUND AND POST-JUDGEMENT
LEGAL STRATEGY...7
1. What exactly happened?..8
2. The Brussels Court of Appeals Decision...17
3. The Opinion of Professor Andreas F. Lowenfeld..20
III. INTERPRETING THE PARI PASSUCLAUSE...24
1. An Alternative Interpretation.24
2. Elements to be considered when interpreting thepari passuclause.36
2.1 Necessity to pay preferred creditors first....37
2.2 The role played by other clauses included in international loan
contracts..39
2.3 Variations on the conventional terms of the pari passu clause.44
2.4 International public policy issue: the holdout creditor problem...45
3. Rules for the Interpretation of International Loan Contracts.48
3.1 New York Rules49
3.2 English Rules...50
IV. FORMAL ASPECTS OF THE BRUSSELS DECISION.54
V. ADDITIONAL SUBSTANTIVE ISSUES58
1. Execution of NY decisions58
2. Property over funds transferred to Euroclear.61
VI. CONCLUSION..62
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I
INTRODUCTION
One of the most important cases of the last decade, in the sovereign debt arena,
was that involving the New York-based hedge fund named Elliott Associates, LP
(hereinafter referred to as Elliott) against the Republic of Peru1(hereinafter referred to as
Peru). After several years of litigation, the final decision favored Elliott and confirmed
various substantive issues relating to sovereign debt litigation. First, it was held that
buying distressed debt and suing the sovereign to make good on its obligations is not
against New York Champerty Law, therefore eliminating one of the few legal defenses
available to sovereigns against holdout creditors. Second, the Court clarified the
application of the US Foreign Sovereign Immunities Act with regard to which assets are
subject to being attached in execution of the Courts decision, stating clearly that all
assets, located in the jurisdiction where the suit is brought, are subject to attachment, if
they belong to an entity that (i) was somehow involved in the matter; (ii) is an agency or
instrumentality2of the defaulting sovereign; and (iii) is engaged in commercial activity in
the US.
1As it will be explained in more detail in the second part of this paper, Peru acted as a guarantor of the twodebtors involved in this case, namely Banco de la Nacion and Banco Popular del Peru.2Under 1610(b) of the US Foreign Sovereign Immunities Act, an agency or instrumentality of a state isdefined as an entity which is a separate legal person, corporate or otherwise; an organ of a foreign state orpolitical subdivision thereof; neither a citizen of a State of the United State, nor created under the laws ofany third country. See Farisa Zarin,How to Sue a Sovereign: The Case of Peru, Moodys Investors Service,Special Comment (Nov 2000). See also Farisa Zarin, Sovereign Debt, What happens if a Sovereign
Defaults, Moodys Investors Service, Special Comment (July 2000), available at
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Despite the favorable judicial decision obtained, Elliott was still faced with the
traditional problem of suing a sovereign, namely, the practical impossibility of attaching
the sovereigns assets in order to obtain payment. Neither Peru nor the Banco de la
Nacion (considered as an agency or instrumentality of Peru3) had property that could
be attached in the US. In response to this situation, Elliott Associates tried to intercept
and attach the Peruvian funds that were being transferred internationally for the payment
of those creditors who had agreed to the Brady Plan debt restructuring.
Elliotts first attempt involved a restraining order obtained against the New York
Fiscal Agent for the Peruvians Brady Bonds (The Chase Manhattan Bank). This bank
was ordered to retain any money that it received from Peru to be used for the interest
payment of the Brady bondholders. The argument was that Chase was merely the agent
of Peru and, therefore, the latter was still the owner of the funds that would be
transferred. However, such a transfer never took place because Peru became aware of the
restraining order. Continuing with the legal strategy, Elliott sought ex parte to obtain an
order from a Belgium Court restraining Euroclear from either accepting money from Peru
or paying it to the Brady creditors. The request was initially dismissed by the Brussels
Commercial Court, but the decision was rapidly revoked by the Court of Appeals,
granting the restraining order according to the terms requested by Elliott. Given the risk
of defaulting in the payment of interest to its Brady creditors, Peru was left with no other
http://www.moodys.com/moodys/cust/research/venus/Publication/Special%20Comment/noncategorized_number/57753.pdf(visited on December 31, 2001).3In this case, all parties agreed that Banco de la Nacion was an agency or instrumentality of Peru. SeeElliott Assocs., L.P. v. Banco de la Nacion. 2000 U.S. LEXIS 14169 (S.D.N.Y. Sept 29, 2000), at 8.
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alternative but to settle the controversy, so that the restraining order was not judicially
contended.
Elliotts victory in Brussels was fundamentally based on the argument that Peru
was attempting to make payments in violation of a principle of equal treatment (pari
passu clause) among foreign creditors, and was trying to use the Euroclear System to
achieve that objective. After analyzing the argument put forward by Elliott, the Court of
Appeals in Brussels expressly reached such a conclusion arguing that the pari passu
clause contained in the basic agreement that governs the repayment of the foreign debt of
Peru in effect provides that the debt must be repaidpro rataamong all creditors.
Such an interpretation was defended by Professor Andreas Lowenfeld, whose
opinion was submitted to the Courts in Belgium. According to Lowenfeld, the pari passu
clause means that, if there is not enough money to pay all creditors in full, the debtor
cannot discriminate amongst creditors, paying some of them in full and leaving others
unpaid; in such a situation, all creditors must be paidpro rata.
Although there is no clear idea about what the real effects of the Brussels decision
are and what its consequences will be in the sovereign debt context, it has been suggested
that it will definitely strengthen the position of holdout creditors. Holdout creditors have
been a major problem for sovereign debt restructuring since the beginning of the nineties,
when the international financial architecture for sovereign borrowing changed from
syndicated bank loans to sovereign bonds. The new bond-based structure led to the
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creation of a secondary market for such instruments and, consequently, to an exponential
growth in the number of bondholders. Due to the NY law applicable to most of them,
individual bondholders are not obliged to negotiate restructurings of the debt or to accept
the new terms of an exchange offer. It has been judicially recognized that those
bondholders are entitled to keep their original instruments and that the sovereign remains
beholden under the old terms. In practice, however, the possibility of holdout creditors
obtaining payment on their old instruments was very remote, because of the US Foreign
Sovereign Immunities Act restrictions. It is precisely in this area that the Brussels
decision will allegedly play a significant role.
Commentators have suggested that such a decision is one of the most important
weapons given to holdout creditors to defend against sovereigns and the majority of
creditors. It has been predicted4 that it will cause serious disruptions in sovereign debt
restructurings and, consequently, it will enhance global financial instability. If those
predictions turn out to be true, then it seems to be extremely urgent to implement an
international bankruptcy system for sovereign countries or any other legal mechanism
which can cause an orderly restructuring of the sovereign debts. However, such
predictions are based on the assumption that the Brussels decision represents a definite
and final conclusion of law, which will be used as a precedent in Belgium and will
probably influence the interpretation of the debated issue in other jurisdictions. It is
specifically this aspect of the controversy that this paper intends to address.
4See G. Mitu Gulati & Kenneth N. Klee, Sovereign Piracy, The Business Lawyer, Vol. 56, February 2001,at 636.
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The focus of this paper is on trying to determine what the real legal effects of the
Brussels decision are. The first part is aimed at analyzing the substantive part of the
Brussels decision. It has been held that it is not clear if Elliotts strategy would survive
legal challenge in future cases. So this part of the paper is intended to clarify such an
issue. The interpretation of the meaning of the pari passu clause in the sovereign debt
context is explored in depth. The paper tries to identify the legal meaning of such a clause
and to determine if there is any divergence when compared with the general
understanding of the clause in the market. Since the interpretation of the pari passu
clause has to be made in light of the laws governing the debt agreement wherein such a
clause is included, the analysis basically focuses on US law, with certain specific
references to English law.
In the second part of this paper, the controversy is explored from a formal
perspective; the paper tries to find answers to the following questions: Does the Brussels
decision represent a firm and definite conclusion of law? How important are the
conclusions stated in a decision on an ex parte motion? Did the Brussels Court really
arrive at a final conclusion of law on the issue under scrutiny? Will such a decision be
used as a precedent for mandatory observance in Belgium?
The outcome of this paper will help determine whether the Brussels decision
represents a real threat to the financial stability of the global sovereign debt market and
whether, therefore, it may be used as an argument to support the creation of an
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international bankruptcy procedure for sovereign debtors or the implementation of any
alternative proposal.
