Harry Tether is a retired managing director at JPMorgan Chase.
As the representative of a large New York financial institution, I participated in numerous sovereign debt restructuring negotiations in the 1980s and ’90s. It is, at long last, gratifying to see the recent rulings by the Federal District Court and the United States Court of Appeals for the Second Circuit regarding the pari passu clause and “equal treatment†clause present, in a variety of formulations, in many sovereign loan agreements. (Pari passu is a Latin phrase meaning “on equal footing.â€) The interpretation adopted by those courts is consistent with the intentions of private creditors when they negotiated these clauses with sovereign debtors.
During the Latin American debt crisis of the 1980s, when sovereign borrowers sought concessions from private creditors, the equal treatment provision became a vitally important affirmative covenant to international banks. Our direct negotiations, often long and arduous, led o mutually satisfactory restructurings of debtors’ financial obligations, in part because they required debtors to include strong legal protections in the new borrowing contracts. The sovereign debtor’s interest was to regain access to international capital markets, while the creditors’ interest was to receive a predictable and sustainable repayment flow. As a diverse group of creditors, we left our competitive instincts at the door. The pari passu clause served as a common denominator that assured equal priority of payment to all creditors of a similar debt class.
To understand the importance of the pari passu clause, it is useful to review the evolution of the 1980s debt crisis. I view the crisis as having had three phases: refinancing, new debt and debt relief. Each of these phases required new debt agreements, and all of these agreements contained equal treatment covenants.
The refinancing phase covered the period from 1982 to 1985. During that time, banks lent new money to! stressed debtor countries such that they could continue paying interest. Sovereign debt service and bank loan books remained current. Lenders and debtors shared a common understanding: In spite of strained debtor-country budgets, all renegotiated external indebtedness would be treated equally in priority of payment.
The equal payment provision became even more important in the second phase of debt restructuring. Starting in 1985, it was generally recognized that lending in excess of interest refinancing was required to foster growth in the indebted countries. This has often been referred to as the “free rider†phase, in that some creditor banks refused to participate in this new lending. Instead, they preferred to continue receiving current debt-service payments without participating in new loans. The pari passu clause provided assurance that large creditor institutions, which were negotiating these agreements and often had differing motivations because of their physical presence in the borowing country, would not receive an unfair advantage in debt repayment over the smaller banks that lacked such negotiating leverage.
“Debt fatigue†developed during this phase, and many banks that probably should not have been lending to sovereigns in the first place exited by selling their loans in the newly emergent secondary market. Other creditors chose to absorb the losses of debt reduction through negotiated debt relief under the “Brady plan,†which served as a negotiated solution between private creditors and sovereign debtors. The guiding philosophy for all parties was that all creditors would receive equivalent treatment, even though there might be a diverse menu of alternative debt-relief options. New securities were typically issued in bearer form and not as registered instruments, to prevent a sovereign from compelling an increase in new debt and possibly discriminating in payments.
To persuade creditors to participate in each of these renegotiated debt agreements, n! ondiscrim! inatory payments by the sovereign were essential.
What is most disturbing about Argentina’s current intransigence is its refusal to uphold its contractual obligation of nondiscriminatory payment and abide by the rule of law to which it agreed in its contracts with the creditor community. Argentina’s political threats, dictated “take it or leave it†terms and selective defaults threaten to upset a balance that prevailed through decades of orderly and successful restructurings.
The international financial community has long depended on negotiated solutions that take into account a country’s ability to pay as the primary measure for resolving payment difficulties. But after years of exceptional economic growth, Argentina is neither insolvent nor impoverished. It simply refuses to pay anything to those creditors that it could not coerce into a voluntary rescheduling.
The recent rulings by federal courts in New York correctly interpret the pari passu clause and the “equal treatment€ covenant. These decisions reinforce what responsible debtors and creditors understood throughout the 1980s debt crisis and beyond. Where economic circumstances required the modification of financial terms and conditions, good-faith negotiations led to positive outcomes for all concerned. The pari passu clause and the fundamental principle of equal payment were understood then and have now been reaffirmed again to mean that debtors cannot discriminate in priority of payment to creditors holding comparable classes of debt.
The courts’ reiteration of these principles should and will motivate responsible sovereign debtors and private creditors to resolve their differences at the negotiating table, and not in the courtroom.
