Ukraine's Defenses to Russian Bond Claims Rejected

The judge hearing Russia's lawsuit to enforce its $3 billion loan to Ukraine issued an opinion today, rejecting Ukraine's defenses to the lawsuit. Bloomberg and the Financial Times both have coverage of the decision. We've discussed the loan quite a bit here on Credit Slips, and also Ukraine's defenses to enforcement (e.g., here, and here, and here). The lawsuit is fascinating, in part because Ukraine's defenses ask the judge to use traditional contract law doctrines to police what is clearly an international dispute between sovereigns who have been engaged in armed conflict. As I have explained in more detail elsewhere, Ukraine's contract-law arguments were actually quite plausible, though by no means a sure thing. Among others, the defenses included duress (always a bit of a stretch, in my view), lack of capacity, and what would typically be called prevention and impracticability under U.S. law (characterized as implied terms of the contract by Ukraine).

In a lengthy opinion, the judge rejected these defenses. The problem with the duress defense, as I mentioned in an earlier post, is that it asked the court to "take sides in a dispute over whether Russia has acted wrongfully, say by breaching international law." The court refused to do that: "The threats of the use of force by Russia in 2013 ... fall within the foreign act of state doctrine. They concern threats, and ultimately aggression by a state and armed conflict between states.... These acts are non-justiciable, and ... cannot give rise to a defence of duress in English law."

One of the benefits of Ukraine's prevention and impracticability arguments is that they could be couched in slightly less politically-charged terms. And in fact, the court's reached the merits of the defenses, going so far as to concede that Ukraine could "powerfully contend that military action by Russia in Crimea and eastern Ukraine has the economic effect of severely impeding the state's ability to meet its obligations" under the loan. But, the court ruled, because the loan was structured as a tradable bond, rather than a direct loan, the defenses were unavailable. Potential transferees, the court explained, would have to base the decision to buy the bonds on the express terms of the contract, not on implied promises not present in the text itself. Fair enough, I suppose, though that seems a bit of a non-sequitur. The need to protect the transferability of the bonds is an argument for not allowing Ukraine to escape its obligations to (innocent) transferees. But here, there was no transfer. So it remains a bit of a puzzle why a bondholder who affirmatively destroys the issuer's capacity to repay can nevertheless insist on repayment.