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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 an argument 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. 


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.

Mitu - it seems unlikely the defense would apply more broadly, although not impossible. If we're talking about a private investor holding non-GDP linked bonds, it's easier to see the conflict with Russia as just one of many background risks that might make it hard for Ukraine to repay. Generally, investors don't take the risk that such risks will materialize; those are presumptively assumed by the borrower. Plus, I doubt a court would want a rule that discourages investors from lending to countries that are at risk of this kind of conflict. Russia, though, explicitly structured its loan to go into default if GDP dropped below a certain threshold. Seems to me there are two ways to interpret that. First, both Russia and Ukraine assumed armed conflict would not break out. That's the impracticability scenario. Second, Russia was planning to instigate armed conflict if necessary to advance its interests in the reason. That sounds like fraudulent inducement. (As I said in the post, the Yanukovich government might have been in on that plan, but I'd hope a court wouldn't dignify that argument by using it to defeat a valid defense.)

I think there's a decent argument to be made as regards piercing the SWF veil. US courts generally look to see if the entity acted like the 'alter ego' of its owner and if there was some sort of fraud or injustice involved. As to the first aspect, I think the fact that the SWF invested in junk-rated bonds of a country in the midst of serious civil unrest and only earned a 5% interest rate is decent evidence that the SWF was operating not as a separate entity concerned solely with receiving the highest possible return, but instead was acting on orders from its owner, the Russian government. As for the second aspect, it appears that the SWF violated a number of Russian regulations in purchasing the bonds in the first place (as one of the recent FT Alphaville posts on the Ukraine bond saga points out). In past US cases at least, the court has been rather permissive as to what constitutes "fraud" for the purposes of veil-piercing; might an English court be so inclined as well?

Additionally, in English courts, justices have been willing to pierce the veil "where a company is used primarily as a vehicle of fraud or as a means of escaping pre-existing legal obligations.” Considering that Russia seems to have chosen a commercial bond offering in order to gain additional leverage and perhaps escape certain requirements that would normally accompany a normal bilateral loan, an English court might look upon Ukraine's attempt to pierce the veil more favorably.

Lastly, throughout the "Risk Factors" section of the prospectus for the $3 bln offering, there are numerous references to risks that "may have a material adverse effect" on Ukraine's economy and its ability to perform its obligations. At the same time, there is no MAC clause (other than the debt-GDP ratio clause that seems a little MAC-y) that would grant the lender (Russia) protection from such materially adverse effects. Given that, could the 'material adverse effect' language be viewed as Russia having "assumed the risk"? And if so, is there any way that Ukraine could exploit such an assumption of risk?

I have to agree with Mark that discovery into Russia's sensitive and embarrassing information is an extensive hurdle. Although I am not sure about UK's interpretation and use of the Hague Evidence Convention (HEC), under US law this convention is not the exclusive method through which to get discovery - FRCP could still be used. However, strategically, the HEC is often the most useful because it bypasses sovereignty concerns (if both countries are signatories), it does provide a basis to collect evidence from a 3rd party, and it allows for easier enforcement of that countries discovery rules were applied.

With that said, the HEC cannot be compelled and I can't see the HEC being much help here even if we assume Russia's accession to the Convention. (While I am not an HEC expert) it is mainly because:

1) Art. 9 provides that the Convening Authority will collect the evidence under the laws of the receiving country. I can't imagine Russia's discovery laws being as relaxed as the US, particularly for the type of sensitive information being requested.

2) The HEC procedural rules themselves (Art. 3) requires more specificity in requests, requiring the requesting party to know what it is they are looking for.

3) Art. 23 allows for reservations of obtaining pre-trial discovery of documents.

4) Art. 11 provides that the person concerned by refuse to give evidence in so far as he has a privilege or duty to refuse to give the evidence, i.e. under the law of the State of execution.

and finally 5) Art. 12 provides the major safeguard provision: a request may be reused to the extent that the State addressed considers that its sovereignty or security would be prejudiced thereby.

Overall, the HEC can be convenient in many contexts, but I believe it lacks power when the party is attempting to obtain sensitive and highly political information from Russia. Therefore, UK discovery procedures would have to apply.

B. Rice - this is a good point about veil piercing, and I'm inclined to agree that Ukraine's argument there is fairly strong (though that's a different question from whether the argument lets' Ukraine get the kind of discovery discussed in the post).

Melinda - Art. 12 is definitely a winner for Russia on the discovery issue.

Hi Mark,

Great post. I was wondering if I could ask you about the MAC/MAE clause, given all the headaches they have caused since the financial crisis.

Under English Law, the primary case seems to be Grupo Hotelero Urvasco SA v. Carey Value Added SL. In analyzing the MAC clause, the English High
Court used a four element test:

1. Financial Conditions:

In Grupo, the court stated that the MAC clause referred only to the "consolidated financial condition" of the borrower, which meant that the financial conditions was to be measured by reference to the borrower's financial statements.