II
THE ELLIOTT CASE: FACTUAL BACKGROUND
AND POST-JUDGMENT LEGAL STRATEGY
1. What exactly happened?
In October 1995, Perus government publicly announced its Brady deal, after the
Bank Advisory Committee agreed to restructure Perus defaulted commercial bank loans,
in order to exchange such credits for Brady Bonds5. Three months after such an
announcement, Elliott, a New York-based vulture fund, began purchasing 1983 Letter
Agreements of Banco de la Nacion (hereinafter referred to as BN) and Banco
Popular del Peru, which had been guaranteed by Peru6. Between January and March of
1996, Elliott acquired a total of US$20.7 million (face value) of such commercial bank
loans. This debt was acquired at the distressed price of about US$11.4 million7. It is
5SeeMerrill Lynch Report,Debt Restructuring: Legal Consideration. Impact of Perus Legal Battle and
Ecuadors Restructuring on Nigeria and Other Potential Burden-Sharing Cases, October 30, 2000.Available at http://www.emta.org/keyper/linden1.pdf(visited on March 10, 2002).6See International Monetary Fund, Policy Development and Review and Legal Departments,Involving thePrivate Sector in the Resolution of Financial Crises Restructuring International Sovereign Bonds , at 12.Available at http://www.imf.org/external/pubs/ft/series/03/IPS.pdf(visited on March 10, 2002).7SeeAmbassador Philip S. Kaplan, Patton Boggs LLP,Memorandum prepared by Perus outside counseladdressed to Perus Minister of Economy, Mr. Carlos Bologna, about the Elliott Associates Settlement(hereinafter referred to as the Kaplan Memorandum), at 1. Available athttp://www.mef.gob.pe/Caso_E/frame_pdf.htm(visited on March 13, 2002). See also Ministry of Economyand Finance of Peru, Final Report about the Elliott Associates case, (hereinafter referred to as the MEF
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interesting to notice that Elliotts purchases occurred after the Brady deal was agreed and
only two weeks after another creditor, Pravin Banker, successfully litigated against Peru8.
The timing of such acquisitions allegedly suggested Elliotts intention to litigate9.
Immediately after completing its acquisition, and while Peru was still negotiating with
the Bank Advisory Committee the term sheet of its Brady deal, Elliott started making
demands for full payment.
In October 1996, Peru issued instructions to execute the Brady Exchange
Agreement. As expected, Elliott refrained from participating in the proposed Exchange
Agreement. Instead, on October 8th, 1996, Elliott filed a suit against Peru and BN and
also filed an ex parte motion for prejudgment attachment. It was clear that Elliotts
intention was to attach the collateral for the Brady closing, which would have caused a
serious impact in Perus ability to close the Brady deal10. However, the Court denied
Elliotts motion for attachment. The Court also denied a summary judgment motion
subsequently filed by Elliott.
With the collateral held in trust for the Brady bond holders and hence protected
from Elliotts attempts to attach such assets, the Brady Exchange Agreement closed on
March 7th, 1997. The closing was achieved upon Perus verbal promise not to provide
Final Report), at 1. Available at http://www.mef.gob.pe/Caso_E/frame_pdf.htm3 (visited on March 13,2002).8 See Memorandum prepared by Perus outside counsel, Mr. Mark A. Cymrot, from Baker & HostetlerLLP, addressed to Perus Minister of Economy, Mr. Carlos Bologna, about External Debt Litigation(hereinafter referred to as the Cymrot Memorandum), at 4. Document available athttp://www.mef.gob.pe/Caso_E/frame_pdf.htm(visited on March 10, 2002).9 See Merrill Lynch Report, supra note 5, at 2.
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any extra benefits to hold out creditors. Peru stood on its word and refused all Elliotts
continuous demands for full payment11. As a consequence, both parties became involved
in a lengthy pre-trial discovery process, trial finally held in March 1998, one year after
the Brady deals closing.
In August 1998, the District Court for the Southern District of New York adopted
a decision in Perus favor, after finding as a fact that Elliott purchased the Peruvian debt
with the intent and purpose to sue and did not seriously consider alternatives to
bringing an action
12
. Accordingly, the court held that Elliots assignment contracts --
whereby it acquired the Peruvian distressed debt-- violated 489 of the New York
Judiciary Law, which makes unlawful the acquisition of debt with the intent and for the
purpose of bringing an action or proceeding thereon. This decision represented the first
time a debtor succeeded in proving the champerty defense at trial13.
However, in September 1998, Elliott filed an appeal arguing that the champerty
doctrine did not apply14. The United States Court of Appeals for the Second Circuit
agreed and, therefore, reversed the judgment of the District Court. In its decision, dated
October 20th, 1999, the Court of Appeals held that 489 of the New York Judiciary Law
is not violated when the accused partys primary goal is found to be satisfaction of a
10Perus Brady restructuring program was made in the context of an IMF-supported program, wherebyIMF funds were used to help finance the acquisition of collateral for the new instruments. See InternationalMonetary Fund, supra note 6, at 12.11 See MEF Final Report, supra note 7, at 4 (Perus strategy was to frustrate Elliott in the litigation,demonstrate that it could not collect from Peru without an agreement, and eventually force Elliott to acceptsomething close to Brady terms, as had successfully been done in the Pravin Banker case).12Elliott Assocs. , L.P. v. Banco de la Nacion, 194 F.3d 363, 366 (2d. Cir. 1999)13See Cymrot Memorandum, supra note 8, at 4.14See Merrill Lynch Report, supranote 5, at 2.
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valid debt and its intent is only to sue absent full performance15. It was found that
Elliotts primary goal was to satisfy a valid debt and not necessarily to litigate 16. The
Court of Appeals remanded the case to the trial court only for the purpose of calculating
damages.
Given the favorable decision obtained by Elliott from the Court of Appeals, on
November 2nd, 1999 the trial court granted Elliott, upon its request, an attachment and
restraining order over the commercial property of Peru and BN. Despite Elliotts success
in obtaining this post-judgment order, in practice it gained very little from that since there
was virtually no property held by Peru and/or BN in New York17. Elliott then requested
that such restraining orders were applicable to all foreign branches of New York banks
served by such orders. The trial court rejected such a petition on January 18, 2000 and,
therefore, Elliott was prevented from relying on one single order of attachment to catch
any transfers through branch offices18.
On June 22nd, 2000, the Court for the Southern District of New York finally
rejected Perus defenses and ordered judgment in favor of Elliott. In its decision, the
court authorized Elliott to recover from the defendants the sum of US$55,660,831.56,
15 Elliott Assocs. v. Banco de la Nacin, 194 F.3d 363 (2d Cir. 1999). Available atwww.tourolaw.edu/2ndCircuit/October 99/98-9268.html , visited on December 12, 2001. See also Samuel
E. Goldman, Mavericks in the Market: The Emerging Problem of Hold-Outs in Sovereign DebtRestructuring, 5 UCLA J. Intl L. & Foreign Aff. 159, at 15 (The court found that the decision to bringsuit was incidental and contingent to the decision to purchase the debt. It was incidental as the primarypurpose was to receive payment, and it was contingent since the decision to litigate came only after thedebtors decision not to pay).16See Merrill Lynch Report, supranote 5, at 2. See also Melissa I. Hoffman, Second Circuit Clarifies NewYork Law on Enforcement of Debt Instruments , Weil, Gotshal & Manges LLP - Bankruptcy Bulletin,February 2000, available at http://www.weil.com/weil/sitesearch_frames.html(visited on March 16, 2002).17See Cymrot Memorandum, supra note 8, at 5.
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representing the principal amount and past due interests up to such date, and authorized
the recovery of post judgment interest as well. The court also made it clear that such
amount did not include the costs and expenses incurred by Elliott in connection with the
enforcement of its rights. Additionally, the court authorized the execution of the decision
against any property of the defendants that is used for a commercial activity in the United
States19.
Under such circumstances, Peru was facing a very complicated situation by
September 2000. Both Peru and BNs commercial assets were subject to the attachment
order referred to above. Peru was faced with serious operational difficulties and, hence,
was forced to design a complete new strategy and procedure to channel and receive funds
derived from international loan agreements and other commercial transactions, as well as
to comply with the payment of international financial obligations. Thus, international
funds were received by and transferred from Peru through financial centers other than
New York20. The scenario was aggravated by Elliotts renewed efforts to attach
defendants property abroad, especially in Germany, Holland, Belgium, England,
Luxembourg and Canada. However, such strategy failed to find any significant property
to be attached.
