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Article: September 2018: The Law Debenture Trust Corporation p.l.c. v. Ukraine

Business Litigation Reports

Quinn Emanuel Achieves Major Legal Victory for Ukraine in the English Court of Appeal Against the Russian Federation in Politically-Charged US $3 Billion Eurobonds Dispute

Background: Politics Sets the Scene
It is well known that the Russian Federation considers Ukraine as being within its “sphere of interest,” despite Ukraine’s independence since 1991. Although both nations were expected to maintain close ties after the collapse of the Soviet Union, in fact, there were growing tensions between the countries in the 1990s and early 2000s over trade, gas disputes, the use of Ukraine’s Sevastopol port (where the Russian Black Sea fleet came to be stationed) and its increased cooperation with NATO. In 2010, after Mr. Viktor Yanukovych took over as Ukraine’s President, Russia pushed to increase her influence over Ukraine.

In 2009, the EU launched an Eastern Partnership aimed at forging closer ties with former Soviet countries. Following years of negotiations, in 2012, the European Union (“EU”) and Ukraine initiated the process for concluding an Association Agreement. The process was to conclude with the signing of the agreement at a summit in Vilnius, Lithuania, on November 28-29, 2013. But throughout 2013, Russia launched a campaign of intense economic and political threats and aggression against Ukraine, going as far as to threaten Ukraine’s territorial integrity. At the eleventh hour, President Yanukovych capitulated to Russian threats and abandoned the proposed agreement with the EU, turning back towards Russia instead. The Presidents of Russia and Ukraine agreed that, in exchange for Ukraine not signing the Association Agreement, Russia would take steps to remove the restrictions on trade with Ukraine that it had imposed during 2013, lend Ukraine up to $15 sell natural gas to Naftogaz, Ukraine’s national gas company, at a discount.

On December 24, 2013, Ukraine purportedly issued US $3 billion Eurobonds, at 5% interest payable bi-annually, which was taken up as to 100% by Russia (the “Russian Bonds”). The Russian Bonds, although dressed up as a standard capital markets issuance, in reality represented a bilateral loan made by Russia to Ukraine and constituted the first tranche of the promised lending of US $15 billion under the Presidents’ deal.

President Yanukovych’s decision proved to be a watershed moment in Ukrainian history. Public protests had already begun in late November 2013 at Independence Square in Kyiv, when President Yanukovych’s decision not to proceed with the EU agreement was first announced. As the days passed, the protests – which became known as the ‘Revolution of Dignity’ – spread across Ukraine. By early 2014, the protests had turned violent, with Ukraine’s security services using force against civilian demonstrators. This came to a terrible head when, in mid-February 2014, scores of civilians were shot dead on the streets of Kyiv, killed by what are widely believed to have been Russian commandos in disguise and operating among the Ukrainian security services. An agreement to try to settle the political crisis was signed by the Ukrainian President and prominent opposition figures on February 21, 2014, but as the protests continued, President Yanukovych abandoned his post and was exfiltrated to Russia by Russian special forces.

With Yanukovych gone, and a more pro-EU (and anti-Russia) administration certain to follow in Kyiv, Russia reversed its position towards Ukraine and effectively cancelled the agreement reached in November 2013. It cancelled its future commitment to lend up to a further US $12 billion to Ukraine, procured Gazprom to cease to continue its discounted pricing of natural gas, and took other steps to punish Ukraine economically. Even more seriously, Russia launched a full scale military operation against Ukraine, illegally invading and purportedly annexing Crimea, and fueling and supporting separatist elements in eastern Ukraine, the country’s industrial heartland. These actions ignited a civil war in eastern Ukraine that to date has resulted in the killing of more than 10,000 Ukrainian people and displaced millions more. The civil war continues despite a peace deal brokered by Western economies.

Economically, Ukraine was brought to its knees. Trade with Russia – which was Ukraine’s largest trading partner – dwindled almost to nothing. The currency went into freefall and the economy collapsed. Ukraine had to seek tens of billions of dollars of emergency assistance from the International Monetary Fund to survive the crisis.

The Fate of the Russian Bonds
December 21, 2015 marked the purported maturity date of the Russian Bonds. However, on 18 December 2015, Ukraine’s parliament passed a law imposing a moratorium on repayment and the Russian Bonds went into “default.” The Government of Ukraine engaged Quinn Emanuel to marshal its defense of Russia’s inevitable legal claim.

Russia’s “Simple” Debt Claim
On February 16, 2016, the Russian Ministry of Finance directed the Trustee of the Russian Bonds, the Law Debenture Trust (“Law Debenture”), to initiate enforcement proceedings against Ukraine. A day later, Law Debenture commenced proceedings against Ukraine in the High Court of England & Wales seeking US $3.075 billion as principal and interest for the second half of 2015, together with legal costs. The bonds contracts were governed by English law and subject to English court jurisdiction.

