The English Court of Appeal has ruled1 in favor of Ukraine in its US$3 billion dispute over sovereign bonds issued to Russia. This ruling overturned an earlier first instance judgment against Ukraine. If not appealed, the Court of Appeal ruling will result in the dispute moving to a full trial.

Some key findings for investors in sovereign bonds governed by English law are:

  • In certain circumstances, a sovereign may have a defense of duress where it enters into a contract with another state at a time when that state is exerting pressure upon it.
  • The capacity of a foreign state recognized by the United Kingdom to issue bonds is not restricted by breaches of domestic law of the type described below.
  • If a government or minister has breached the provisions of its own domestic laws by causing the sovereign to issue bonds, it may have lacked the authority to bind the sovereign. However, the sovereign can only avoid payment where a bondholder has actual or constructive knowledge of the breach.
  • It is more difficult to imply terms into transferable debt instruments such as bonds than in the case of other types of agreement, even in circumstances where the bond was issued to and held by a single investor.
  • There is no general rule that requires the implication of a duty not to impede the performance of another party.

Factual Background

The case concerned English-law-governed bonds issued by Ukraine in December 2013. The Russian Federation was the sole subscriber for the bonds, although, pursuant to the transaction documents, a trustee was appointed to represent the interests of all bondholders. The bonds were scheduled to be redeemed in full in December 2015, but Ukraine refused to make payment. Russia directed the trustee to take enforcement proceedings.

In defense of its refusal to pay, Ukraine argued, among other things:

(i) Duress: Ukraine issued the bonds only as a result of “massive, unlawful, and illegitimate economic and political pressure” from Russia against Ukraine in 2013 to deter the sitting administration from signing an association agreement with the European Union; that pressure, applied by the investor to the issuer prior to the issue of the bonds, provided a defense of duress under English law and so the bonds were void.

(ii) Capacity: In approving the issuance of the bonds, Ukraine’s Minister of Finance and Cabinet of Ministers failed to comply with essential requirements of Ukrainian law; accordingly, the bonds were void as Ukraine did not have the legal capacity to issue them.

(iii) Authority: Alternatively, the Minister of Finance and Cabinet of Ministers lacked the authority as agents of the state to approve the issuance of the bonds.

(iv) Implied Terms: Russia had, by its invasion of Crimea after the bonds had been issued, breached an implied term that the holder would not prevent or hinder performance by Ukraine of its obligations under the bonds.

At first instance, the English High Court awarded summary judgment against Ukraine on each of the above arguments.

The Court of Appeal Ruling

Duress

The Court of Appeal overturned the High Court, determining that Ukraine’s defense of duress should proceed to trial. The High Court had found that the facts underlying Ukraine’s duress argument were not justiciable by the English courts as they related to “transactions on an international plane.” The Court of Appeal, to the contrary, ruled that the English courts remained able to rule on such “transactions” in circumstances where both of the relevant states were (either directly or through the trustee) party to the proceedings and had provided expressly for any disputes between them with regard to the bonds to be determined by the English courts. Capacity and Authority

The parties agreed, for the purpose of the summary judgment application, that the correct procedures under Ukrainian law to allow the bonds to be validly issued had not been followed, in particular because issuance of the bonds took Ukraine above the external borrowing limit imposed by Ukrainian law.

The Court of Appeal confirmed, however, that the question of Ukraine’s capacity to issue the bonds was a matter for English law as the governing law of the bonds. It concluded that a sovereign state, once recognized as such by the UK government, enjoys unlimited capacity under English law.

Therefore, Ukraine could not lack capacity to issue the bonds, regardless of any argued breach of its own domestic laws.

The parties accepted, for the purposes of summary judgment, that the Finance Minister lacked actual authority to issue the bonds. Ukraine argued that the Finance Minister could also have no ostensible authority because the trustee (and Russia) had knowledge of the external borrowing limits contained in publicly available legislation. However, the Court of Appeal considered that while the limit itself was publicly available, Russia and the trustee could not have known whether the issuance of the bonds would take Ukraine over the limit, as the status of Ukraine’s other borrowing was not publicly known.

Ukraine also argued that the terms of the bonds, which differed from those of other public Ukrainian sovereign bonds, were sufficiently unusual and onerous on Ukraine that the trustee and Russia were under an obligation to make reasonable enquiries to ensure that the authority of the Minister of Finance was sufficient to bind Ukraine. The Court of Appeal disagreed, making clear that, while the terms “were onerous and, for Ukraine, unusual, none of them is a term that self-evidently stands out as abnormal so as to put [the trustee] on enquiry and there was no evidence that they would have appeared abnormal to those regularly trading in the sovereign debt market.”

Implied Terms

Ukraine argued that two terms should be implied into the contract, the most significant being that a party will not seek to prevent performance by the counterparty.

In rejecting Ukraine’s argument, the Court of Appeal found there was no general rule that such a term will be implied into every contract. It is likely to be implied only where there is some agreed precondition for performance that a party to a contract requires the counterparty’s assistance.

The Court of Appeal focused on the fact that the bonds were tradable on the Irish Stock Exchange. In the case of such transferrable instruments, all terms of the contract must be derived from the contractual documentation available to both the initial and subsequent holders. To imply terms that can be derived only from the background of facts specific to the circumstances when the initial holder purchased the bonds would run contrary to those principles and effectively render the bonds unworkable and untradeable.

The Court of Appeal’s finding on implied terms may have wider relevance in the context of corporate restructurings where investors frequently hold positions in securities or loans outside of the listed bonds, which might be exploited for their impact on the performance of listed bonds.

Both parties have been given permission to appeal to the Supreme Court.