It could either be a step in the direction of isolating Argentina, or a sign that the creditors’ strategy in that case is becoming the way of the sovereign debt world. For now, all we know is that another federal district judge in New York has refused to dismiss [pdf] another pari passu [pdf] case in late August, this one against Grenada, and sent it full steam ahead to media frenzy.
Here is the saga in a nutshell. Grenada got hit by two hurricanes and restructured its debt—minus the four loans owed to Taiwan’s Export-Import Bank—circa 2005. At about the same time, it picked Beijing over Taipei, which probably ensured that the ensuing debtor-creditor spat would be about more than money. Grenada defaulted, and Taiwan sued and got a judgment in New York but has not gotten paid.
Fast forward to March 2013, when Taiwan filed a copycat lawsuit against Grenada, claiming violation of the pari passu (equal step) clause in its loan agreements. This lawsuit piggybacks on NML Capital’s recent victories against Argentina, a case where Judge Thomas P. Griesa ordered the government to stop paying its restructured debt unless it pays the holdout creditors in full. Taiwan wants Judge Harold Baer Jr. to block payments on Grenada’s new debt, and, mimicking NML v. Argentina, to threaten a wide range of market intermediaries with sanctions to pressure the government to comply. Grenada asked the court to dismiss the case on the ground that breach of any particular contract term must be subsumed in the money judgment for payment default on the same contract, which Taiwan got years ago. This is known as the merger doctrine.
Judge Baer rejected Grenada’s merger argument on August 19, partly on the grounds that the alleged pari passu violation—payment on restructured bonds while in default to Taiwan—happened mostly after the original contract case was filed. So Taiwan could not have brought the claim back then, even though it mentioned the pari passu theory in its briefs. Of course if pari passu were just another contract clause, it would not matter, because the remedy for breach would be acceleration, and the same old money judgment. But pari passu is no longer just another promise; it is the one nuclear remedy that just might make sovereign debt collectable.
The ruling to let the suit against Grenada go forward is important because it expands the universe of potential plaintiffs in sovereign debt litigation. The NML bunch deliberately avoided getting judgments in the case pending before the Second Circuit, just in case merger might get in the way. The same folks have been working hard to change New York law [pdf] to do away with merger. And fellow creditors holding judgments against Argentina have hinted at bringing similar lawsuits, arguing that merger does not apply. So the latest Grenada decision simplifies matters for creditors contemplating a lawsuit against a sovereign—you no longer have to pick between two uncertain roads, money judgment and pari passu. You can take both.
Adding to the drama, the holders of Grenada’s restructured bonds, whose payments would be blocked if Taiwan were to procure NML-style remedies, were allowed to join the lawsuit as defendants. Like Grenada, they wanted the case dismissed—not on simple merger grounds, but because Grenada has more favorable contracts and has acted nicer than Argentina. Judge Baer gave them what they asked for—a full fact-finding on whether and how Grenada might be different from Argentina.
Presumably, these folks want more leverage for creditors in general from doing away with the merger argument, and view this case as an opportunity to preserve and finesse the pari passu remedy. If a narrower version of the remedy emerges from a case involving a smaller, poorer, and more sympathetic sovereign, it could pave way for a compromise of sorts between more mainstream creditors and the policy world, which is concerned about the implications of NML v. Argentina.
Three things can happen from here on.
First, Grenada might settle with Taiwan—especially since it is out of money again, needs to restructure all its debt again, and would not want any glitches along the way. Given the political dimension, Taiwan might not wish to settle for less than what it is owed (roughly $30 million plus past due interest). Regardless, if the case settles, the takeaway would be that the merger doctrine does not apply to pari passu violations that happen after the initial lawsuit on the debt contract is filed. The incentive will be to file such lawsuits early, preserving both enforcement paths. The scope of the pari passu remedy will continue to be broad, defined by Argentina.
Second, assuming the case goes forward, Judge Baer could distinguish Grenada’s contracts and behavior from Argentina’s, and deny Taiwan the injunction. This would be a narrowing of NML v. Argentina. The effect on merger is the same as in the first scenario. This paves the way for more suits against Argentina, but perhaps not many others.
Third, the judge could grant the injunction. This would be a broadening of NML v. Argentina, because Grenada has a less vulnerable ranking formulation of the pari passu clause, and has been much more circumspect than Argentina about freezing out holdout creditors in its official enactments and public statements.
I am not going to begin to speculate on the broader fallout. Whatever happens, we will be here.
A different version of this post appears on CreditSlips.org.