Being aware that the first Peruvian Brady coupon following the June 22nddecision
would fall due on September 7th, 2000, Elliott sought to attach Perus interest payment to
18See Merrill Lynch Report, supranote 5, at 2.19See Elliott Associates, L.P., v. Banco de la Nacion, 2000 WL 1449862 S.D.N.Y. Sep 29, 2000.20See MEF Final Report, supra note 7, at 1.
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its Brady bondholders21. According to the terms of its Brady deal, in order to comply
with such payments, Peru was obliged to deliver US$80 million to the Chase Manhattan
Bank (hereinafter referred to as Chase), on September 6th, 2000. After receiving such
funds, Chase, acting as the fiscal agent for the Brady bonds, would proceed to make the
payment of the interests basically through three clearinghouses: Depository Trust
Company (DTC) of New York, Euroclear of Belgium and Clearstream of Luxemburg. As
part of Elliotts strategy to intercept such funds, it obtained ex parte restraining orders
against Chase, DTC, Morgan Guaranty Trust Company of New York (hereinafter
referred to as Morgan) and Bank of New York. The order was notified to the latter in its
role as cash custodian of Euroclear and to Morgan as operator of Euroclear.
Simultaneously, Elliott initiated legal proceeding in three different jurisdictions: England,
Belgium and Luxemburg, seeking to block the interest payment through the European
clearinghouses referred to above22. It was clear then that Elliots strategy was twofold:
first, trying to attach the funds at the level of the fiscal agent; second, capturing funds at
the level of the clearing houses.
However, the first part of Elliott strategy failed to achieve its objective when
Peru, presumably informed that a restraining order had been served upon Chase 23, did not
deliver the funds as agreed originally in the Brady plan. Notwithstanding having
frustrated Elliotts first plan, Peru failed to pay the corresponding interest to its Brady
bond holders on September 7th, 2000. Therefore, according to the terms of the agreement
governing the Brady instruments, Peru was granted a grace period of 30 days. So, if the
21See Cymrot Memorandum, supranote 8, at 5. See also Merrill Lynch Report, supra note 5, at 2.22See MEF Final Report, supra note 7, at 3. See alsoCymrot Memorandum, supranote 5, at 5.
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interest payment was not made before the end of the grace period, Peru would have
legally incurred in formal default and, hence, triggered the right of all its Brady
bondholders to demand full payments of their securities, which represented a total
exposure of up to US$3,837 million24.
Constrained by time pressure, Perus legal advisors25 devised a multi-level
strategy26 in order to have the Brady interests paid before October 7th, 2000. Initially,
they tried to find an alternative way to comply with the interest payments through a route
other than Chase, therefore avoiding Elliotts attachments attempts. This initiative was,
however, unsuccessful. As explained by Perus outside legal counsel, with DTC blocked
by Elliotts restraining order, and most of the international banks and clearinghouses
reluctant to cooperate due to fears of new lawsuits by Elliott27, the possibility of finding
an alternative route for the interest payments was quite complicated: Elliott was very
active in trying to block the Euroclear route, and the other natural alternative,
Clearstream, agreed to participate but only in return for an indemnity from Peru 28. In
spite of such difficulties, there were some rumors suggesting that Peru had seemingly
secured the backing of the Bank of International Settlements to go around Elliott. This
Switzerland-based institution is, as most international organizations, immune from
23
See Merrill Lynch Report, supra note 5, at 2.24See MEF Final Report, supra note 7, at 6.25 Perus legal advisory team in this particular matter was lead by Mr. Mark A. Cymot, from Baker &Hostetler LLP, and Mr. Roger Thomas, from Cleary, Gottlieb, Steen & Hamilton.26See Cymrot Memorandum, supranote 8, at 7.27See Id., at 7.28See Id., at 7. (Clearstream, the clearinghouse in Luxemburg, however, agreed to pay about 40 percent ofthe bondholders in return for an indemnity from Peru. Clearstream also held open the possibility that otherbondholders could transfer their accounts to Clearstream to receive payment. The indemnity involved somerisk of liability to Peru).
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lawsuits and attachments29. However, due to reasons that have not been publicly revealed
by Peru, this alternative route was never put in place. Presumably, the terms and
conditions of the Peruvian Brady bonds might have included a detailed mechanism for
the payment of interest and capital, whose non compliance would have been considered
as an event of default. This possibility, nonetheless, is merely speculative since it has not
been confirmed.
In addition, Perus advisors also considered the filing of motions challenging
Elliotts restraining orders and, most specifically, the possibility of posting with the court
a security bond equal to the amount of the judgments in order to have such orders
withdrawn30. Notwithstanding its appeal, this course of action was not followed because
it was considered that giving Elliott a security bond would have reduced Perus leverage
at the negotiation table31.
On September 21stand 22nd, 2000, two Courts from New York granted Elliott ex
parte restraining orders whereby, if a deposit or transfer occurred, Elliott would have the
right to serve additional restraining orders on Chase, DTC, Morgan and the Bank of New
York. Such orders were specifically aimed at avoiding the payment of the Brady
interests. Arguing that the orders appeared to reach beyond the US in violation of the
29See Carol S. Remond, Peru Settles Creditor Dispute with Elliott for US$58M,Dow Jones Newswires.Available at http://www.emta.org/ndevelop/djnews.html(visited on March 21st, 2002).30This is the same approach taken by Peru in the Pravin Banker case.31See Cymrot Memorandum, supra note 8, at 7. See alsoKaplan Memorandum, supra note 7, at 1.
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restrictions imposed by the decision of June 22nd, 2000, Peru, as well as Morgan and
Chase, challenged the referred orders32.
Also on September 22nd, Elliott filed an ex partemotion before the Commercial
Court of Brussels, Belgium, in order to prevent Euroclear from accepting or paying out
cash from Peru, intended to pay interest on the Brady bonds33. Elliotts petition was
aimed at enjoining Morgan, for reasons of absolute necessity, to instruct its Cash
Correspondents not to have any amounts credited to their accounts that originate from
the Republic of Peru or Banco de la Nacion, including amounts designed to pay interest
under the Brady bonds and, in case such funds had already been received, to instruct
such Cash Correspondents to block such funds and also not to take any action that
would result in such funds being distributed in any manner within the Euroclear
system34. Elliotts motion was denied because the Court considered that the tests of
absolute necessity and extremely urgent had not been fully met35. Not satisfied with
the decision, Elliott appealed in September 25th.
On September 26th, 2000, one day after Elliotts request for appeal was filed, the
8thChamber of the Brussels Court of Appeals reversed the Commercial Courts decision
and, hence, ordered the restraining order according to the terms requested by Elliott. As
mentioned before, the key argument presented by Elliott, and recognized as such by the
32See MEF Final Report, supra note 7, at 6.33See Merrill Lynch Report, supra note 5, at 2.34See Elliott Assocs. L.P., General Docket No. 2000/QR/92 (Court of Appeals of Brussels, 8 thChambers,Sept. 26, 2000) Unofficial translation (hereinafter referred to as Brussels Decision UnofficialTranslation), at 1.35See Id., at 2.
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Brussels Court of Appeals, was that Peru was trying to use Euroclear to violate the
principle of equal treatment of creditors, allegedly derived from the pari passu clause
contained in the original loan agreements held by Elliott36.
Under the pressure of having been put in a position where it might be forced to
default in its interest payments, Peru settled the controversy with Elliott on September
29th. Peru did no even wait until after the hearing that had been set to consider a request
made by Peru and Morgan to throw out the restraining orders affecting Morgan, Chase,
DTC and Bank of New York37
. The practical effect of the Brussels decision was
determinant. Although the Brussels Court of Appeals decision could have been legally
attacked, default in the payment of the Brady interest was imminent. In consequence,
Peru was left with no other alternative but to negotiate a settlement with Elliott. Peru paid
US$58.45 million in total to Elliott and had all restraining orders lifted38. Thus, Peru was
able to comply with the payment of its Brady interest on October 5th, 2000.
2. The Brussels Court of Appeals Decision
As mentioned before, the 8thChamber of the Brussels Court of Appeals issued the
decision under analysis (hereinafter referred to as the Brussels decision) on September
36See International Monetary Fund, Involving the Private Sector in the Resolution of Financial Crises
Restructuring International Sovereign Bonds, supra note 6, at 12.37See Reuters Banking-Financial Services Report, Peru Settles With Hedge Fund For More Than US$58M,available at http://www.mediaislandgroup.com/~financial/pilots/banking/STORIES/bank17.htm (visitedon March 21, 2002).38See MEF Final Report, supra note 7, at 6.
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26th, 2000, reversing the Commercial Court decision which denied Elliotts request for a
restraining order against Euroclear.