Law Debenture characterized Russia’s claim as a “simple debt claim,” reflecting the clear terms of the bonds documentation that (as is customary in such capital markets instruments) prohibited any counterclaims, set-offs or other defenses to repayment. Law Debenture maintained that the factual backdrop to the Russian Bonds was irrelevant to the legal position, and it filed an application for judgment to be entered against Ukraine in the full amount on a summary basis, without the necessity of a public trial.

Ukraine’s Defenses
The Quinn Emanuel team, ably assisted by leading English barristers Bankim Thanki QC, Ben Jaffey QC and Simon Atrill, advanced four principal defenses for Ukraine, emphasizing that Russia’s claim formed part of a broader strategy of illegitimate economic, political, and military aggression by Russia against Ukraine and its people.

Defense 1 – Lack of Capacity / Authority

First, Ukraine argued it lacked capacity, alternatively authority, to enter into the contracts for the Russian Bonds, thus rendering those contracts void. This defense relied on matters of Ukrainian law, which Ukraine argued should be taken into account when determining the issues under English conflict of laws rules.

Specifically, Ukraine argued that the Russian Bonds breached the borrowing limits in its Budget Law of 2013 and that, as a consequence, the Cabinet of Ministers of Ukraine (“CMU”) lacked capacity to approve the borrowing, in addition to which Ukraine’s Minister of Finance had no authority to enter into the contracts. Moreover, the process for approval of the borrowing by the CMU failed to satisfy various formal requirements under the applicable Ukrainian rules, rendering it ineffective as a matter of Ukrainian law. Law Debenture argued in response that Ukraine, as a nation-State, had unlimited capacity to contract, that the Minister of Finance had authority by virtue of his position (as well as on other grounds) and in any event that Ukraine had ratified and affirmed the Russian Bonds through its subsequent acts – which included paying interest throughout 2014 and again in June 2015.

Defense 2 - Duress

Secondly, Ukraine contended that its entry into the contracts for the Russian Bonds was procured by duress. Under English law, duress renders a contract voidable and Ukraine asserted that it had avoided the contract. Ukraine’s position was that its purported consent to the debt was vitiated by the unlawful and illegitimate threats and pressure exerted by Russia during 2013 which resulted in Ukraine having no alternative other than to accept Russia’s money. Ukraine further argued that it was the subject of Russia’s continuing duress in the period after the Russian Bonds were purportedly issued.

Law Debenture, on the other hand, argued that the English Court was precluded by the doctrine of Foreign Act of State (non-justiciability) from adjudicating on Ukraine’s duress defense as, in order to do so, the court would be required to consider and make rulings on the legality or otherwise under international law of the acts of one foreign sovereign state (Russia) towards another (Ukraine) on the international plane. Having regard to the decision of the UK Supreme Court in Belhaj v. Straw ([2017] UKSC 3), Law Debenture argued that Ukraine’s defense lacked a “domestic foothold” as it was not based on English law rights and duties, but matters between States under international law.

Ukraine, in return, advanced reasons as to why, under applicable principles, its duress defense ought to be held justiciable. Additionally, Ukraine argued that, even if held non-justiciable as Law Debenture claimed, the consequence of such a ruling should be a “stay” (i.e. suspension) of the proceedings, and not the entry of a summary judgment against Ukraine. Otherwise, Ukraine would be denied its right to a fair trial and suffer an adverse judgment without being allowed to plead a defense.

Defense 3 – Implied Terms

Ukraine also argued that, under English law principles, terms fell to be implied into the contracts for the Russian Bonds to the effect that Russia would not deliberately interfere with or hinder Ukraine’s ability to repay, or demand repayment if in breach of its obligations towards Ukraine under public international law. Ukraine said that Russia was clearly in breach of such terms by virtue of its aggressive acts towards Ukraine. Law Debenture advanced various arguments against the implication of such terms, including that the contracts for the Bonds are tradeable instruments which could be purchased by third parties and which must therefore be certain on the face of the documents as to their terms.

Defense 4 - Countermeasures

Fourthly, Ukraine argued that its non-payment was a valid countermeasure under public international law in response to Russia’s own violations of its international law obligations towards Ukraine, which English law ought to recognize. Countermeasures are unilateral reprisals by a State as justified responses against unlawful acts committed against it by the other State that is the target of the countermeasure. In response, Law Debenture argued that English law does not and ought not to recognize any such a defense.

“Other Compelling Reasons”

In addition to these defenses, Ukraine contested Law Debenture’s entitlement to summary judgment, citing that Law Debenture’s claim was in reality another tool of Russian oppression against Ukraine and that, in light of the underlying circumstances, there were “other compelling reasons” why the matter should be subject to a full public trial and Russia denied the benefit of the summary judgment in the face of its egregious conduct.

The High Court Sides With Russia
Mr. Justice Blair, sitting in the specialist Financial List division of the High Court of Justice, delivered his decision on Russia’s summary judgment application in March 2017. Whilst the judgment recognized the “deeply troubling circumstances” surrounding the Russian Bonds, the Court held in short that it was constrained by the applicable principles of English law to hold that none of Ukraine’s defenses stood a realistic prospect of success at trial.

