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Ukraine's Loss: A Skid, Not a Crash

posted by Anna Gelpern

Mark posted a lucid analysis of Ukraine's loss to Russia in London yesterday (full 107-pp opinion here). The case will surely be appealed, and will drag on for a while, alongside the many other legal, political and military disputes between Russia and Ukraine. It will settle, if ever, as part of a grand-ish bargain between the two countries. For now, neither has any reason to fold, so I am not holding my breath for quick resolution.

While we wait, I wanted to think about what this ruling might mean for sovereign debt workouts, and for Ukraine's recently-restructured bonds.

First, consider the implications for a distressed sovereign who owes money to other governments (or monetary authorities) in the form of tradable market instruments. In the words of Mr. Justice Blair, while "it is not credible to describe [Russia's Ukrainian notes] as an 'ordinary debt claim'," the "troubling circumstances" of this debt under international law are not subject to review by an English court under English law. Meanwhile, "the fact that these were tradable instruments" precludes the court from reading into the contract an implied duty, say, for the creditor not to break into the debtor's house and steal his stuff.*

If ever a borrower had an argument that these market instruments are more in the nature of a political power play on top of a land grab, Ukraine would be it. Bondholder invasions are not exactly common these days and, it seems, may not be enough to let a sovereign borrower off the hook anyway. We must now assume that as far as the courts are concerned, bonds in the hands of a government stand on par with bonds in the hands of private creditors.  I am watching for subtle policy adaptation from the Paris Club and friends.

Second, the holders of Ukraine's restructured bonds might have some decisions to make--though not anytime soon, I think. Under the terms of these bonds, Ukraine promised not to settle with holdouts, no way, no how. Its "Most Favoured Creditor" (MFC) clause has no sunset and no wiggle room to carve out litigation settlement -- in contrast to Argentina's "Rights Upon Future Offers" (RUFO) clause of blessed memory. On the other hand, bondholders would seem to be able to waive the MFC clause with a vote of 50% of a quorate meeting, where the quorum is 50%, dropping to 33 1/3% at a postponed meeting. A single vote can bind multiple series of bonds issued under the same trust deed. So--I am neither holding my breath for a settlement, nor worrying about MFC quite yet.

Finally, I suspect that those hoping for another pari passu saga should not hold their breath either. On the one hand, Russia has shown itself perfectly capable of throwing everything and the kitchen sink at this dispute. Trying to block payments to restructured bondholders in London while demanding to be paid in full under a pari passu theory would be in line with the kitchen sink strategy. On the other hand, the pari passu clause in the defaulted $3 billion issue is a mix of Argentina ("payment obligations ... shall rank") and escape hatch, since it does not apply to "obligations ... preferred by mandatory provisions of applicable law." I believe that Ukraine might have passed just such a law preferring payments on its new bonds (at the behest of certain law students in North Carolina?), and if it did not, it could do it now to insulate itself from a pari passu attack. This strategy has not been tested in courts, which could find it too cute, but that too buys time. Finally, even if English courts were to agree with U.S. federal courts' reading of the contract language (pre-nevermind detour), it is hard to see Russia getting a ratable payment injunction. At equity if not at law, creditors must wash their hands before reaching for other creditors' money.

*An earlier version of this post excerpted the court's summary of the Trustee's argument. This version more fully reflects the court's misgivings about the circumstances of the borrowing, but also its emphasis on the tradable character of the debt limiting Ukraine's defenses.


Ukraine did pass a law subordinating non-restructured bondholders (ie, Russia).
Which may explain why Russia apparently did not pursue the pari passu remedy route.
The pari passu at stake is very clear, no misunderstanding possible: some creditors lose parity of treatment (or rank, whatever), from within.
As was eventually shown by some researchers (many years after this version of pari passu had been totally ignored by the literature and even top pros), this pari passu has been extremely prevalent all over the sovereign debt world. Thusly, the Ukrainian case would have been a perfect opportunity to test the legal ramifications of a widely extended clause.

As recently as 2005 or so, the top sovereign debt laywers in London apparently did not know that pari passus like the one adorning the Ukrainian bond held by Russia even existed (indeed, they basically said that it shouldn´t exist).
Which would have made this potential pari passu trial that much more interesting.
(by the way, while such version of pari passu has been prevalent under all kinds of jurisdictions, by far English Law has been the dominant one).

I'm following the Ukrainian situation with interest. I actually think the basis of a settlement would logically involve a financial deal, and the $3 billion could be part of the final settlement. However, I am hopelessly optimistic.

Cambodia just hit the radar screen again. https://www.nytimes.com/2017/04/02/world/asia/cambodia-trump-debt.html?_r=0

They don't want to pay back a 1969 loan. It's getting close to 50 years since they were given a loan to buy food, their farmers having fled US carpet bombing. Haven't people given up on pre Castro Cuba, which was less than a decade earlier? Is there any statute of limitations on these sorts of programs, like 'Food for Peace' which was the basis of the loans?

If Ukraine has an argument that Russia has raised issues of equity by annexing Crimea, for instance -- I would say Cambodia has stronger ones.

thanks for the interesting post.

What is your take on the implications for sovereign debt workouts more broadly. Since you doubt that the English court will issue an injunction, would the more traditional 'hunt for assets' provide Russia with sufficient leverage to make Ukraine pay, eventually?

Also, do you reckon that this developement undermines the effectiveness of CACs? If country, say China, buy bonds and hold the whole bond (or at least a blocking majority), they would enjoy the benefits of standing at par with private creditors while at the same time blocking any restructuring attempts.

Dear Par in Parem, Thanks for your comment. Sure, Russia retains all the leverage that a creditor would have under a defaulted sovereign debt instrument, including discovery and random attempts at grabbing assets, minus a pari passu injunction. However, I think it would be a mistake to focus too closely on this bond. What the court has done so far is kept the $3 billion claim fully alive as part of the grand bargaining process between the two countries. That is Russia's best leverage--blocking Ukrainian exports, energy supplies, tanks, seized property, etc. As an aside, Russia might be careful about overplaying its litigation discovery card because it might not like some of the information that comes to light as a result. Who knows.

On CACs - heck yes.

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