According to the terms of the Brussels decision, Elliott challenged the
Commercial Court ruling by invoking the following arguments: (i) it has a claim of
more than US$55 million against the Republic of Peru and has obtained two enforceable
judgments from a New York judge; (ii) the Peruvian Republic attempts to make
payments in violation of a principle of equal treatment (pari passu clause) among foreign
creditors, whereby Elliott Associates is excluded, and tries to use the Euroclear system to
achieve that objective; and (iii) the requested measures are necessary to achieve that
objective and this is only possible by bringing an ex parte motion39.
In sum, the Court of Appeals understood Elliotts motion as one intended to
prevent that Peru would resort to using the possibilities offered by the Euroclear System
in order to make discriminatory payments in a legal environment that avoids the effect of
the American judgments40. The court concluded that Elliott had an enforceable claim
against Peru and that the latter was trying to escape the enforcement thereof by making
an interest payment () via Euroclear41. Obviously, this rationale was based on the
premise that Peru was contractually barred from paying one group of creditors before
paying Elliott42.
39Brussels Decision Unofficial Translation, supra note 34, at 2.40Id.41Id.42SeeGulati & Klee, supra note 4, at 636.
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To reach that conclusion, the Court of Appeal had to analyze and interpret what
was the real and effective content and meaning of section 11(c), the pari passu clause, of
the Guaranty dated as of May 31, 1983, whereby Peru had guaranteed the 1983 Letter
Agreements of BN and Banco Popular del Peru. The clause under scrutiny reads
literally as follows43:
Representations and Warranties. - The Guarantor [i.e., theRepublic of Peru] represents and warrants as follows: ()(b) This Guaranty is the legal, valid and binding
obligation of the Guarantor, enforceable against the
Guarantor in accordance with its terms.(c)
The obligations of the Guarantor hereunder do rankand will rank at least pari passu in priority ofpayment with all other External Indebtedness of theGuarantor, and interest thereon.
The interpretation given by the Court of Appeals to the clause in question
concurred with the argument put forward by Elliott. The court expressly held that it
appears from the basic agreement that governs the repayment of the foreign debt of Peru
that the various creditors benefit from apari passu clause that in effect provides that the
debt must be repaid pro rata among all creditors. This seems to lead to the conclusion
that, upon an interest payment, no creditor can be deprived of its proportionate share44.
The ruling is very straightforward on this point and does not analyze the legal
matter in greater detail. It seems that the Court of Appeals just took for granted the
argument presented by Elliott and did not worry about exploring other possible meanings
43 See Declaration of Professor Andreas F. Lowenfeld, before the Southern District Court of New York(hereinafter referred to as the Lowenfeld Declaration), page 8.
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of the referred clause. The court assumed that the pari passu clause represents no more
than apro rata rule and, therefore, that Elliot had a legal right to be protected against a
serious and real threat, namely, the payment of interest to other creditors. However, the
Court of Appeals never mentioned nor explained the legal argument upon which such an
assumption is based. It was totally convinced by Elliotts arguments, which in turn, were
vividly explained by the New York University Professor, Andreas F. Lowenfeld, in his
declaration before the Southern District Court of New York45.
Strategically speaking, the Brussels Court of Appeal decision (hereinafter referred
to as the Brussels decision) played a crucial role in the final outcome of the Elliott case.
It could be argued that this decision was the one which finally forced Peru to accept the
terms requested by Elliott at the negotiation table. Once the Brussels Court of Appeals
issued the restraining order against Euroclear, there was, apparently, no legal remedy that
could have allowed Peru to pay its Brady interests before the end of the grace period.
Consequently, Peru settled the case and the referred order was not appealed.
3. The Opinion of Professor Andreas F. Lowenfeld
In his declaration, Lowenfeld explained that Elliott claims that it is entitled, under
section 11(c) of the 1983 Guaranty, to be treated with respect to payment of principal
and interest at least on equal terms with all other External Indebtedness46, and therefore,
44Brussels Decision Unofficial Translation, supra note 34, at 3.45 As mentioned by Gulati and Klee, Professor Lowenfelds opinion was also submitted in the Brusselscase.See Gulati & Klee, supra note 4, at footnote 12.46Lowenfeld Declaration, supra note 43, at 6.
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any payment to the Brady bondholders and not to Elliott would constitute a preferential
arrangement contrary to the terms of section 11(c)47. After analyzing Elliott request,
Lowenfeld concluded thus:
my conclusion is that the pari passu clause in theGuaranty entitles each Lender to share equally and ratablywith any other holder of External Indebtedness as defined. Ihave no doubt that the Brady Bonds described aboveconstitute External Indebtedness of the Republic of Peru.Accordingly, if the Republic pays principal or interest toholders of the Brady Bonds or some of them, it is obligatedto make payment of a proportionate amount to all holders
of Affected Debt incurred in the Letter Agreements,including Plaintiff Elliott Associates, L.P., and thatobligation is enforceable in this court if necessary by aninjunction48.
Lowenfeld explains that there is no difficulty in understanding the literal meaning
of the term pari passu. He refers that such a term comes from the Latin noun
passus, which means step, pace, stride, and from the Latin adjective
par, meaning
equal or like. His conclusion is also based on the Websters New International
Dictionary49, which defines the term in question as with or at an equal pace; in or to an
equal proportion, degree, place, rank, or title, as well as on the Blacks Law
Dictionary50, which defines pari passu as By an equal progress; equably, ratably;
without preference. Used specially of creditors who, in marshalling assets, are entitled to
receive out of the same fund without any precedence over each other. Accordingly,
under this literal approach to the meaning of the aforementioned clause, Lowenfeld
47Id.48Id., at 7.49See Websters New International Dictionary. Second Edition, unabridged, 1951.
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concludes that any debt under the Letter Agreements is to have at least equal rank with
all other Peruvian External Indebtedness51.
Continuing with his explanation, Lowenfeld argues that the fact that sovereigns
do not go bankrupt and cannot be liquidated does not mean that thepari passu clause has
no sense or direct effect when applicable to sovereigns. Based on the opinion of an
English commentator, William Tudor John, Lowenfeld concludes that the pari passu
clause is of the greatest importance in governmental loan agreements because it is
primarily intended to prevent the earmarking of revenues of the government towards a
single creditor, the allocation of foreign currency reserves, and generally against legal
measures which have the effect of preferring one set of creditors against the others or
which discriminate between creditors52.
Additionally, Lowenfeld expresses his disagreement with all those academic
articles53which suggest that the pari passu clause --in the sovereign debt context-- does
not exactly mean what it literally says, or that it cannot be relied on by lenders if
disregarded or violated by borrowers. In Lowenfelds opinion, the pari passuclause does
50See Blacks Law Dictionary, Sixth Edition, 1990.51It has not been possible to verify the textual definition of the term External Indebtedness in the LetterAgreements mentioned above, but according to what Professor Lowenfeld mentions in his Declaration, itseems that such a definition was included in Section 1 of the Letter Agreements, covering any other portion
of the debt issued under said Letter Agreements and also any bonds or other evidence of debt issued orguaranteed by Peru, including the Brady bonds.52See William Tudor John. Sovereign Risk and Immunity under English Law and Practice, inRobert S.Rendell, ed., International Financial Law, Vol 1, p. 71 at 95 (2d ed. 1983). See also LowenfeldDeclaration, supra note 43, at 10.53Lowenfeld makes express reference to an article written by Lee C. Buchheit, The Pari Passu Clause subspecie aeternitatis, 10 Intl Financial L. Rev. No. 12, p. 11 (Dec. 1991), where the author mentions thatThe fact that no one seems quite sure what the pari passu clause really means, at least in a loan to asovereign borrower, has not stunted its popularity among drafters of loan agreements and debt restructuringagreements.
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really mean what it says: a given debt will rank equally with other debt of the borrower,
whether that borrower is an individual, a company, or a sovereign state54. The logical
and legal basis for this conclusion is clearly explained by Lowenfeld as follows:
A borrower from Tom, Dick and Harry cant say I willpay Tom and Dick in full, and if there is anything left overIll pay Harry. If there is not enough money to go around,the borrower faced with apari passuprovision must pay allthree of them on the same basis:Suppose, for example, the total debt is $50,000 and theborrower has only $30,000 available. Tom lent $20,000 andDick and Harry lent $15,000 each. The borrower must pay
three fifths of the amount owed to each one i.e., $12,000to Tom, and $9,000 each to Dick and Harry. Of course theremaining sums would remain as obligations of theborrower. But if the borrower proposed to pay Tom$20,000 in full satisfaction, Dick $10,000 and Harrynothing, a court could and should issue an injunction at thebehest of Harry. The injunction would run in the firstinstance against the borrower, but I believe (puttingjurisdictional considerations aside) to Tom and Dick aswell55.
