It’s good to understand the clauses that are found in the great majority of the bonds placed in the international markets.Â AsÂ these issues are important for those who want to issue foreign debt, it is good to understand what the normalÂ clauses are in debt contracts.
Although these types of loans start as a loan from a specific entity to a country, theyÂ are tradable securities between professional investors and these transfers are free from the debtor’s interference. Meaning a countryÂ does not have the capacity to limit these transfers nor to decide who can or not invest in their bonds.
This clause has two elements, according to theÂ Bank for International Settlements (BISÂ PDF):
- The internal element, where the bonds will have the same rank of importance with each other
- The external element, where the bonds will have the same rank compared to other indebtedness, not only with existing debt, but with debt issued in the future
AsÂ theÂ legal document from Argetina’s massive loan a few years ago states:
“The debt securities will be direct, unconditional, unsecured and unsubordinated obligations of the Issuer and will rank pari passu and without preference among themselves. Issuer’s payment obligations under the debt securities will rank at least equally with all other present and future unsecured and unsubordinated “The payment obligations of the Republic under the Securities shall at all times rank at least equally with all other present and future unsecured and unsubordinated external indebtedness (as defined in this Agreement).”
This clause makes it clear thatÂ all bondholders have to be paid equally.
There are versions of theÂ pari passuÂ clauseÂ in bonuses:
- That the bonds will be classified equally with the rest of the debt.This version protects creditors from involuntary subordination by laws or actions that could be approved later.
- That the bonds are classified equally in priority of payment.
TheseÂ pari passuÂ clauses have benefits because itÂ guarantees investors that they will not be treated differentlyÂ with each other and also protects them from being treated differently compared to future investors in new bonds.
Collective action clause
This clause, now more common in bonds issued byÂ countries, allows aÂ majority of bondholders to accept a debt restructuring and this acceptance would be legally bindingÂ on all bondholders, including those who vote against the restructuring.
Without this clause, some creditors may refuse to participate but benefit from the positive impact if most bondholders go ahead.Â This problem, called theÂ free rider, would be eliminated with the inclusion of this type of clause.
Rights Upon Future OffersÂ (RUFO)
This clause is generally included and says that if the country receiving the loan gives a better offer to some creditors before a pre-set date, than other bondholders have the right to receive the same treatment.Â
This type of clause is included to give bondholders confidence thatÂ they too would benefit from improved terms to other creditors or new investors.
This clause prohibits the debtor from guaranteeing, or even offering guarantees backed by assets of the company or the country, in a special way to other creditors, without offering the same guarantees to the current investor.Â What this clause does is to protect a creditor from future actions that would place him in a situation less advantageousÂ than the new creditor.Â It also prohibits offering the same asset guarantee to various lenders or taking other forms of actions that may jeopardize the security of existing lenders.
The result of not having this clause would be that, if the debtor offers other creditors more guarantees, in a situation of suspension of payments, the original creditors would be more behind in the queue of repayments.
Representations and warranties
Each financial contract includes a large number ofÂ declarations, obligations and guarantees that ensureÂ :
- That the debtor is in legal status
- You can enter into the type of contract you are signing
- Who can deliver what he has promised
If any of these were not met, the debt holder would have the right to appeal, even with the possibility of requesting the loan back immediately.Covenants
These are pledges or promises that debtors present to creditors where theyÂ promise to do things in the future or promise not to do things in the future.Â If any of these were not met, the debt holder would have the right to appeal, even with the possibility of requesting the loan back immediately.
Events of default
These provisionsÂ list economic and financial situations where creditors consider the country to be in defaultÂ .Â These situations may include breaching the stated financial ratios or breaching declarations, obligations and guaranteesÂ or other agreed pacts.
Cross default clause
When a debtor enters anÂ event of defaultÂ situation, all other creditors who have theÂ cross defaultÂ clause in their contractsÂ can begin the process of requesting their loan back immediatelyÂ .
In this case, bondholders would not sit around and see other creditors request repayment of their loans while they can not.Â With theÂ cross defaultÂ clauseÂ these creditors would also be put in the queue.
That is why it is important that a debtor does not enter into suspension of payments since debt contracts usually includeÂ cross defaultÂ and any suspension of payments would give all creditors of all debt the possibility to borrow back their loans immediately.
This clause says that if anyÂ events outside human control, so calledÂ Acts of God, which are unforeseen natural disasters, such as earthquakes, hurricanes and floods, that impact on the possibility of paying the debt or interests, the contract would be suspended without detriment to the debtor.
This clauseÂ lists the conditions where creditors could request their loans backÂ immediately, including those mentioned above.Â Since any of these would cause all other creditors to join, the events on this list are important.