High Court rules against Republic of Argentina in GDP-linked sovereign bond claim finding in favour of the claimants’ construction of provision "rebasing" GDP measurement

The High Court has ruled against the Republic of Argentina (Republic) in a claim brought by investors in Euro-denominated sovereign bonds issued in 2005 and 2010 for approximately €1.33 billion: Palladian Partners & Ors v The Republic of Argentina & Anor [2023] EWHC 711 (Comm).

While the present decision turns on the facts and specific terms of the sovereign debt securities, it provides a helpful example of the court's approach to the contractual interpretation of bond documentation, particularly GDP-linked bonds.

Under the terms of the securities, the Republic's obligation to pay was linked to the level and growth of the Republic's GDP, compared to a "Base Case" for each year. In 2014, the Republic had "rebased" its measurement of GDP, so that it used 2004 prices rather than 1993 prices as it had done previously. The Republic subsequently did not pay under the securities for 2013 or any later years because it argued that the Base Case for those years, as adjusted following the rebasing of GDP, had not been met.

The key issue in dispute was the proper construction of the terms of the securities. The court concluded that the claimants were correct that, following a rebasing of GDP, the Base Case was subject to an annual adjustment using the ratio between GDP measured in the new and old prices for each year, rather than a one-off adjustment using a fixed fraction derived from a single year (as the Republic had contended).

The court therefore ordered payment of €1.33 billion for the year 2013, and specific performance for subsequent years of the Republic's obligations in accordance with the correct approach to adjusting the Base Case.

We consider the decision in more detail below.

Background

The bonds in question were issued as part of a major sovereign debt restructuring launched in 2005, in the wake of a financial crisis which had resulted in the Republic suspending payment of over US$80 billion of debt. At that time, this was the largest sovereign debt default in history.

In the context of the restructuring, the Republic undertook a debt sustainability analysis to assess the necessary level of debt reduction and to model the level of payments which it could afford to make in the future. Certain groups of bondholders, however, believed that the Republic's economy would grow at a higher rate than projected and that the Republic could, therefore, sustain higher levels of debt payments. For this reason, the Republic introduced the concept of GDP-linked securities, which would provide bondholders with additional payments if it did, indeed, grow at a higher than projected rate.

GDP-linked securities

GDP is a key macroeconomic indicator that measures a country's economic output. It is an estimate of the total production of goods and services within a country's borders over a given period. Economists measure "Real GDP" by excluding the effects of inflation/deflation, in order to compare GDP between different time periods and to measure growth. Real GDP is calculated by designating a particular year as a "base" year and using the fixed prices of goods and services in the base year to calculate the value of goods and services in all other years. At the time the bonds were issued, the Republic used 1993 as the base year for measuring GDP. Therefore, Real GDP for 2005 (by way of example) was calculated by using (i) prices of goods and services from 1993 and (ii) quantities from 2005.

It is necessary to "rebase" Real GDP periodically by updating the base year by which GDP is measured, because otherwise there can be distortions over time as the economy evolves and changes structure from the one represented by the base year. After a long process, the Republic rebased GDP in 2014, replacing 1993 prices with 2004 prices. Once the new base year had been adopted, the Republic ceased measuring or publishing GDP data in 1993 prices.

The terms of the bonds

The bonds contained terms which linked payment to real GDP. In each year, payment would only be due if certain "Payment Conditions" were met, which required Real GDP and Real GDP growth each to be higher than a "Base Case" set for that year. The bond documents included a chart which set out the Base Case for each year until maturity, measured in constant 1993 prices. For 2005, Base Case GDP was 287m pesos in 1993 prices; this rose each year until the bonds matured in 2035, by which point Base Case GDP was c.694m pesos in 1993 prices.

The bond documents also provided that if there was a rebasing of GDP during the lifetime of the bonds, then the Base Case GDP as set out in the chart would need to be adjusted for each year (or "Reference Year"). Following a rebasing, Real GDP would be measured by reference to the new "Year of Base Prices" (i.e., the year that had replaced 1993 as the base year), and Base Case GDP would be adjusted by:

"… multiplying the Base Case GDP for such Reference Year (as set forth in the chart above) by a fraction, the numerator of which shall be the Actual Real GDP for such Reference Year measured in constant prices of the Year of Base Prices, and the denominator of which shall be the Actual Real GDP for such Reference Year measured in constant 1993 prices."

