Ukraine’s biggest private bondholders have a plan for its debt restructuring,Joseph Cotterill writes — and, oddly enough, it doesn’t involve them writing down their principal. The Ukrainian government will need to negotiate hard for the $15bn or so in debt relief it needs, then. Not least, one or two holders may have stakes in individual bonds large enough to block restructuring votes. (Russia’s adifferent story.)
But there is that “applicable or other fiscal laws” provision.
As we’ve written previously, one source of leverage for Ukraine might be that its English-law bonds are actually a lot more local-law — and thus changeable on a legislator’s whim — than many bondholders realise. That might perturb them enough to accept legally stronger, if economically diminished, bonds in an exchange.
How would that work? Recently, students of Mitu Gulati at Duke University Law School came to us with an interesting idea. We repost it below.
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Ukraine has a few options to craft a local fiscal law that regulates bond payments in a way that would force bondholders to reconsider holding out of an exchange offer.
One option is establish an emergency appropriations agency, which the government can grant responsibility for all spending decisions. There is nothing more “fiscal” than a law regulating how to spend government funds. This agency will then have the power to decide where “bailout” funds are spent (as well as the limited tax revenue that trickles in). The Ukrainian government, and this newly formed agency, can then move quickly to issue regulations that grease the wheels of an exchange offer.
The plan
First, the Ukrainian government will issue new, exchange bonds (hereinafter “Class A” bonds), with terms that provide for at least the $15 billion in savings demanded by the IMF (through maturity extension or principal/interest reduction). Second, the government will offer to give these Class A bonds to any bondholders willing to give up their full-value, presently held bonds (which we will refer to as “Class B” bonds).
This will not be a forced exchange, or an exchange that the bondholders will be compelled by majority to participate in, but rather an open offer from the Ukrainian government. The third, and final, step comes from the new appropriations agency, which will declare that only Class A bonds can be paid on time and in full while Class B bonds will only be paid at the agency’s discretion. Considering the ongoing war and the declining humanitarian and economic circumstances, the agency will have strong constitutional, and political, support for declaring that funds are better used away from the pockets of holdout private creditors (the Class B bondholders).
This proposal would require Franklin Templeton — as one of the most salient holders of Ukraine’s debt — to decide whether or not it would like to hold Class A or Class B bonds. In all likelihood, the firm would want to hold Class A bonds because Class B bonds will not be of much (if any) value, as long as the appropriations agency (again, established by “applicable fiscal law”) says so.
But what about this “pari passu” business that proved to be such a thorn in Argentina’s side?
Ukraine’s bonds have a pari passu clause as well, but the language used seems to give Ukraine significant wiggle room that Argentina lacked. Here, the pari passu clause reads: “[t]he payment obligations of the Issuer under the Notes shall rank at least pari passu with all other unsecured and unsubordinated obligations of the Issuer, present and future, save only for such obligations as may be preferred by mandatory provisions of applicable law.” Again, Ukraine’s friend “applicable law” enters to save the day. All it takes to render the pari passu clause moot is a stroke of the Ukrainian legislature’s pen, or a decision by the appropriations agency, that Class B bonds are not, in fact, pari passu.
The problems
Of course, many creditors will refuse to go quietly. While the fiscal law threat (we hope) will be enough to convince Franklin Templeton and other large institutional investors to wipe their hands of the situation through an exchange offer, smaller investors more open to risk (like those in NML Capital) must be addressed. The Class B holders will have a few tools of their own when entering litigation.
First is a recent English case, Assenagon v. Anglo Irish Bank. In that case, the judge strongly admonished an exchange offer that left holdouts with worthless bonds (Anglo Irish Bank had the right to exchange all unexchanged bonds for a payment ratio of 0.00001). But in Assenagon, Anglo Irish only gave new A bonds to B holders if the B holders voted to change the B terms to make them worthless. In our scenario, Ukraine need not ask for any such change: the clause that renders Class B bonds effectively valueless is already in the bond.
Another cause for concern might be the validity of “consent payments,” which have been given recent attention. The Class A bonds issued by Ukraine will have this fiscal “loophole” closed and may very well have other incentives attached (in the past, restructuring debtors have provided exchange bonds with GDP-linked payouts, so that if the debtor’s economy grows, the creditors benefit as well). The Class B holders left behind may very well argue these are effective consent payments that amount to coercion, classically banned by English common law.
But beyond the fact coercion is a very high legal standard to meet, helpfully for Ukraine, an English court recently spoke on this very matter. In Azevedo v. Imcopathe court held consent payments made only to those holders who voted in favor of an approved resolution are permissible, so long as the original offer (to vote in the affirmative) was available to everyone.
In our plan, all of Ukraine’s current bondholders are invited to participate in exchanging their Class B bonds for Class A. So long as Ukraine does not discriminate in its exchange offer, it will not run afoul of English law.
A final legal spanner disaffected bondholders may try to throw into the works is to claim expropriation. In the American context at least, to determine if expropriation has occurred, courts engage in a fact-intensive analysis that focuses on the coerciveness, underlying purpose and discriminatory nature of the action, as well as the amount of loss involved.
That the exchange would be subject to a vote, is in response to very dire financial situation in Ukraine, is not discriminatory and induces relatively small losses (compared to Greece and Argentina) — leads us to believe that Ukraine need not worry too much about such claims.
Ultimately, we believe threatening to pass the (pari passu-nullifying) “fiscal law” described above, coupled with the offer of closing the loopholes in the new Class A bonds, should convince Ukraine’s private bondholders to accept an exchange offer. The purpose of this proposal is not to create new law or impermissibly stretch existing legal doctrines; instead, it simply aims to loosen the bargaining stranglehold of bondholders. Further, changing local law is not easy and, given the potential consequences of scaring away future investors, it should not be taken lightly.
However, this proposal shows Ukraine could credibly (and lawfully) threaten to make holdout bonds essentially worthless — while offering its creditors terms that would close the loopholes that left them exposed here.
By Sriram Giridharan, Martin De Jong, Barret Jackson Nye, Brandon Rice, and Melinda Goralczyk — Juris Doctor candidates at Duke University School of Law
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