The final argument put forward by Lowenfeld notes that the same District Court
and the Court of Appeals have already decided on the issue under analysis when
resolving a closely analogous case, namely Alliance Bond Fund, Inc. v. Grupo Mexicano
de Desarrollo, S.A.56. In this case, the Mexican borrower and its guarantors were enjoined
from making payments to some creditors while the plaintiffs, who were the beneficiaries
of apari passuclause, were going to be left out. Despite the fact that this case was finally
reversed by the U.S. Supreme Court --on the ground that prejudgment injunctions
54See Lowenfeld Declaration, supra note 43, at 11.55Id., at 12.56143 F.3d 688 (2d Cir. 1998)
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preventing the payment of money were not authorized in the Federal Rules of Civil
Procedures and were inconsistent with traditional equity jurisprudence-- Lowenfeld
argues that its rationale may still be applicable to the Elliott case, for there being a final
judgment favoring the plaintiff already57.
Based on the aforementioned arguments, Lowenfeld concludes that Section 11(c)
of the 1983 Guaranty creates a binding and continuing obligation to treat all covered
borrowers equally without discrimination, including Elliott.
III
INTERPRETING THEPARI PASSUCLAUSE
1. An Alternative Interpretation?
On the basis of its historically well recognized literal meaning, commentators
have claimed that the essence of the pari passu provision is that it is an undertaking of
the borrower to maintain parity between its creditors58. In the same line of thought, it
has been said that the very purpose of this clause () is to ensure equal treatment for all
unsecured creditors59. In other words, the primary objective of the clause is to ensure
57See Lowenfeld Declaration, supranote 43, at 13.58Ibrahim F. I. Shihata, The World Bank Legal Papers, Chapter 12 (2000), at 303.59 Esin Taboglu, The International Debt Problem: Legal Problems of Restructuring Sovereign Private
Debt. Paper submitted to professor Phillip Wellons in satisfaction of LLM Written Work Requirement.Harvard (1990), at 42.
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that the borrower has not conferred priority to any other unsecured creditor60. Parity or
equal treatment between creditors is clearly the main principle upon which the legal
significance of thepari passu clause is conceived. However, equality seems to be a very
broad and abstract concept that has been differently understood and interpreted by
practitioners and academics when trying to elaborate a precise definition of the clause
under analysis.
As a result, there is not a general consensus on the definition of the pari passu
clause. It has been held that the pari passu clause in a loan agreement is a covenant
under which the borrower agrees that all of its payment obligations under the agreement,
currently and in the future, will rank at least equally with all of its other existing and
future unsecured debts61. Under this definition, the main focus of attention must be in
determining what the phrase will rank at least equally exactly means.
In a more comprehensive definition, the clause under consideration has been
defined as a covenant whereby it is agreed that the payment obligations of the borrower
under the agreement constitute unconditional general obligations of the borrower and will
rank at leastpari passu in priority of payment with all other external indebtedness of the
borrower62. This definition makes it clear that the equal ranking amongst creditors is
exclusively in relation to priority of payment. Nonetheless, the term in reference is still
60Ravi C. Tennekoon, The Law & Regulation of International Finance, Butterworth (1991), at 89.61 See UNITAR Online Resource Center, Training and Capacity Building Programmes in the LegalAspects of Debt, Financial Management ad Negotiation, Glossaries. Available athttp://www.unitar.org/dfm/Resource_Center/TrainingPackage/TP10/GlossaryP.htm (visited on March 17,2002).62Ibrahim F. I. Shihata, supra note 58, at 303.
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highly confusing given the various and different interpretations that can be put forward
with regard to the phrase to rank at leastpari passu in priority of payment.
Equality in priority of payment is evidently the key term in order to understand
the practical application and effects of the pari passu clause. But, what does priority of
payment effectively mean? It is precisely in answering this question where the final
divergence in the Elliott case arose: was such a term related or not to apro ratapayment?
As seen above, the interpretation suggested by Lowenfeld is straightforward and
compelling:pari passumeans that all payments must be made on apro ratabasis, that is,
that such a clause entitles its beneficiary to share equally and ratably with any other
external indebtedness. And Lowenfeld arrives at such a conclusion without making any
distinction as to whether the borrower is an individual, a company, or a sovereign. Thus,
any beneficiary of the pari passu clause has the right to share equally and ratably63
with any other external indebtedness. Hence, if the borrower makes payments to just one
or some of its creditors, the beneficiaries of the referred clause have the right to be paid a
proportionate amount64, meaning, on a pro rata basis.
It has been difficult to find commentators backing expressly what Lowenfeld
suggested. Following Tudor Johns opinion --in the context of governmental loan
agreements (quoted above)--, Vinok K. Agarwal seems to agree with such a particular
interpretation as well. After mentioning that the pari passu clause requires that the
63Lowenfeld Declaration, supra note 43, at 7.64Id.
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borrower shall treat all the unsecured lenders equally, the latter argues that the borrower
will not give preference to any particular lender in the matter of recovery of loan
amount65. The same author also states that, as a direct effect of thepari passu provision
and in connection with external debt only, the lender shall not be discriminated in the
matter of availability of assets66.
Also in the same line of thought, Brian Semkow argues that, in the context of
sovereign borrowing, the pari passu provision will prevent sovereign borrowers from
discrimination against the lending banks in the payment of creditors out of general
revenues or foreign currency reserves67. Similarly, Philip Wood agrees with this idea
when related to the sovereign context. The author argues that the referred clause bears a
different construction in the case of a sovereign state. Since the latter cannot go bankrupt
nor can be liquidated --notes Wood-- the hierarchy on force dissolution is not the point68.
The commentator then concludes, following what was previously mentioned by Tudor
John, as follows:
The clause is primarily intended to prevent the earmarkingof revenues of the government or the allocation of itsforeign currency reserves to a single creditor and generallyis directed against legal measures which have the effect of
65 Vinod K. Agarwal, Negotiation of Specific Clauses of Loan Agreements, available athttp://www.unitar.org/dfm/Resource_Center/Document_Series/Document10/15Covenants.htm (visited onMarch 9, 2002)66Id.67Brian W. Semkow, Syndicating and Rescheduling International Financial Transactions: A Survey of the
Legal Issues Encountered by Commercial Banks, 18 Intl Law. 869, 899 (1984).68See Philip Wood,Law and Practice of International Finance, volume 2, International Business & LawSeries, 1984, at 6-23.
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preferring one set of creditors over the others ordiscriminating between creditors69
That also seems to be what Derek Asiedu-Akrofi suggests. This author analyzes
the effects of a sovereign debt repurchase transaction in the light of a pari passu
provision and concludes as follows:
[T]he sale of the debt at a discount of the true marketvalue arguably does not confer any special benefit on thecreditor banks, as sale at discount entails considerablelosses. Whether or not such an argument can withstandlegal challenge, however, remains doubtful. Once a creditoragrees to accept a lesser sum in substitution for the full
value of the original debt, it is unlikely that it maysuccessfully plead that it has not received adisproportionate payment while the other creditors have notbeen paid pro rata. Such payment inevitably conferspreferential treatment on the creditor(s) engaging in thattransaction, thus infringing the mandatory prepayment andpari passuclauses.70
Notwithstanding the natural appeal of the Lowenfeld interpretation of the pari
passu clause, there are a number of commentators that believe that the real meaning of
the clause in the sovereign context is not so clear. Also, international organizations have
made public their skepticism about the legality of the argument put forward by Elliott.
The International Monetary Fund, for instance, has opined that [t]he legal bases upon
69 Id. But see Philip Wood, Project Finance, Subordinated Debt and State Loans, Sweet & Maxwell,London 1995, at 165 (the same author mentions that [i]n the state context, the meaning of the clause is
uncertain because there is no hierarchy of payment which is legally enforced under a bankruptcy regime.Probably the clause means that on a de facto inability to pay external debt as it falls due, one creditor willnot be preferred by virtue of an allocation of international monetary assets achieved by a method goingbeyond contract.70 Derek Asiedu-Akrofi, Sustaining Lender Commitment to Sovereign Debtors, Columbia Journal ofTransnational Law, 1992. The author continues referring that [i]n order to ensure that such breaches donot occur, it is necessary for the debtor country/buyer to extend participation in the transaction to all thecreditors. The debtor government also should seek and obtain waivers of the mandatory prepayment, pari
passuand sharing clauses in existing loan agreements. In this way, banks that refuse to participate in the
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which Elliott litigated its case --particularly its reliance on the pari passu clause-- are
somewhat controversial71.