Here, I think we lose. The court focused its opinion on how carefully the parties had crafted the MAC clause, while we are asking a court to enforce an implicit MAC clause.

2. Significant Effect:

The Groupo Court held that an adverse change will only be material if it significantly affects the debtor's ability to service its loans.

It seems like a pretty easy victory, unless I'm missing something. Russia has taken over a geographical area that produces a substantial amount of revenue for the state.

3. Unknown Events:

Grupo stated that a party could not use a MAC clause as a defense if it was aware, at the time of the agreement, that the event were likely to take place in the future.

I would consider this another victory. While Ukraine might describe its relationship with Russia as "tense" the invasion of Crimea could hardly be considered forseeable.

4. Duration of Impact

Finally, Grupo stated that a mere temporary change was insufficient to be considered a MAC.

Here again, I think we win. I don't think Russia has any plans on giving up Crimea.

Additionally, before Grupo, the most prominent decision surrounding the MAC/MAE clause was a decision involving an advertising agency that tried to argue a MAE had taken place following the events of 9/11. While the court refused to consider this as a MAE, we can distinguish our case at hand, given that the event had a direct and concentrated effect on our client.

In conclusion: I think we have a pretty strong argument for a MAC/MAE, if we can get a court to interpret the prospectus as such.

The only problem is there is very little case law on the matter, both in the context of sovereign debt as well as in the context of an "implicit" MAC. I was wondering if you or Mitu could provide any guidance. I know courts are generally hesitant to enforce MAC/MAEs, since they do not want parties to back out of contractual obligations, but I feel as though a creditor seizing a vital revenue stream might fit the bill.

Couldn't the Russain side, be it SWF or whomever holds the debt at that point, use the same disclosure laws -if Ukraine decides to go that route- to ween information about how the maidan coup was set up and the parties involved? This would also bar impracticability as it could show quiet well that the government in Kiev (the one now) actually intented for the coup to happen. Without getting into the whole "Anti Terrorist Operation" in Donbas (more like ethnic cleansing). Wouldn't the Russian side then be able to extend those disclosure requests to details of the "ATO" and show that the Adverse Event actually was started by the party claiming impracticability (launching the ATO themselves) and that therefore it would be reasonable to assume that the event itself was not unforeseen, but was actually put in place by them? Same applies to the Maidan events. Wihtout getting into the whole US implications and the aid and instigation provided through DoS and several NGOs.

For discovery to work for Ukraine in a US court, the court would have to be willing to enforce discovery sanctions against Russia: striking pleadings, entering summary judgment, limiting evidence, limiting claims. I don't see it happening.

Yan: Yes - ugly all around, no question about it. Possibly, the argument could be less about who started the conflict and more about the assumptions made, at the time of the loan, about the potential escalation of conflict. The GDP linked loan suggests the parties were willing to bet against significant escalation, much less the loss of a significant amount of Ukraine's territorial integrity.

Great post, Mark, and vitally important information when assessing whether the threat of litigation is a real bargaining chip for Ukraine in its discussions with Russia.

Interestingly, a recent case in English Law on piercing the corporate veil concerned a loan from an English financial institution to a Russian company. See VTB Capital PLC -v- Nutritek International Corp. & Others [2012] EWCA Civ 808. Usefully (or perhaps not, as we will see), the Agreement stipulated that the loan was covered by English law. Nutritek/RAP (the Russian company borrower) defaulted on the loan and, in pursuing repayment in an English court, VTB sought to pierce the corporate veil in order to secure repayment from the real "beneficial owners" of Nutritek/RAP.

The English court obliged in piercing the corporate veil, finding that Nutritek/RAP was indeed such a sham, particularly with regards to the loan at issue, as to justify dropping limited liability. However, the English court held that simply because the veil was pierced, Nutritek/RAP's beneficial owners (those now subject to repayment) were not actually in contractual privity with VTB. Thus, in its pursuit of repayment, VTB could not turn to English Law because Nutritek/RAP's beneficial owners had never subjected themselves to English Law via the Loan Agreement. VTB was condemned to head to Russian court with its English judgment in hand...not sure how that turned out.

Extrapolating this to our case at hand, while it may be possible to pierce the sovereign wealth fund's veil, the VTB decision seems to make it clear that the terms of the Note will not be imputed to Russia if the veil is indeed pierced. I take this to mean that English Law (discovery and otherwise) will be moot in then dealing with Russia. However, this may prove to be a nice advantage; if the veil is pierced, and the terms of the Note (currency of repayment, negative pledge, pari passu, etc) are thrown out, Ukraine may have greater flexibility in dealing with Russia.

This thought needs a lot of evolution, and even more criticism (Mark and readers please poke all the holes that you can), but may be something to work with.

Hi Mark,

Great Post. I'm still not sold on the idea that if Russia tries to enforce the debt in English courts, Ukraine can use English procedural rules to demand sensitive information from Russia. Technically, Ukraine can and should try to demand discovery into Russia's sensitive and embarrassing information, but as you conceded, this will be difficult and a major hurdle.

