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Ukraine’s Debt to Russia: Efficient Breach Vindicated

Ukraine’s Debt to Russia: Efficient Breach Vindicated

Russia has had quite a year. The Kremlin’s militaristic gallivanting has become a staple of this year’s news cycle, with perhaps its most pugnacious acts of hostility being those involving Ukraine. While Russia’s armed harassment of Ukraine has received the lion’s share of the media’s attention, it is its financial badgering with respect to sovereign debt that may prove to be most harmful of all to the bedeviled nation.

In this article, I endeavor to explicate briefly Ukraine’s sovereign debt dispute with Russia, with an eye towards arguing how Ukraine might make use of different international legal remedies to exculpate itself from its regrettable situation. One of the most discussed of these remedies is the legal notion of “odious debt,” and many—most prominently Georgetown University Professor Anna Gelpern and Newsweek’s Anders Åslund—have argued that the “odious debt” legal remedy is Ukraine’s golden ticket out of repayment. I will argue that the legal grounds for the use of the “odious debt” solution are shaky at best, but that rather “efficient breach” is the optimal legal remedy for Ukraine in this case. On the first day of 2016, Russia formally began legal proceedings against Ukraine over the non-payment of their $3bn debt, as reported by the Financial Times. This issue will now come down to a courtroom battle, and to understand the legal implications of this dispute, we need to understand its history.  

The story behind Ukraine’s sovereign debt to Russia is convoluted. The Economist called it “the world’s wackiest bond.” Ukraine has had many issues with external debt as of late. In August of 2015, Ukraine finished negotiations with numerous creditors (primarily investment houses) over Ukraine’s international bonds, altogether valued at around $18 billion. These renegotiations included a slashing of 20% of the bonds’ principal on average, as well as postponement of repayment until 2019. Even in August, Russia’s immediate rejection of these terms adumbrated the growing conflict brewing today over the $3bn bond that Ukraine was due to pay Russia on December 20th, 2015.

The bond in question was issued in December of 2013. Listed on the Irish stock exchange, the bond was clearly backed by spurious motives. As the Economist’s Christmas double-issue summarized:

The bond was essentially a bribe to Viktor Yanukovych, Ukraine’s now-ousted president, who was dithering between European and Eurasian integration. Senior Ukrainian officials say that the government itself never saw the money; most probably it was spirited out of the country by Mr. Yanukovych’s cronies.

While some might disagree with such a malicious characterization of the Russian debt, they would be in the minority, as numerous reputable sources—from the Financial Times, to Reuters, to Bloomberg—have lamented Ukraine’s unfortunate situation. Vladimir Putin proposed a staggered plan in November in which Ukraine would pay back the debt over three years, but the stipulation that a western government or bank serve as guarantor went unfulfilled, and the deal fell through. Some have attempted to argue that the whole issue of a legal remedy to Ukraine’s debt to Russia does not merit consideration, as the debt is commercial, not sovereign. On this issue most of the international community disagrees with Kiev, including the IMF, that on December 16th confirmed the sovereign status of Ukraine’s debt to Russia.

So, where does this leave us? The December 20th deadline has come and gone, along with the 10-day grace period thereafter, and Russian President Vladimir Putin has given the green light to file a lawsuit against Ukraine. In short, the bond, as it stands, will not be repaid. Given that the solution doubtlessly lies at the tail end of arduous, drawn-out courtroom arguments, let us now delve into some potential legal remedies to which Ukraine may take recourse as it attempts to rid itself of this debt.

As Anders Åslund argues in his piece on Ukraine’s debt to Russia, published on the Atlantic Council’s site, one potential legal remedy is proposed by Professor Gelpern from Georgetown, who argues that “Ukraine should not pay this debt because it amounts to "odious debt.” I refute this argument, as the argument for the applicability of the “odious debt” remedy is tenuous at best in this scenario.

“Odious debt,” as defined recently by the Centre for International Sustainable Development Law (CISDL), is a debt that meets three criteria: “it was contracted without the consent of the population of a debtor state, without benefit to it, and the creditor had knowledge of the circumstances.” To borrow the summary of odious debt from Jeff King of CISDL, this means that “under the contemporary definition… a debt is said to be odious when there is an absence of popular consent, an absence of benefit, and creditor awareness of these two elements.” As those familiar with the field of International Law will know, the sources of International Law are treaties, customary international law, and general principles. While some may disagree with the legitimacy of certain sources of International Law, these are the principles that will govern the courtroom arguments between Ukraine and Russia. Given that Russia and Ukraine are not signatories of any binding treaty that references odious debt, and there is no “general principle” of odious debt, to prove the applicability of the odious debt remedy in this situation, it is necessary to prove that it has crystallized as customary international law in a way applicable to Ukraine’s case.  

For customary international law to be considered binding, certain thresholds must be met; namely, the “thresholds in customary international law of uniformity, consistency and generality of practice, together with the requisite opinio juris,” as explained by King. Thus, Professor Gelpern and those who advocate for the doctrine of “toxic debt,” are arguing against the customary international “rule of repayment,” arguing instead that there are cases where forgoing repayment is a legal norm of customary international law due to toxic debt.