Moreover, it has even been held that, indeed, the Lowenfeld interpretation is
precisely what the clause does not mean72. According to Gulati & Klee, the main
objective of thepari passuclause is to ensure that the borrower does not have, nor it will
subsequently create, a class of creditors whose claims will rank senior in priority to the
lending claims of the current creditors73. The referred authors explain that the meaning
of such a clause in the corporate debt context is that no other lender will enjoy a priority
in a liquidation distribution of the borrowers assets74.
The argument put forward by the aforementioned authors --regarding the
interpretation of the provision in the corporate context-- finds support in Wood. He
expressly mentions that the undertaking is to be construed as a commitment or a
warranty that on an insolvent liquidation or a forced distribution of assets unsecured
creditors will be entitled to pro rata payment and also that, on the occasion of judicial
compromises or agreed debt settlements, the bondholder will be not discriminated
against75. Also supporting this restrictive construction is Lee C. Buchheit, who explains
that the interest of the lenders in including apari passuprovision in their contracts is that,
transaction may be stopped from making claims on the proceeds accruing to those banks engaging in thedebt repurchase transaction.71See International Monetary Fund, supra note 6, at 12. See also Anne Krueger, International Financial
Architecture for 2002: A New Approach to Sovereign Debt Restructuring, available athttp://www.imf.org/external/np/speeches/2001/112601.htm(visited on March 9, 2002). (It is not clear ifElliotts strategy would survive legal challenge in future cases).72Gulati & Klee, supra note 4, at 639.73Id.74Id.
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in case of a bankruptcy or compulsory distribution of the borrowers assets, the lenders
do not wish to be surprised by the appearance of other creditors holding claims against
the debtors state that rank senior to their own76.
This restrictive interpretation of the clause under analysis does not leave room for
Lowenfelds pro rata theory in the corporate context. The upshot is that corporate
borrowers subject to apari passuprovision can feel free to deal with and discharge their
indebtedness as they may deem more convenient to their interests. This outcome is made
clear by Wood, who expressly points out that the pari passu clause has nothing to do
with the time of payment of unsecured indebtedness since this depend upon contractual
maturity. The pari passuundertaking is not broken because one creditor is paid before
another77. Buchheit is even more explicit when explaining his position in the following
terms:
A lender who remains unpaid at a time when othercreditors are current on their loans may articulate hisgrievance in terms of liberty, equality or fraternity, but heshould not invoke hispari passucovenant as the legal basisfor his disappointment. This provision assures the creditorthat its loan will not be subordinated to the claims of othercreditors in the event of the borrowers bankruptcy, but itdoes not force the solvent borrower to make pro ratapayments to all its creditors78.
75Philip Wood, supra note 68, at 6-23.76Lee C. Buchheit, The Pari Passu Clause Sub Specie Aeternitatis, 10 International Financial Law ReviewNo.12 (December 1991), at 11.77SeePhilip Wood, supra note 68, at 6-23 . See alsoPhilip Wood, supra note 69, at 165 (It does not meanthat one debt cannot be paid before another in time).78Lee C. Buchheit,How to Negotiate Eurocurrency Loan Agreements(2nded. 2000), at 83.
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This idea of the pari passuprovision being directly effective only in case of the
distribution of the borrowers assets due to insolvency or bankruptcy (in the corporate
context) has also received support from Joseph J. Norton. This author argues that the
provision in question has been designed to ensure the equal ranking of unsecured claims
on liquidation of assets to unsecured creditors on the borrowers insolvency79. He goes
even further explaining that thepari passuclause does not require concurrent or equal
payment prior to that time [borrowers insolvency], and does not restrict guaranteed loan
or setoffs80.
The main conclusion arrived at by the referred commentators, although referring
to the corporate context only, is of the greatest importance. Contrary to what Lowenfeld
argued in his Declaration, these authors make it clear that the pro rata argument cannot
be accepted out of the context of an insolvency or bankruptcy situation. But this rationale
does not seem to be that convincing when applied in the sovereign context. As it is
generally known, a sovereign country cannot legally go into bankruptcy, nor declare itself
insolvent81. This is clearly explained by Buchheit, who argues that [s]overeigns are not
subject to domestic bankruptcy regimes nor is it likely that a sovereigns assets can be
marshaled and distributed to creditors without the sovereigns consent82. In consequence
--concludes the author-- "when a sovereign promises in a loan agreement that the loan
79Joseph J. Norton, International Syndicated Lending and Economic Development in Latin America: The
Legal Context, in Essays in International Finance & Economic Law No.9 (1997), at 43.80 Id. (The author mentions that the pari passu clause prevents the borrower from assuming new debtswhich subordinates the interests of the syndicated members).81SeePhilip Wood, supra note 68, at 6-23.82Lee C. Buchheit, supra note 76, at 11.
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will rankpari passuwith all of the sovereigns other external indebtedness, the lender is
not being told anything about where it will stand in a queue of bankruptcy creditors83.
Assuming the validity of the argument referred to above, what would then be the
purpose and exact meaning of thepari passu provision in the sovereign arena? Gulati &
Klee, after recognizing that there is no liquidation in the sovereign debt context84, explain
the significance of thepari passu clause in the sovereign context thus:
The pari passu clause works as a covenant by theborrower that it will not bestow a legally senior prioritystatus on certain lenders. This protects against thetemptation for the sovereign to enact laws affecting thelegal ranking of creditors. Rankingpari passutherefore isabout insolvency payouts (in the corporate context) orabout the alteration of payment priorities by law (in thesovereign context). It is an equal ranking, but it applies tospecific contexts85.
In accordance with the explanation provided by the referred authors, Buchheit is
also explicit in recognizing that the only function of the clause in the sovereign context is
to restrain the sovereign borrower from passing laws aimed at distorting the position of
equality given to the beneficiaries of the clause. He explains his argument as follows:
If a sovereign borrower intends as a practical matter todiscriminate among its creditors in terms of payments, the
83Id.84The same premise is also put forward by Wood, who mentions that in the case of a sovereign state, the
pari passu clause bears a different construction. A government cannot be liquidated (at least not in thatsense) nor of course are there procedures for the ranking of governmental debt on sovereign bankruptcyequivalent to those pertaining in private bankruptcy. SeePhilip Wood, supranote 68, at 6-23.85Gulati & Klee, supra note 4, at 640.
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pari passu undertaking will at least prevent the sovereignfrom attempting to legitimize the discrimination byenacting laws or decrees which purport to bestow a seniorstatus on certain indebtedness or give a legal preference tocertain creditors over others86.
Apparently, the great concern here is related to the possibility of subordination. In
general, a regular corporate borrower cannot legally subordinate a lender without its
express consent87. Accordingly, Gooch & Klein argue that the pari passu clause88 in
effect states that there are no legal provisions which would cause the loans to be
subordinated to other indebtedness of the borrower89. However, in the case of a
sovereign, it could simply alter the law to subordinate the disfavored lender90. That is a
matter that is under the sovereigns control. In this regard, Buchheit mentions that
sovereign borrowers, because they have it within their power to enact laws affecting the
legal ranking of creditors, are thought to be appropriate objects of a pari passu
covenant91.
Therefore, it is held that lenders normally request the inclusion of this provision in
their contracts to ensure that their credits will not automatically be subordinated to other
existing senior indebtedness of the borrower92and, specially in the case of sovereigns, to
86Lee C. Buchheit, supra note 76, at 11.87See Gulati & Klee, supra note 4, at 640. See alsoLee C. Buchheit, supra note 76, at 11.88
The idea put forward by these commentators is referred to the pari passuclause included in a contract asa representation and warranty, not as a covenant. That explains the using of present tense by the authors.89Anthony C. Gooch & Linda B. Klein,Annotated Sample Loan Agreement, in International Borrowing:Negotiating and Structuring International Debt Transactions, Second Edition, Daniel D. Bradlow, Editor(1986), at 332.90Id.91Lee C. Buchheit, supra note 78, at 84.92 Lee C. Buchheit & Ralph Reisner, Inter-Creditor Issues in Debt Restructuring, in InternationalBorrowing: Negotiating and Structuring International Debt Transactions, Third Edition, Daniel D.Bradlow, Editor (1994), at 438.
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bar the borrower from attempting to create a class of senior indebtedness in preference
to that outstanding under the loan agreement in which the clause appears93. Blocking
contractually the ability of sovereign borrower to affect the status of its lenders seems to
be the main (if not the only) function of thepari passu clause in the sovereign context.
