Pari Passu and Bouillabaisse

I have always thought that “pari passu” and bouillabaisse a couple of the coolest things to say, but with the latest plan by the ECB to exchange their Greek bonds for new bonds only they would hold it is worth taking a closer look at “pari passu”.

This is not meant to be in any way legal advice, but as a credit market practitioner these are my thoughts about some potential problems with what the ECB and Greece are doing, and are worth digging into deeper with your lawyers, especially if you are motivated to slow the process down.

There have been some stories stating that the deal is already done.  That may be true, but so far Bloomberg has not updated notional amounts outstanding on existing bonds, so the deal may be done and they haven’t told the right people yet to get the data updated, or the deal is “done” as in agreed in principal but not actually done in a real world way.

Pari Passu

The bulk of Hellenic Republic debt is issued under Greek Law.  The documentation is flimsy and one-sided.  Here is a little section from the offering circular for the March 20^th, 2012 bonds.

Status:	Direct, unconditional, unsubordinated and unsecured obligations of the Republic.
Negative Pledge:	None.
Cross Default:	None.
Purchase:	The Republic may at any time purchase or otherwise acquire Bonds in the open market or otherwise.

Not a whole lot to rely on as a bond holder.  The bonds documented under English Law are a lot more interesting.  I am working from the offering circular for the 5.2% bonds due 2034 (funny how in 2004 no one thought 5.2% coupon for a 30 year bond was a bad deal or unsustainable).

2. STATUS OF THE BONDS AND NEGATIVE PLEDGE

The Bonds constitute direct, general, unconditional, unsubordinated and, subject to this Condition, unsecured obligations of the Republic. The Bonds rank pari passu with all other unsecured and unsubordinated obligations of the Republic outstanding on 30 April 2004 or issued thereafter without any preference granted by the Republic to one above the other by reason of priority of date of issue, currency of payment, or otherwise. The due and punctual payment of the Bonds and the performance of the obligations of the Republic with respect thereto is backed by the full faith and credit of the Republic.

So long as any Bond remains outstanding, the Republic shall not create or permit to subsist any mortgage, pledge, lien or charge upon any of its present or future revenues, properties or assets to secure any External Indebtedness, unless the Bonds shall also be secured by such mortgage, pledge, lien or charge equally and rateably with such External Indebtedness or by such other security as may be approved by an Extraordinary Resolution of the Bondholders (as described in Condition 10).

Until now, the pari passu language has largely been ignored.  While pari passu may be fun to say, I’m not sure it is particularly well defined in the legal sense and I am seeing some evidence that it has been interpreted dramatically differently by various courts.  The direct translation is “on equal footing” and Black’s defines it as “proportionally; at an equal pace; without preference”.

Do the actions of the Hellenic Republic and the ECB breach the pari passu condition?  The “terms” of the bonds the ECB is getting will be “identical” to the old bonds except they will be explicitly exempted from certain rule changes that may be made (collective action for example).  The intent is clearly to create a “superior” class of debt.  While the ECB isn’t getting collateral or breaking the negative pledge argument, these bonds no longer seem to me to be “pari passu with all other unsecured …”  The “without preference” clause of the Black’s definition seems the area to target, but again, how courts have determined it, will play a big role.

It is obvious that the new bonds held by the ECB are (or soon will be) superior to the old bonds, but is it in a way that breaches the “pari passu” covenant?  There are a few factors that make it easier to pursue the case.

Since the clause would be breached if any bond was “elevated” it doesn’t matter whether the ECB holds any English law bonds.  If the ECB held Greek law bonds and these English law bonds were deemed to no longer be pari passu with those new bonds, that breach would be sufficient to trigger this covenant.  So the fact that it doesn’t rely on the ECB holding any English bonds is a benefit since it makes it difficult for the ECB to work its way around this issue since they can’t just treat their English law bond holdings separately.

The other key reason this may be worth pursuing is that generally English law favors creditors.  Not only does English law generally give strong protection to creditors, but since England has not been a part of the “solution” in the way France and Germany have, their courts don’t have a bias to support their politicians over the law.  So you would get to litigate the case in a court system that tends to favor creditors and does not have a strong reason to support the decision at the expense of the law (unlike a Greek, or even French or German court).

So what does it all mean?  Now we move to the “Event of Default” section.

