Introduction and Background
The English Court of Appeal has recently decided a case about sovereign debt. Russia holds the debt - bonds with a face value of US$ 3bn, issued in December 2013. In 2014, Russia seized the Ukrainian province of Crimea and backed separatists in a civil war in eastern Ukraine. Ukraine's economy almost collapsed. It defaulted on repayment of the bonds in 2015.
The Court of Appeal has decided that Law Debenture, the bond trustee acting on Russia's behalf, should not have judgment on its claim for payment without a full trial of Ukraine's main defence arguments. The Court has reversed the court of first instance (the Commercial Court), which in March 2017 decided that Ukraine had no defence in law and that, as a result, a full trial was not necessary.
In practical terms, the Court's decision gives Ukraine more time to pay its debt to Russia. The parties are appealing the decision to the UK Supreme Court. The Supreme Court is unlikely to give judgment for some time – we expect about a year. If a trial does go ahead, it could be another two or three years before the litigation is over.
While the Court of Appeal's decision and the prospect of another appeal offers new hope and time for the parties to find a commercial solution, the bonds will continue to weigh on Ukraine's economic prospects. Ukraine claims that the IMF would refuse to extend it further funding if Russia's claim for payment in full succeeds. It is not clear that Ukraine's national debt is sustainable if that happens.
But the Court's decision is not just about Ukraine's public finances, important though they are. The case also decides issues which are important to sovereign investors and to debt capital markets. In particular, when should a country have to repay so-called ‘odious debt’ which is tainted by the misconduct of its former government, as Ukraine says its debt to Russia is? In the past, that has been a question for politicians, international tribunals, academics and supranational bodies like the IMF. The Court of Appeal has not tried to give a general answer, but has signalled that domestic UK courts will decide on a case-by-case basis whether it is a question they can answer.
The legal issues in the case arise against a background of deteriorating relations between the UK and Russian governments. Events in Ukraine are no exception. Russian President Vladimir Putin has sought to justify Russia's role in Crimea as being to guarantee the right of the people of Crimea to self-determination, and Russia's military action in Eastern Ukraine as being in defence of Russian nationals. The UK government, on the other hand, has made clear it regards Russian activities in Crimea and Eastern Ukraine ‘as being in clear violation of Russia’s obligations under international law’, as the Court of Appeal noted in its judgment.
Official Russian reaction to the decision has been restrained. But Russian state media have condemned the decision as an example of the "legal nihilism and voluntarism of our Western partners", and for signalling "that Russians don't have to be paid". The same Russian commentator criticises the Court for taking "the sly path of judicial delays", and insinuates that the Court is part of a Western financial system that cannot be trusted.
Such complaints are greatly overstated. The Court of Appeal noted in its judgment that the UK government had declined to intervene in the hearing. And in 2012, Lady Justice Gloster, one of the three judges on the Court, ruled against Boris Berezovsky, a Russian exile and vocal critic of Vladimir Putin, in one of the biggest civil cases in British legal history - hardly the act of an anti-Russia partisan.
Ukraine's Duress Defence: "acts of state" and "public policy exceptions"
That is not to say that the decision is uncontroversial. The main argument the Court of Appeal heard was about whether Ukraine could run a defence of ‘duress’ at trial – that is, the argument that Ukraine had issued the bonds, and became unable to repay them, because of illegitimate Russian pressure. The official Russian line is that these arguments are untrue. The Commercial Court held that, although there was enough evidence to justify a trial, the subject matter of the defence was essentially political and therefore not ‘justiciable’ – ie, not something that is suitable for a court to judge. The Court of Appeal agreed that the Russian actions complained of by Ukraine were ‘acts of high policy…in the sphere of international relations’ – something UK courts have traditionally refused to examine. But, the Court went on to say, in this case there were exceptional reasons of UK ‘public policy’ which justified a trial, and which outweighed any perceived need for judicial self-restraint.
The Ukraine-Russia litigation is not the first time that the UK courts have decided they can examine ‘foreign acts of state’. But it is one of only a very few examples, in modern times, where the alleged wrongdoing – military aggression by one nation against another - is as fundamental. Citing the recent precedent of Belhaj v Straw (‘Belhaj’), the Commercial Court at first instance declined jurisdiction precisely because that subject-matter formed, in its view, one of the ‘central areas of abstention’ for UK domestic courts. The Court of Appeal, however, turned that reasoning on its head. There was, in the Court of Appeal's view, an ‘especially strong public policy’ in preventing a country from being able to take advantage of possible breaches of fundamental rules of international law, such as the rule against military aggression.