This is clearly suggested by Walker & Buchheit when holding that thepari passu clause
will restrict the [sovereign] borrower from subordinating in a formal way the debt being
incurred (or restructured) pursuant to the agreement containing this clause in favor of
some other external obligation94.
Subordination, however, can occur in a legal/formal sense e.g. when a sovereign
enacts a statute altering the priority status of its creditors, or it can also occur in practice,
namely when a sovereign just treats some creditors more favorably than others, in what
could be referred to as de factosubordination. This type of subordination, nonetheless, is
allegedly not restricted by the pari passu clause in the sovereign context. This is the
argument put forward by Buchheit & Reisner, who expressly state that [t]he borrower
does not violate this clause by electing as a matter of practice to pay certain indebtedness
in preference to the obligations outstanding under the agreement in which this clause
appears95. Exploring this idea much further, Buchheit explains that:
The existence of a conventional pari passu undertaking ina loan agreement will have no effect on the sovereign
93Id.94 Mark Walker & Lee C. Buchheit, Legal Issues in the Restructuring of Commercial Bank Loans toSovereign Borrowers, in International Borrowing: Negotiating and Structuring International DebtTransactions, Second Edition, Daniel D. Bradlow, Editor (1986), at 464. See also Esin Taboglu, supranote 59, at 42.95Buchheit & Reisner, supra note 92, at 438.
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borrowers legal ability to pay one creditor even if it is thenin default on its payment obligations to other creditors, toprepay one lender or group of lenders ahead of some othersor to pledge assets to secure the borrowers obligationsunder one loan without giving equal security in respect of
its other indebtedness. If a lender wants these protections, itmust search for them in other clauses of the loan agreementor restructuring agreement96.
In sum, what can be concluded so far is that there are several and divergent
interpretations of thepari passuprovision, apart from the one presented by Lowenfeld. In
fact, his broad suggestion that thepari passu provision implies that all payments must be
made on apro rata basis without considering the context in which the clause is applied,
does not find much support amongst commentators. Most of the academic writings
consulted analyze the issue in question from a double perspective, that is, differentiating
expressly between the two dissimilar contexts where the clause plays its role, namely the
corporate and the sovereign contexts97. Certainly, there is a uniform position with regard
to the meaning of the clause in the corporate context: It does not mean what Lowenfeld
suggested. However, when referring to the sovereign context, commentators opinions
are divided. The two extremes of the spectrum can clearly be observed. On the one hand,
Lowenfelds theory, on the other, Buchheits argument. The question then becomes: How
to decide which is the right one? This is exactly the question that the next part of this
paper will address and try to answer.
96Lee C. Buchheit, supranote 76, at 11.97 See Guillermo Soliven, Some Issues in the Negotiation of Commercial Foreign Exchange Loans in
Developing Countries, in Issues in Negotiating International Loan Agreements with Transnational Banks,United Nations Centre on Transnational Corporations, New York 1983, at 17. (It has been expresslyrecognized that this is one of the areas where there are marked differences in the clauses applicable to
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2. Elements to be taken into account when deciding for the right
interpretation of thepari passu clause
As can be concluded from what has been explained above, academics have not
arrived at a uniform position with regard to the correct interpretation of the pari passu
rule. Academic opinions based on abstract rationales, however, are not always in line
with what normally happens in real life. Accordingly, probably the best way of
determining which of the interpretations presented is the more coherent is to contrast
them against the market understanding of the clause under consideration. Understanding
what would be the reaction of lenders, borrowers, and the market, when facing the pari
passu provision under its different interpretations, is of the utmost importance for the
goal of this paper. After going through the analysis suggested, Gulati & Klee conclude
that if Lowenfelds opinion were the correct one, [d]ebtors, and especially sovereign
debtors, would be crazy to agree to such a term with all of their creditors 98. These
authors suggest that if debtors agreed to give creditors pari passu rights under
Lowenfelds terms, this would then result in a lower interest coupon for the creditors
who receive it, to be granted only after hard negotiations, and to be given to only a few
creditors99. In order to test this conclusion, the next few paragraphs will focus on
determining the general market understanding of thepari passuclause.
2.1 Necessity to pay preferred creditors first
private and public sector borrowers, arising as a result of the differences in the debt obligations of these twotypes of entities).98Gulati & Klee, supra note 4, at 639.99Id.
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It is expressly mentioned in Lowenfelds Declaration that a clause such as Section
11(c), the pari passu clause, is standard in virtually all loan or debt restructuring
agreements and sovereign guaranties100. It is therefore reasonable to assume that most --if
not all-- of the external indebtedness of sovereign creditors is subject to the same
provision: ranks, and will rank, pari passu. Thus, under Lowenfelds interpretation of
the clause, there cannot be preferred creditors and it would be impossible for a sovereign
to pay one creditor before another. This author expressly states that [w]hen the borrower
(or guarantor) is a sovereign state, there are no super-priority unsecured creditors and the
pari passuclause is a general non-discrimination clause.
This assumption clearly contrasts with what can be observed in practice, where
International Financial Institutions have effectively assumed a status of preferred
creditors. About this particular issue, Ibrahim F.I. Shihata states that [n]othwithstanding
the pari passu clause, borrowing governments have, in practice, generally accorded
preferred creditors status to international financial institutions such as the World Bank
and the IMF101. The author concludes mentioning that [t]he preferred creditor status is
a practical arrangement accepted by borrowers and other lenders102. Gulati & Klee
explain the gravamen of such a conclusion in the following terms:
A sovereign that is short of cash will not wish to makepayments pro rata, thereby defaulting on all its debts andbringing upon itself the ire of every creditor. Instead, a
100See Lowenfeld Declaration, supra note 43, at 9.101See Ibrahim F.I. Shihata, supra note 58, at 303.102Id.
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sovereign will want to be able to pay the importantcreditors first so that they continue to provide support103.
In addition, there are other categories of creditors that also assume a de facto
status as preferred creditors due to their strategic significance for the welfare of the
sovereign borrower. Thus, any attempt to restructure or default on the payment of these
types of credit will trigger adverse consequences for the debtor country. Amongst this
class of preferred creditors can be found, for instance, those derived from short-term
trade and also suppliers credits. Default in the payment on such type of credits will
inevitably jeopardize the sovereigns ability to participate in international trade104.
Given the recognized interest of sovereign borrowers --and even other lenders-- in
maintaining such a de facto preferred status of International Financial Institutions and
other type of creditors, it is difficult to understand why these parties would incorporate a
pari passuclause in their contracts if this bore the meaning attributed by Lowenfeld.
2.2 The role played by other clauses normally included in international loan
contracts
It is widely recognized by most commentators when referring to the typical
clauses included in international loan contracts, that the pari passu clause is normally
accompanied by a negative pledge clause. Ian F.G. Baxter remarks that [t]he purpose
103Gulati & Klee, supra note 4, at 641.104See Lee C. Buchheit, Of Creditors, Preferred and Otherwise, 10 International Law Review, No. 6 (June1991), at 12.
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of the negative pledge is to prohibit the borrower from granting a security interest in its
assets or funds in favor of another creditor, or other creditors, which would give a priority
over the lender or lenders105. The author explains that the main functions performed by
the negative pledge clause are 1) to prevent the allocation of substantial assets of the
borrower to one or more secured creditors; 2) to produce equality among creditors of the
same class ; and 3) to discourage excessive borrowing, made possible by the grant of
security over assets106.
The rational function of these two clauses, which are normally found together, is
to complement each other within the text of the contract. This is recognized by Walker &
Bucheit, who mention that the negative pledge clause is intended to complement the
protection sought by the lender in thepari passuundertaking by ensuring that subsequent
creditors of the borrower will share the lenders status as a general creditor107.
Under the broad interpretation presented by Lowenfeld, the pari passu clause
could be understood as limiting even any eventual intent of the sovereign borrower to
benefit any of its external creditors by granting them security over any of its assets. Given
the fact that the creditor benefited with the security could eventually foreclose such
assets, this action would be considered as a breach of the pro rata rule suggested by
Lowenfeld. Therefore, under the interpretation argued by the latter, thepari passuclause
would end up performing the function normally attributed to the negative pledge
clause. As mentioned above, both clauses are supposed to complement each other and
105Ian F.C. Baxter,International Banking and Finance, Carswell (1989), at 73-74.106Id.
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not to overlap in their functions. Consequently, this outcome seems to suggest that
Lowenfelds interpretation is not completely accurate.