The issue of Russia being a third party, because it would likely be the Sovereign Wealth Fund that would try to enforce the debt in English courts and not Russia, is one big issue procedurally. Even if Ukraine is able to make a strong veil-piercing argument, Russia is likely to rebut this argument and frankly, as you said, will be unwilling to respond to a foreign court's request for information about Crimea. If these were private parties, the court could essentially "force" the parties to comply with discovery requests, but how would an English court force Russia, a sovereign nation, to provide sensitive information that would be used against them in court? Russia can just explicitly refuse to comply with an English court's request for information about Crimea, and there are many legitimate defenses it can raise. Russia can argue that it will not provide information about Crimea for national security concerns, or it can say that providing this information will cause a huge burden to find relevant information, or it can simply deny the existence of this information. Basically, Russia can raise many defenses to support its refusal and they could be viewed as perfectly legitimate. Additionally, as you pointed out Mark, 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.

I also think that we are placing too much weight on the discovery of information that we think is sensitive and embarrassing to Russia. It's no secret that Russia was involved and planned the annexation of Crimea. On the anniversary of Russia's annexation of Crimea from Ukraine, Russian President Vladimir Putin even acknowledged that given Russia's annexation, there has been harm caused by Western sanctions. There is also news that speaks to Putin's popular image in Russia due to the annexation of Crimea, which many view to be a huge success that he accomplished. In Professors Gulati and Blocher's article, they also raise a point that even if we could show that Russia planned the annexation of Crimea, Russia could argue that Crimea was mostly a pro-Russian territory and there is no violation in a state wanting secession (in this case, no violation in Crimea wanting to be a part of Russia rather than Ukraine).

We continue to believe Ukraine attempting to use English procedural rules to demand sensitive information from Russia is not a strong or reliable strategy. Ukraine should instead look for more viable defenses to an action to enforce the debt and without relying on information from Russia to assert them.

-Nirmal and Liz

To those looking to use the doctrine of impracticability,

I want to address the use of impracticability. Specifically focusing on "Surely it is a basic assumption of a GDP-linked loan from Russia that Russia will not thereafter start a GDP-destroying war?" While I have recently been a proponent in finding a doctrine of contract law that Ukraine could use as a defense for payment I have now reached an impasse.

My concern is the following:

If a "GDP-linked loan by Russia" includes a basic assumption that Russia will not "thereafter start a GDP-destroying war," what prohibits the application of this principle beyond just war? While the impracticability doctrine is not limited to actions taken by the parties in contractual privity, even assuming that the proposed application of the doctrine requires such privity, I still have a major concern in using the doctrine.

If a court were to agree that this was a basic assumption (no war by Russia), and then use the impracticability defense to allow Ukraine to not honor their obligations, what would stop a court from using the same logic to a country that lends to a specific country and then imposes trade restrictions on that country? Or, if the country significantly altered business relations with that country?

Russia is Ukraine's largest exporter (and importer), would a basic assumption to a GDP-linked loan to Russia be that Russia would not take steps to materially alter these trade relations? If Russia altered their trade relations, this would surely impact Ukraine's ability to pay back their loan. I am not aware of a scienter requirement for the use of the impracticability defense (but let's assume that Russia knew before the loan that they were going to stop all trade relations with Ukraine) I don not see how the doctrine would not apply based on your proposed usage.

Impracticability is a result orientated doctrine (Prong (4) specifically requires that "the negatively-affected party didn't assume the risk of the event"), therefore it would be a logical interpretation of the proposed application ("Russia you started a war in Ukraine which destroyed their GDP") to say "Russia you significantly decreased your trade relations with Ukraine which destroyed their GDP."

While I am not trying to analogize war with trade, it is merely to state that the results could potentially have the same outcome on GDP. The negatively-affected language requires a result that "negatively-affects" a party. If a court were to accept the war argument, I find it difficult to reconcile why the trade argument would not also be consistent.

While I think the Ukraine situation is unique in Russia annexing a significant GDP producing portion of the country, Russia had the capability to secure the same GDP results by alternative means. If Russia took these steps, could Ukraine propose the same contractual defense?


BJN: In ordinary circumstances, I'd be inclined to agree that the defense presents the kind of slippery slope that concerns you. Not here, though, for two reasons. First, the GDP provision is absolutely integral to this loan (and so unusual in what is otherwise a relatively boilerplate document). Second, if Russia wanted to avoid these kinds of defenses - not uncommon in commercial loans - it had a simple mechanism available to it: ordinary bilateral credit. It decided to structure this as a commercial loan, seeking to benefit *both* from its official status and from ordinary contract protections and enforcement mechanisms. But it should take the good with the bad, and the bad includes ordinary contract defenses. And of course, ordinary commercial creditors can't typically wreck a borrower's GDP.

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