To the Supreme Court – and beyond?
Official Russian predictions of the outcome in the Supreme Court have been mixed. Finance Minister Anton Siluanov's cautious line was that he was "confident that British justice will be able to objectively figure out and make the appropriate decision". Konstantin Vyshkovsky, head of the Russian Finance Ministry's debt department, was more optimistic, stating he expected the Supreme Court to agree that Ukraine's duress argument does not merit a trial.
Recent indicators do not entirely support Mr Vyshkovsky's optimism. Less than two years ago, the Supreme Court in Belhaj unanimously held that the UK government could not rely on the ‘foreign act of state’ doctrine as a defence to a claim that it had been complicit with the US government in the detention and mistreatment of a Libyan citizen. Of the seven presiding judges, only two (Lady Hale and Lord Wilson) will remain in office by the time the Supreme Court hears the Ukraine-Russia appeal. But another two judges – Lady Sharp and Lord Lloyd Jones – who reached the same decision in the Belhaj case in the Court of Appeal in 2014 (and whose decision the Supreme Court then affirmed in 2017) have since been promoted to the Supreme Court. Any or all of those four judges might be on the panel that hears the Ukraine-Russia appeal.
Sovereign investors who have or will transact under English law should watch closely for the outcome. Sovereign wealth funds and other state-owned investment corporations should pay particularly close attention. The presence of a capital markets structure and a trustee have not been sufficient – so far, at least – to prevent Russia's foreign policy becoming the subject of a trial.
What of sovereign debtors? Russian state media foresee indebted Eurozone governments using the precedent to renege on their own commitments. Time will tell whether such predictions are merely mischievous. It is not unimaginable that Greece, say, might one day argue that the austerity imposed on it by creditors has prevented it from ever being able to pay off its debts.
Court of Appeal's Decision on Implied Terms
The Court of Appeal has also dismissed Ukraine's contract law argument that the bonds should be subject to an ‘implied term’. Ukraine's case was that it was implicit in the bond trust deed that it should not have to repay if Russia had prevented it from being able to do so. The Court rejected that case. That is important for sovereign debt markets, where English law is a common choice of law.
The decision on that argument is a victory for form over substance. The reality of the deal was not an offering to the capital markets. It was a Russian bail-out of Ukraine's economy. Russia was lending for political not commercial reasons. The interest rate on the bonds was below Russia's own cost of funds, and was too low to be of interest to the secondary market at the time. Russia and Ukraine appear to have put a eurobond structure in place to evade applicable laws and procedures about ‘official’ (state-to-state) lending. The deal was really a bilateral loan. Had the legal agreements between the parties reflected that, the Court probably would have accepted Ukraine's argument for a contract term against Russia preventing Ukraine from being able to repay.
Ultimately, the Commercial Court and the Court of Appeal have made a policy decision on Ukraine's contract law arguments, which makes sure bond markets work properly. Their judgments reaffirm the rule that background facts will be irrelevant when it comes to interpreting or supplementing the trust deed under which bonds are issued, unless those facts are disclosed in the listing prospectus and would otherwise be known to the market.
What the implied terms decision means for capital markets
The Courts' decision will be welcomed by commercial lawyers, and should be welcomed by capital markets. No sensible system of law should make investors investigate the political and military context of a public bond offering. The Court of Appeal's decision on the implied terms point is a step in the right direction, after BNY Mellon v LBG Capital two years ago. The prospectus in that case did not contain the granular details of regulatory policy that, according to the Supreme Court, investors must have known.
The Court of Appeal did not give Ukraine permission to appeal to the Supreme Court about implied terms, so its judgment is likely to be the last word on implied terms in sovereign debt offerings for some time. Even so, private investors should remain especially wary of ‘politicised’ securities like the bonds in the Russia/Ukraine litigation. Former Ukraine finance minister Oleksandr Danyliuk, writing in the Financial Times, called his country's bond offering a ‘façade’. In the litigation, Ukraine has held off – so far, at least - from making the drastic argument that the bond issue was a ‘sham’ (and therefore totally void), presumably for fear of spooking the markets. Another sovereign on another day might not show such restraint.