A very interesting explanation of the historical co-relation between the pari passu
clause and the negative pledge provision is that given by Gulati & Klee. The authors
suggest that one of the possible explanations of the position assumed by Tudor John --
upon which Lowenfelds opinion is based-- is that at the time such argumentation was
elaborated (probably at the beginning of the 20th century) there were no sovereign
security interest and, hence, no negative pledge clauses
108
. They conclude speculating
that [t]he pari passu clause, therefore, probably served as something as a substitute
because the primary risk to guard against was not collateralization but subordination109.
Along with the negative pledge clause, international loan agreements also include
other type of clauses with a very straightforward meaning, whose purpose and function
can be deemed as overlapping with the significance attributed by Lowenfeld to the pari
passu clause. The two most prominent clauses in this group are the mandatory
prepayment clause and the sharing clause110.
The sharing clause, also known as pro rata sharing clause, has been defined
in the international banking context as a syndicate equality clause designed to share
individual receipts by one bank but not the others (e.g. set-offs, proceeds of litigation,
107Walker & Buchheit, supra note 94, at 464.108Gulati & Klee, supranote 4, at 640, footnote 29.109Id.110See Id., at 646. See also Lee C. Buchheit, supra note 76, at 12.
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direct payment by the borrower, etc.)111. In the words of Wood, it provides that if any
bank receives a greater proportion of its share, it must pay the excess to the agent who
redistributes to the banks pro rata112. Put in simple terms, it is a clause whereby
whatever one lender receives has to be shared ratably with the others113. The meaning
of this clause has been expressly recognized by US courts. In a recent case, a creditor
sued the Republic of Congo and was able to find a US court imposing an effective
sharing clause on the payments made by the sovereign to other creditors114. There is,
therefore, a general consensus about the basic concept involved in this clause: the sharing
of individual receipts on a pro rata basis. But, what is the purpose of this clause and its
relation to the pari passu clause? First, it is argued that this clause helps to fill the
vacuum caused by the absence of an enforced pari passu bankruptcy code115 by
discouraging the piecemeal seizure of the borrowers assets. Second, the clause aims to
avoid the borrowers making of preferential discriminatory payments to favored
creditors, so that the clause merely carries into effect the doctrine of recapturing
preferences universally adopted by municipal bankruptcy law116. Surprisingly, according
to Lowenfeld, these are allegedly the same objectives of thepari passuclause.
111 See Von Holger Langer, International Finance Law, in Syndicated Loan Agreements I TheSyndication Process, available at http://www.ganz-recht.de/stlehre/Ausland/finl1.htm(visited on April 8,2002)112Philip R. Wood, supra note 69, at 166.113Gulati & Klee, supra note 4, at 646. See also Lee C. Buchheit, Changing Bond Documentation: TheSharing Clause, in International Financial Law Review (July 1998), at 17. (Sharing clauses are provisions
that force a creditor receiving a disproportionate payment under a multi-creditor debt instrument like asyndicated loan (including a payment following litigation) to share that payment on a ratable basis withother creditors in that facility. These provisions are standard in syndicated commercial bank loans but arenot common in publicly-issued bonds).114 See Nouriel Roubini, Bail-ins, Bailouts, Burden Sharing and Private Sector Involvement in Crisis
Resolution: The G-7 Framework and Some Suggestions on the Open Unresolved Issues, Sterns School ofBusiness (NY 2001), available at http://www.stern.nyu.edu/~nroubini/asia/bailins.doc(visited on April 8,2002)115Philip R. Wood, supra note 69, at 166.116Id.
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On the other hand, the mandatory prepayment clause has been defined as a
provision whereby borrowers can be barred from making non-ratable prepayments to
other creditors117. This provision is basically aimed at assuring lenders that they will be
paidpro rataon their credits. Joseph Norton mentions that the clause in question requires
that, whenever a creditor is prepaid, the borrower must prepay the rest of creditors on a
pro rata basis118. The content and effects of the clause are explained in the following
terms:
This clause is designed to provide remedies to banks andfinancial institutions which have restructured their debt ifthe obligor concerned services comparable indebtedness ina manner which is more preferential to that of therestructuring or new money agreement. For example, theclause would require that if the obligor pays 10% of thedebt to a free rider, then the creditors who have restructuredare entitled to 10% of the debt owing to them (at most), orthe actual amount paid to the free rider (at least), dependingon how the clause is drafted.119
Under the same reasoning applied when comparing the role of the negative
pledge clause and Lowenfelds construction of thepari passu provision, it is clear that
the latter interpretation evidently overlaps with the role widely recognized for the
aforementioned clauses, and hence, renders them meaningless. If Lowenfelds assertion
were correct, would there be any reason to include any of the referred two clauses in a
117SeeGulati & Klee, supra note 4, at 646. See also Lee C. Buchheit, supra note 76, at 12.118See Joseph J. Norton,International Syndicated Lending: The Legal Context for Economic Developmentin Latin America, in NAFTA: Law and Business Review of the Americas (Summer 1996).119 See UNITAR Training and Capacity Building Programmes in the Legal Aspects of Debt, FinancialManagement ad Negotiation; Online Resource Center, Glossaries. Available at
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contract together with a pari passuprovision? Apparently, there would not. It could be
considered as redundant or as a typical act of over-lawyering. Such clauses are,
nonetheless, likely to be found in practice along with pari passu provisions in
international loan contracts. Again, international financial practice seems to disagree with
Lowenfelds position120.
2.3 Variations on the conventional terms of the pari passu clause
The text of the pari passu clause included in the 1983 Letter Agreements
guaranteed by Peru is generally acknowledged as the standard text of the clause. It
represents what can be deemed as the pari passu provision in its basic form: rank and
will rank at leastpari passuin priority of payment. However, the international financial
arena has witnessed different variations of the basic terms of the clause.
Buchheit121makes reference to several different types of variation introduced by
practitioners. Thus, for instance, it is possible to come across pari passu provisions
bearing the following phrase: will rankpari passuin priority of payment and in all other
respects. Likewise, though less frequently, it is possible to find the text: will rank pari
http://www.unitar.org/dfm/Resource_Center/TrainingPackage/TP10/GlossaryP.htm (visited on March 17,2002)120SeeGulati & Klee, supra note 4, at 646. (Besides the clauses already referred to above, there are twoothers, the turnover clause [creditors who receive preferential payments have to turn it over to the others]as well as the acceleration clause [creditors who hold debts in default gets to ask for all of the debt to bepaid immediately], that can be subject to the same analysis).121See Lee C. Buchheit, supra note 76, at 12.
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passu in priority of payment with all other External Indebtedness of the Borrower and
will be paid as such122.
It is claimed that the additional language incorporated in the text of the basic pari
passuclause reinforces the argument against the interpretation presented by Lowenfeld.
The author quoted above suggests that the variation introduced shows that practitioners
recognize that the clause, under its conventional terms, throws only a blubbery arm in
the path of a sovereign borrower intent on mischief123. Gulati & Klee agree. They
mention that if the standardpari passuclause means what [Lowenfeld] says it does, then
lawyers have been wasting their time in specifically contracting for this additional
language124.
This argument does not seem to be, however, irrefutable. By the same token, it
could easily be argued that the drafting variations introduced to the conventional terms of
thepari passu clause, were made only for the sake of clarity and preciseness.
2.4 International Public Policy Issue: The holdout creditor problem
122See Id. (Buchheit expressly consigns the text of a provision that he refers to as the mother of all pari
passuclauses: Pari Passu status. The obligation of the Borrower to pay the principal of and interest on the
Loans shall at all times rank pari senior to, or pari passuwith all other indebtedness, direct or contingent,of the Borrower for borrowed money, payable, or which at the option of Borrower or a creditor maybecome payable, in Dollars or any currency other than [local currency] without any preference in favor ofany such other indebtedness by reason of priority of the date of issue, priority by reason of form, securitythereof by way of pledge, assignment, mortgage, security interest or any other encumbrance on gold orholdings of foreign currency deposits, agreements to maintain deposits, agreements to turn over specificmoneys or in any other way, direct or indirect, express or implied, or by way of any other agreement, orother terms or provisions).123Id.
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Under the current international financial scenario, there is no longer possible to
restructure the external debts of sovereign countries using the same strategy applied at the
beginning of the eighties. By then, when any of the sovereign borrowers was going
through a liquidity crisis and, therefore, was unable to meet its international financial
obligations, creditors (mostly commercial banks125), represented by a Bank Advisory
Committee, would promptly negotiate with the sovereign the restructuring of the debt.
Anne Kruger explains s