The January 2017 issue of Debt Dialogue reported on a decision rendered in federal court for the Southern District of New York, Penades v. The Republic of Ecuador (SDNY Sept. 30, 2016), on the application of a no-action clause found in an indenture governing sovereign debt of Ecuador. The debt consisted of bonds issued in 2000 and due in 2030, under which Ecuador was obligated to pay interest semiannually. After Ecuador ceased paying interest on the bonds, the plaintiff sued on the past-due interest. The district court dismissed the complaint because the plaintiff had failed to comply with requirements of the no-action clause.

Ordinarily, particularly under indentures crafted in compliance with the Trust Indenture Act, compliance with a no-action clause is not required to collect past-due interest. But the Ecuadorian indenture had peculiar language. The exception to the no-action clause read: “Notwithstanding any other provision of this Indenture, each Bondholder shall have the right ... to receive payment of the principal of and interest on ... its Bonds on the stated maturity expressed on such Bonds and to institute suit for enforcement of any such payment. ...” Interpreting this provision with brutal literalness, the court held that stated maturity meant the due date for the bonds in 2030, even as to the interest.

The district court looked to various provisions of the indenture that appear to treat maturity and interest payment events as separate dates. The court also looked to the amendment provisions of the indenture, which provided that unanimity was required to change “the stated maturity of the principal of or interest on any such bond,” which in the court’s view differentiated between “stated maturity of the principal of,” on the one hand, and “interest on,” the bonds, on the other.

The Second Circuit Affirms

The Second Circuit affirmed the district court decision in a per curium order. In addition to the reasoning of the district court that analyzed the comparative usage of maturity and interest payment date in the indenture, the appeals court adverted to the definition of “maturity” in two financial dictionaries.

The appeals court also reiterated the argument based on the amendment provisions. “[B]y placing a preposition after ‘principal,’ [to wit ‘of’] [the clause] separates the two subclasses in the provision ... differentiating between the ‘stated maturity of the principal of’ a Bond and the ‘interest on’ a Bond. ...” This argument is hardly compelling, since as any bond practitioner knows, “principal of” and “interest on” are standard grammatical formulations in debt-speak. The appeals court conceded, but quickly discarded as being outnumbered by counterexamples, the one instance in the indenture in which maturity was used in reference to the due dates of interest installments.

The plaintiff in the case was a resident of Rio de Janeiro, acting pro se at both the district court level and on appeal. While the plaintiff appears to have acquitted himself honorably, one cannot help but wonder if the result in the case would have been different had the plaintiff been represented by counsel with skill that matched that of the defendant. There is moreover a sense of uneasiness and unfairness with a ruling that declared a bondholder unable to sue to recover interest for up to 30 years, unless he or she can muster a cohort of bondholders with 25% of the outstanding bonds and satisfy the other requirements of the no-action clause.

Unfairness and even counter intuitiveness, however, are not sufficient to overthrow plain meaning under New York contract law. Penades calls to mind a somewhat similar case decided by the New York Court of Appeals, Matter of Wallace v. 600 Partners Co., 86 N.Y.2d 543 (1995). Matter of Wallace involved a property lease for a 33-year initial term with options to renew for two successive 33-year terms. The annual renewal rent, if the parties were unable to agree, was to be 6% of the “value” of the land. By the terms of the lease, value was to be determined by an appraiser at the expiration of the renewal term. The tenant claimed that this must have been a scrivener’s error, since it was unthinkable that the tenant might be required to make some outsized catch-up payment after 33 years. The appeals court was unpersuaded and held that the provisions of the lease should be read as written.

Penades may be of a piece with Matter of Wallace. Just because a provision in an indenture is unconventional, even radically so, does not mean it will not be enforced. Once again, let the bondholder beware!