Upon examining the legal history of “toxic debt” as a defense against repayment, one can recognize that the argument is instantaneously weakened given that for most of the history of the “toxic debt” doctrine, the defense only referred to cases of “cessation and dissolution of a state, where the legal personality of the borrowing state often remains intact.” As the Ukrainian case involved neither cessation nor dissolution, the interpretive window whereby the “toxic debt” defense might be applicable is quite small.

Next, we can look for cases in which a successful application of the “toxic debt” defense has been outlined. In the Tinoco Arbitration case, we saw that for the debt to be toxic, there must not only be a change in regime (normally revolutionary), but also a failure on the part of the bank or government in question to show that the funds were used for “legitimate governmental use.” Few doubt that Ukraine’s debt was not used for legitimate governmental purposes, but the lack of a concomitant regime change renders the application of the “toxic debt” defense unsupported by precedent.

There is only one subset of legal scholarship on “toxic debt” that may support the applicability of the defense in Ukraine’s case: O’Connell’s “hostile debts” doctrine. Also referred to by scholars such as Mohammed Bedjaoui as “subjugation debts,” this subset of “toxic debt” is defined as “debts that are contracted by a state representative without the population’s consent and against its interests, with both these issues to the creditor’s knowledge.” While this may sound perfectly fitting in Ukraine’s case, Bedjaoui—the intellectual father of “subjugation debts”—suggests a “very high threshold for the standard,” specifically: “debts contracted by a State with a view to attempting to repress an insurrectionary movement or war of liberation in a territory that it dominates or seeks to dominate, or to strengthen its economic colonization of that territory.” While most of the evidence suggests that Mr. Yanukovych did not use the funds for the benefit of his country, it would be challenging for anyone to make the argument that Yanukovych used the $3 billion to quell insurrection.

In summary, given the lack of precedent in utilizing the “toxic debt” defense in cases where no revolutionary regime-change took place, the “toxic debt” defense is weak in Ukraine’s case. There is a small possibility that Ukraine could argue its bond debt to Russia is a “subjugation debt,” but here there is no precedent of such an argument being made when it has not been proven that the state leader who incurred this debt utilized the funds to quell an insurrection. Moreover, all of these considerations necessitate the assumption that the “odious debt” doctrine can be considered customary international law, which, on its own, is questionable. While, in theory, legal scholars might wish that such a norm had crystallized in the system, there appears to be no case in recent history where a tribunal has accepted the “toxic debt” defense. Moreover, there is a dearth of opinio juris et necessitatis, meaning that for the “toxic debt” defense to crystalize as customary international law in the future, we must not only see more states decline to pay “toxic debt,” but we must see more states officially argue that the reason for their forgoing repayment is their belief that they are absolved of the responsibility because of the “toxic debt” defense.

As I have argued, there is little chance that a “toxic debt” defense will exculpate Ukraine from paying Russia; so, the question remaining is, what might? In general, my perspective on international law derives from an economic perspective of international law similar to that advocated by Dunoff & Trachtman. Put colloquially, this is a legal perspective based on optimal welfare outcomes, not one based on any a priori assumptions of the morality and bindingness of international law. For this reason, the case of Ukraine offers an interesting case where Posner & Sykes’ argument of “efficient breach of international law” may pertain. The logic behind Posner’s “efficient breach” theory is that if the costs of compliance outweigh the costs of non-compliance, then a breach of international law—such as the customary law of repayments in Ukraine’s case—is efficient, and thus, can be an optimal remedy.

In the case of Ukraine’s sovereign debt, simple non-compliance with the law of repayments may be optimal. Differently stated, one of the best present legal strategies for Ukraine might simply be not to pay back Russia until they concede more in negotiations. The reasoning behind this ploy is simple: few entities aside from Russia are against Ukraine in the case of its bond debt. Most of its private international bondholders have already settled a restructuring package with Ukraine. Moody’s—the international rating agency—has made it clear that it expects Russia eventually to restructure Ukraine’s debt. Perhaps most importantly, however, is the surreptitious way in which the IMF has gone about altering its rules for aid provision, so as indirectly to show its support for Ukraine. On the 15th of December, the FT reported that the IMF decided “to change its strict policy prohibiting the fund from lending “to countries that are not making a good-faith effort to eliminate their arrears with creditors.” The decision was criticized by Moscow, as it will allow the IMF to continue doing business as usual with Kiev even if it fails to pay its sovereign debt to Russia.”

Most of the western world—i.e. most of the power players in international finance—are in Ukraine’s camp. Ukraine is trapped by a predatory bond deal orchestrated by a lecherous former leader with no desire to use the funds to strengthen Ukraine. While Ukraine has been left with a repugnant debt to pay, it is not one that meets the legal thresholds necessary to deem it “toxic debt.” That said, if one is willing to accept an economic perspective of international law in place of a moralistic one, then “efficient breach” seems to be both the current choice Ukraine has selected in proceeding to deal with its debt, as well as the legal course of action that may be most beneficial for Ukraine, as even the IMF—one of the most important entities with a role in determining Ukraine’s economic wellbeing—appears to be supporting Ukraine in its abstention from repayment by the accommodations it is making in its policies. With Russia’s foreign reserves tanking, and its economic outlook growing dimmer each day due to the plunging price of oil, it is likely that Russia will eventually take whatever they can get from Ukraine, and, like Moody’s predicted, will agree to restructure Ukraine’s debt after a period of suffering efficient breach.

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