Ukraine is telling investors it must trim external debt by $15.3 billion. Its bonds have CACs but no aggregation, and a 50% vote is needed to bind holdouts. (Modification requires a quorum of at least 2/3 in aggregate principal amount; 75% of "persons voting" must approve the modification.) Faced with some determined investors, it will have to make holding out unattractive in order to gain approval on favorable terms, and this means dusting off its bonds to see what clauses work to its advantage.

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Ukraine's Russian Problem, Part 2

posted by Mark Weidemaier

Ukraine is telling investors it must trim external debt by $15.3 billion. Its bonds have CACs but no aggregation, and a 50% vote is needed to bind holdouts. (Modification requires a quorum of at least 2/3 in aggregate principal amount; 75% of "persons voting" must approve the modification.) Faced with some determined investors, it will have to make holding out unattractive in order to gain approval on favorable terms, and this means dusting off its bonds to see what clauses work to its advantage.

It needs to be even more creative to deal with Russia, which (has an army and) controls 100% of its $3 billion bond issue. Assuming Ukraine is willing to play hardball, I discussed in an earlier post how it might have plausible defenses to enforcement of the debt. The doctrine of prevention--even impracticability (not normally available to debtors, but these are not normal circumstances)--comes to mind. That post elaborated on anargument made in an article by Mitu Gulati and Joseph Blocher. Mitu and Joseph make a second argument, which I want to address in some detail here. In a nutshell, the argument is that, if Russia tries to enforce the debt in English courts, Ukraine can use English procedural rules to demand sensitive information from Russia. As Joseph Cotterill elaborates over at FT Alphaville: "Ukraine could then bring Crimea, plus an examination of the inner workings of both the Putin regime and its relations with the Yanukovich government, into a legal defence..." The resulting embarrassment would be costly for Russia, and this cost, if material, would give an additional incentive for Russia to compromise. But I'm skeptical of the proposal.

I'm primarily familiar with US procedure; lawyers familiar with English civil procedure, please jump in here. (For example, unless English courts will respond by imposing litigation-related sanctions, potentially including the entry of judgment in Ukraine's favor, then Russia can withhold information with impunity.) But it seems to me that this strategy faces any number of serious barriers:

1. To have any legitimate claim to information, Ukraine must show that the information is relevant to a claim or defense against an opposing litigant.
2. Russia will not be an opposing litigant. The bonds are reportedly all owned by the Russian sovereign wealth fund (SWF). (In a lawsuit to collect on the bonds, the plaintiff would technically be the trustee, but let's ignore that detail.)
3. Ukraine might try to "pierce the veil" between the SWF and Russia--basically, show that the SWF is simply Russia's proxy--but the information relevant to this argument relates to Russia's control over the SWF, not Russia's involvement in Crimea. Anyway, why would the SWF have access to information about Russia's involvement in Crimea? That information would have to come from the Russian government.
4. Even if Ukraine convinces the court that it is entitled to information about truly sensitive matters, like Crimea, it must find a way to use English disclosure rules (akin to "discovery" as the term is used by US lawyers) to get it.
5. English rules allow for disclosure orders against third-parties (e.g., 31.17), but not to the same degree as US discovery rules.
6. Even if an English court thinks this information is relevant, it can't just order Russia to provide it. Courts can't compel information from third parties in other countries (much less from other non-litigant countries). Instead, they must request assistance from authorities in the other country--for example, through the mechanism specified in the Hague Evidence Convention.
7. Russia is known for many things. Enthusiastically responding to foreign requests for judicial assistance is not one of them. The US doesn't even recognize Russia's accession to the Hague Evidence Convention, although apparently the UK does. 
8. Take Russia's general unwillingness to help foreign tribunals get information from Russian citizens. Multiply by ∞. That's how unwilling Russia will be to respond to a foreign court's request for information about Crimea. 
9. Although Russia will in no event respond to an English court's request for information about Crimea, it can defend the refusal as legitimate. The Hague Evidence Convention, for example, contemplates that requests for judicial assistance will be executed under the internal law of the executing country. Russian law won't allow the discovery, and that's that. (See Articles 9-12.) 
10. Even if Russia's refusal to provide information is viewed as wrongful, the English court won't necessarily respond by imposing serious litigation-related penalties against the SWF.
11. This all gets even more far-fetched if the SWF sells the bonds to another entity.

In a lawsuit involving the SWF, I can imagine an English judge allowing Ukraine to seek information regarding Russia's control over that entity. The information would be directly relevant to veil-piercing and is available from the SWF itself. Turning over the information might prove embarrassing but will hardly expose Russian plans for Crimea. And even if the SWF refuses to turn the information over, there is no guarantee the court will seriously penalize it for doing so. Things get a bit easier for Ukraine if the court decides to pierce the veil between SWF and Russia, but even that doesn't get you all the way to discovery into Crimea. So if Russia is scared of this discovery threat, I'm not sure why.

I continue to believe Ukraine has viable defenses to an action to enforce the debt and that it doesn't need information from Russia to assert them. Return to impracticability. The defense applies when, among other things, (1) an adverse event occurs, (2) the event makes it commercially unreasonable for a party to perform the contract, (3) it was a basic assumption of the contract that the adverse event would not occur, and (4) the negatively-affected party didn't assume the risk of the event. Normally, borrowers can't assert impracticability, because they are presumed to assume the risk that subsequent events will adversely affect their ability to repay. But that's just a presumption. Surely it is a basic assumption of a GDP-linked loan from Russia that Russia will not thereafter start a GDP-destroying war? (The loan provides that Ukraine is in default if its debt-to-GDP ratio exceeds 60%.) I mean, cynically, sure, Russia and the Yanukovich regime might have envisioned armed conflict if Yanukovich got ousted. But that's not an argument the SWF wants to make. And unlike prevention and similar defenses, impracticability at least arguably could be asserted against third-party holders of the debt even without a showing that they were acting as Russian proxies. Certainly any third-party holders would have knowledge of this potential defense if they bought now.

In any event, it seems to me that Ukraine has viable arguments on the merits, whether under impracticability or another doctrine. But I'm still not convinced that English disclosure rules provide significant extra leverage. 

March 30, 2015 at 11:34 AM in Sovereign Debt

 

Comments

Wow. This is an extremely clever way to use the impracticability doctrine turn the Debt/GDP clause in the Dec 2013 Ukrainian bond (that most of us thought gave Russia an advantage) to the advantage of the Ukrainians. Is there a way for Ukraine to also use this impracticability argument against other creditors? Or is it going to be limited to Russia and the $3bn bond which has that Debt/GDP ratio provision.

Posted by: Mitu Gulati | March 30, 2015 at 12:54 PM