This was referred to as the "Adjustment Provision". The critical issue in the case was how the Adjustment Provision was to be construed.

The claimants' case was that, following a rebasing, Base Case GDP for each year was adjusted by the ratio between (i) Real GDP in that year measured in the new Year of Base Prices, and (ii) Real GDP in that year measured in 1993 prices. This would involve adjusting Base Case GDP by a different fraction every year and hence was labelled the "Annual Adjustment Construction". The claimants argued that the wording of the Adjustment Provision was clear and that this interpretation afforded the words their plain and natural meaning.

The Republic's case was labelled the "One-Off Overlap Construction". This required that Base Case GDP for each year was adjusted using a single fixed fraction applied to every year going forward. The fixed fraction was determined by reference to an "Overlap Year", which in this case was 2012 because that was the last year in which data for Real GDP in 1993 prices was available. The fixed fraction was the ratio between (i) Real GDP for the Overlap Year in the new Year of Base Prices, and (ii) Real GDP for the Overlap Year in 1993 prices. This construction entailed a one-off adjustment to the levels of Base Case GDP in the chart, rescaling the entire series into the prices of the Overlap Year. For any subsequent rebasings during the lifetime of the bonds, a new fixed fraction would need to be calculated, by reference to a new Overlap Year.

The Republic argued that this interpretation ensured that Base Case GDP would be updated in such a way that the bonds were linked to the real economic performance of the Republic as measured by the most reliable estimate of GDP available, rather than being tethered to an outdated and obsolete measure, namely 1993 prices.

Decision

Legal principles

The court reviewed the authorities on contractual interpretation, including the well-known Supreme Court decisions in Rainy Sky SA v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24. The court emphasised that contractual construction is a unitary or iterative exercise which involves checking rival meanings against the provisions of the contract and testing the commercial consequences (as stated in In re Sigma Finance Corpn [2009] UKSC 2). This iterative process was appropriate even though the bond documents specified rights and duties that may be passed on to others who were not a party to the original bargain, i.e., subsequent purchasers of the bonds.

The court also noted that the Republic's case in effect required the court to construe the Adjustment Provision in such a way as to correct its drafting. The Republic was therefore relying on the principle that a clear mistake in the drafting of a document may be corrected as a matter of construction, if it can be established that something has "gone wrong with the language" (Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101) and provided there is only one possible solution to the drafting error (Trillium (Prime) Property GP Ltd v Elmfield Road Ltd [2018] EWCA Civ 1556).

Application to the present case

The court accepted that the intention behind the bonds was that payments would only be made when the Argentine economy was growing at a sufficiently healthy rate, and that they would not be made if its economy was not growing. However, the court did not accept the Republic's key contention (discussed further below) that the parties had proceeded on an assumption of long-term 3% growth trend in real GDP without regard to any particular base year, based on the historical performance of the Argentine economy. While 3% had been used for illustrative purposes in some of the investor presentations given by the Republic, they did not stipulate that the Adjustment Provision should be understood as requiring the application of a fixed percentage for Real GDP growth and nor did the bond documents themselves.

The court concluded that the Annual Adjustment Construction was correct. The court said that this was for, "what, ultimately, is a very simple reason…the One-Off Overlap Construction just does not reflect the wording used in the Adjustment Provision. In contrast, the Annual Adjustment Construction is faithful to the wording used". In particular, the court made the following observations as part of its contractual interpretation exercise:

• No drafting error. The court noted that the One-Off Overlap Construction would require the Adjustment Provision to be read as though it contained additional wording to reflect the concept of the Overlap Year and the insertion of a separate step for any subsequent rebasings (because this would require a new fixed fraction to be calculated which would not depend on 1993 prices). Neither of these were defined or identified in any way by the words of the Adjustment Provision.
• Intended commercial impact. Moreover, the underlying premise of the Republic's case was that the One-Off Overlap Construction was the only commercially reasonable interpretation because the parties had intended, following any rebasing, to preserve the same percentage changes in real GDP growth as had been implied by the Base Case GDP figures set out in the chart (which from 2015 onwards was 3% per year). The One-Off Overlap Construction "preserved the percentages" in this way, whereas the Annual Adjustment Provision would result in different percentage growth rates from those in the chart. However, when considering the factual matrix, the court had rejected the suggestion that the Adjustment Provision required the application of a fixed percentage for GDP growth.
• Economic considerations. The court also did not consider that economic considerations dictated the premise for which the Republic contended. Under the claimant's interpretation, rebasing did not make a difference to whether or not the Payment Conditions were satisfied since the Annual Adjustment Construction tied those conditions to 1993 prices. However good or bad the contractual bargain had been at the time the bonds were issued, the Annual Adjustment Construction preserved that bargain, with the result that a creditor or investor who decided at any point to accept or purchase the bonds, based on the known position in terms of 1993 prices, would know that a rebasing would not affect their assessment of whether payments were likely in the future. By contrast, the One-Off Overlap Construction entailed the "goalposts being moved" by a rebasing.
• Practical utility of using a measurement known at the time of issuance. The court did not accept the Republic's contention that there could not be any practical use or value to investors in tying a bond that was supposed to pay out depending on the performance of the real economy to what the Republic characterised as an outdated and superseded measure of the performance of the economy. To the contrary, the court held that there were reasons why investors may have considered the link to 1993 prices to be a good thing. GDP measured in 1993 prices was a known measurement when the bonds were issued in 2005, having been in operation since 1999, and the parties would have certainty in advance as to what level and growth of Real GDP was required to meet the Payment Conditions; conversely, the parties had no idea what any rebased measurement would look like.
• Non-linearity of GDP series. The court also noted the non-linear relationship of two GDP "series" in different year of base prices, i.e., the relationship between Real GDP measured in two different Year of Base Prices in any given year will not be the same as in any other given year. The One-Off Overlap Construction did not account for this non-linearity because it involved adjusting the Base Case by a single ratio based on the relationship between Real GDP in 1993 prices and Real GDP in the new Year of Base Prices in a single historic year (the Overlap Year), even though the actual ratio between Real GDP measured in those two ways would be different in each following year.
• Moral hazard. Similarly, the One-Off Overlap Construction made the choice of the year used to generate the fixed fraction highly significant. The single Overlap Year would inevitably produce a fraction that was not representative of other years. The court considered it difficult to see why this would be regarded as a commercially sensible arrangement to have entered into or why everything should essentially "pivot" on one year. Indeed, on the One-Off Overlap Construction, the Republic was effectively able to choose the Overlap Year by deciding when to undertake a rebasing and when to cease publishing data in 1993 prices. This gave rise to a "moral hazard" objection, and the court held that there was no reason why investors would have wanted to give the Republic the power to select the Overlap Year, when that could determine whether or not the Republic was liable to make payment under the bonds.

Conclusion and remedies

The court concluded that the language used in the Adjustment Provision pointed towards the correctness of the Annual Adjustment Construction and that there was an economic logic to that construction being more appropriate than the One-Off Overlap Construction. It was in the court's view impossible to conclude that the latter was the only rational construction such that there was a mistake in the wording of the Adjustment Provision which needed to be corrected.

Applying the Annual Adjustment Construction, the Payment Conditions for 2013 were met, with the amount due being €643 million in respect of the claimants' holdings and €1.33 billion in respect of all the bonds. The court also made an order for specific performance, requiring the Republic to apply the Annual Adjustment Construction in all subsequent years in determining whether it is obliged to pay under the bonds. Given that the Republic has not measured GDP in 1993 prices since 2013, this will require the Republic to re-start the production of data in 1993 prices and to continue producing it until the maturity of the bonds in 2035.

Note: In August 2023, the defendants applied to the Court of Appeal for permission to appeal.

In January 2024, the Court of Appeal allowed the defendants' application for permission to appeal. The Court of Appeal hearing has been fixed for 21 May 2024.