The court scene from The Merchant of Venice dramatises the balance between justice and equity. Argentina’s conflict with its ‘holdout’ creditors, which led to default on its New York-law bonds, suggests that it ought to be required reading for sovereign debt investors.
Shylock has extended a loan to the merchant Antonio, cash-poor with his ships abroad. All he asks is the famous pound of Antonio’s flesh as collateral should he default – which he duly does.
In court, the heiress Portia urges mercy “to season justice”. “’Tis not in the bond!” Shylock insists. “I crave the law!” He comes to regret his intransigence when Portia observes that the letter of the contract specifies precisely a pound of flesh with no blood.
In the case of Argentina’s bonds, the creditors who accepted the 2005 and 2010 restructurings, and own 93% of the bonds, seasoned justice with mercy – or at least pragmatism. But the other 7% are held by those who view contracts more like Shylock, including NML Capital, which bought non-exchanged bonds in 2008 and pursued payment in court.
This summer US Supreme Court Judge Thomas Griesa eventually established that the bonds’ ‘pari passu’ clause meant creditors should be paid ‘ratably’ – that is, all at once on the same basis. Unless the holdouts agreed to accept the same payment as the owners of the restructured bonds, or Argentina agreed either to pay everyone in full or come to new terms with the holdouts, the sovereign would have to stop paying coupons on its restructured bonds. Argentina railed against the “vultures” and colonialist US courts, NML protested at Argentina’s refusal to talk, and the sovereign eventually defaulted.
Many insist that Argentina is a special case. But most bonds contain pari passu clauses, often with vague ratability language. Some say that other jurisdictions would never follow this eccentric interpretation of pari passu. Whatever one’s view, this could dissuade sovereigns from issuing debt under New York law.
Most seriously, others argue that this scuppers sovereign debt restructuring. Critics of Griesa and NML observe that this is an important process for breaking cycles of indebtedness. Their defenders say they are standing up to governments that abuse sovereignty by bullying investors and maintaining profligate policies that are against the long-term interests of their citizens.
This is where justice versus equity comes in. Where you sit in the gallery will determine whether your solution is a Griesa interpretation of the law backed with proper premia for the risk of lending to sovereigns, or collective action clauses that allow a large majority of bondholders to prevail against holdouts.
Most agree that the current process for distressed sovereigns is muddled and contentious. In the case of Argentina, surely reasonable onlookers would also agree with Portia: “Though justice be thy plea, consider this,/That in the course of justice none of us/Should see salvation.”