7. EVENTS OF DEFAULT

If any of the following events (each an “Event of Default”) occurs:

(a) the Republic defaults in any payment of interest in respect of any of the Bonds or Coupons and such default is not cured by payment thereof within 30 days from the due date for such payment; or

(b) the Republic is in default in the performance of any other covenant, condition or provision set out in the Bonds and continues to be in default for 30 days after written notice thereof shall have been given to the Republic by the holder of any Bond; or

(c) in respect of any other External Indebtedness in an amount equal to or exceeding U.S.$25,000,000 (or its equivalent), (i) such indebtedness is accelerated so that it becomes due and payable prior to the stated maturity thereof as a result of a default thereunder and such acceleration has not been rescinded or annulled or (ii) any payment obligation under such indebtedness is not paid as and when due and the applicable grace period, if any, has lapsed and such non-payment has not been cured; or

(d) a general moratorium is declared by the Republic or the Bank of Greece in respect of its External Indebtedness or the Republic or the Bank of Greece announces its inability to pay its External Indebtedness as it matures; or

(e) any government order, decree or enactment shall be made whereby the Republic is prevented from observing and performing in full its obligations contained in the Bonds

So part (b) would be the relevant section.  The pari passu covenant/condition would have been breached.  There is a cure period, but since they would have to reverse the decision not just on the English law bonds, but also the Greek law bonds, there is no easy workaround.  There are various procedures that bondholders have to follow, but the end would be acceleration of the payments.  That acceleration would likely derail the bailout plans, or just cost the taxpayers of the EU a lot more money.  Greek law bonds don’t have this right, so it is only the smaller (but still large) amount of English law bonds outstanding that can play this game.  You do run into the issue of having to collect from Greece in the end, which has been a problem all along with fighting Greece – even if you win a judgment, it is hard to enforce.  Any asset with cross default language would be triggered and CDS would almost certainly get triggered, unless the Troika paid off all the English law bonds in full.

While we are in the “Events of Default” section, (d) and (e) are worth a quick glance.  I think they have been careful to avoid doing anything that would trigger this language (or they have just been lucky), but as the crisis and negotiations intensify, either of these seem to have a real possibility of being triggered.

Even the Greek law bonds have some similar protection (must have been included by accident) in their Event of Default section

(d)        any government order, decree or enactment shall be made whereby the Republic is prevented from observing and performing in full its obligations contained in the Bonds,

It is probably hard to trigger under those sorts of statements, but it will be interesting to watch the language that comes out in the “retroactive collective action” clauses.

Tender

There may also be some opportunities to fight the action based on the “tender” clause.  This will be specific to English law bonds and can be avoided just by not including English law bonds in the ECB’s deal (whether they have English law bonds or whether the deal is already “done” is still anybody’s guess).

(2) Purchases

The Republic may at any time purchase or otherwise acquire Bonds in the open market or otherwise. Bonds purchased or otherwise acquired by the Republic may be held or resold or, at the discretion of the Republic, surrendered to the Agent for cancellation (together with (in the case of definitive Bonds) any unmatured Coupons attached thereto or purchased therewith). If purchases are made by tender, tenders must be made available to all holders of Bonds alike.

So Greece can buy bonds in the open market.  They can then cancel bonds purchased that way or otherwise.  Okay, but can Greece do a deal to buy (or exchange) only the bonds held by the ECB and cancel them?  There is no way that is an open market purchase.  This clause specifically states that if purchases are made by tender, the tenders must be made available to ALL holders.  Is the exchange with the ECB actually a tender offer?  I think at best this is unclear.  There is no way it can be viewed as an open market purchase (even though the ECB originally acquired them that way), and there is the “otherwise acquired by” language that seems like a loophole.  But what is the tender language meant to pick up?  Are there times when a tender offer is mandatory?  Can they really just say this is something else?  Possibly, but what is the intention of this?  Aren’t tender offer rules designed specifically to ensure that certain holders don’t get preferential treatment?  If the position is big enough, why wouldn’t a court deem it necessary to do this as a tender offer rather than some made up term the ECB and Greece are going to try and use?

This can only be pursued if it turns out the ECB holds some English law bonds, and even then, only to the specific bonds they have.  That might be relatively easy for the ECB to work around, depending on their holdings, and is only an issue if the “exchange” they are doing would be deemed a tender.  Clearly more knowledge about when something has to be done by tender under English law is required.  If they breached the law and did this deal already, and it should have been done by a tender, can you also try and collect from the ECB as a party to the transaction?  That becomes interesting.  If you can get a claim on the ECB through this, then you finally get a shot at the deep pockets.

None of these ideas are obvious winners in litigation, but they don’t seem too stupid to explore in more depth.  Especially with March 20^th rapidly approaching, anything that can be used to convince them to pay you out at par rather than accepting PSI may be well worth the effort.  With the latest PSI rumors showing an even worse package, the downside from fighting, delaying, and possibly winning is higher, is marginal.  Will a settlement after a payment default really be that much worse than the PSI default settlement?

The Troika and Greece are trying to change the rules of the game on the fly.  Who knows what the long term consequences will be (probably bad), but they are also likely to create a lot of unintended short term consequences.