On the particular defenses raised by Ukraine, the Court held that:

i. The capacity of a sovereign nation-State is unlimited as a matter of English law – a point not previously considered in any English court judgment – and the Ukrainian Minister of Finance had authority to transact the Russian Bonds;

ii. Although Ukraine has “a strong case” on duress, English law prohibits the Court from adjudicating on allegations which concern the acts of one sovereign state towards another on the international plane; and the consequence of such a finding of “non-justiciability” is that Law Debenture should be entitled to judgment (and Ukraine should be refused its request for a stay of the claim);

iii. The terms contended for by Ukraine do not fall to be implied into the contracts for the Russian Bonds as those terms contradict express terms of the contracts and would render the agreements unworkable;

iv. The defense of countermeasures failed for the same reason as the failure of the duress defense, namely that it would require the English Court to adjudicate on matters between foreign sovereign states which are non-justiciable; and

v. There were no “other compelling reasons” to justify permitting the case to proceed to a full trial.

In Ukraine’s favor, the Court also held that Law Debenture’s argument that Ukraine had ratified and affirmed the bonds contracts by its subsequent acts was not suitable for summary determination, as it required a detailed examination of the evidence which could only properly be undertaken at a full trial. However, in light of the Court’s primary findings, this had no impact on the Court’s decision to enter summary judgment against Ukraine.

But High Court Also Grants Permission to Appeal and Stay of Execution of the Judgment
Despite that adverse decision, because of the novelty and complexity of the legal and factual issues at play, as well as the importance of the case, the Court granted Ukraine’s request for general and unconditional permission to appeal the Judgment to the Court of Appeal. The Court also imposed a stay of execution of the summary judgment pending the outcome of that appeal.

The case therefore took a step up to the Court of Appeal.

The Court of Appeal Vindicates Ukraine’s Position
Ukraine’s appeal was heard by the Court of Appeal at the end of January 2018 before a senior panel of appeal justices (Lady Justice Gloster, Lord Justice Sales and Lord Justice Richards). On September 14, 2018, the Court delivered a landmark judgment breaking new legal ground and vindicating Ukraine’s position.

The Court reversed the High Court’s decision on Ukraine’s duress defense, finding that there is a clear “domestic foothold” for the English Court to adjudicate the defense. The Court of Appeal ruled that English courts are “well capable of construing treaty obligations…and assessing their application,” particularly so given the choice of English court jurisdiction in the Russian Bonds contracts, the clear condemnation of Russia’s acts by the UK government (as well as the EU) and significantly, Russia’s refusal to take up Ukraine’s offer of having the dispute determined before the International Court of Justice. The Court of Appeal judges said “It would be unjust to permit...Russia to proceed to seek to make good the contract claim without Ukraine being able to defend itself by raising its defense of duress at trial,” and that it was desirable for the case to go to trial “to allow the whole pattern of alleged threatening behavior by Russia to be assessed in its full context.” Thus, the Court concluded that a full trial of Ukraine’s duress defense was required.

Additionally, the Court held that, even had it agreed with the judge below that the duress defense was non-justiciable, it would as a consequence have ordered a permanent stay of the proceedings since it would be contrary to the requirement of natural justice and fairness for Ukraine to be denied the opportunity to defend itself before the Court and yet face an adverse judgment.

Although the Court of Appeal upheld the High Court on the remaining grounds of Ukraine’s appeal, the reversal of the High Court on the duress defense was sufficient to overturn the summary judgment and require the case on that defense to be sent to a full public trial. Unusually, as such matters are almost always left for the Supreme Court to determine, the Court of Appeal also granted both parties permission to appeal to the Supreme Court. This again reflects both the importance of the case and the novelty and complexity of the issues.

The decision of the Court of Appeal sets down new law on a case without precedent in the English courts. It posits the principles that the English court will apply when dealing with sovereign-sovereign disputes that have a commercial context and are subject to English law and court jurisdiction by the parties’ agreement. Amongst other new points of law, it clarifies the application of the Supreme Court’s ruling in the Belhaj case and makes clear that, if an otherwise viable defense is non-justiciable, a permanent stay of proceedings will be warranted to ensure that the defendant is not condemned unheard.

It can be expected that the case will now move to the Supreme Court for the next round in this fierce dispute which will likely run through 2019. The Supreme Court will have the opportunity further to develop the common law in the novel areas touched by this case, and in the process reinforce the distinction of English law and the pre-eminence of the English courts in adjudicating complex and sensitive disputes of an internationalist nature. In the meantime, this decision represents a huge victory for Ukraine in this bitter fight in which it seeks to cast a public spotlight on Russia’s acts of aggression and to have those adjudicated on by a transparent and impartial tribunal, something which Russia has strained every muscle to resist.