Wasting no time after the 10-day grace period expired on December 31, 2015, Russia’s Ministry of Finance announced that it had initiated proceedings against Ukraine for nonpayment of $3.075 billion that came due on December 20. In addition to simple nonpayment, the Russian side also has claims that Kyiv violated certain covenants and triggered at least one other event of default in the months and weeks leading up to the maturity date. Crucially, under the prospectus of the notes listed on the Irish Stock Exchange, Ukraine was required to keep its debt-to-GDP ratio below 60 percent and any moratorium on payment was tantamount to a default. Ukraine’s debt long ago ballooned beyond that 60 percent threshold, and on December 18, Kyiv imposed a moratorium on servicing the $3 billion bond owed to Russia (as well as some $500 million owed from Ukrainian state agencies to Russian banks).
There’s not too much else to say about the pending case just yet; however, after spending far too much time reading through the comments section of FT articles on the topic, I think there are a couple of related issues worth discussing briefly.
1) The IMF’s compromise regarding the $3 billion bonds and the aid package to Ukraine
Last month the Washington-based institution had equal parts good news and bad news for crisis-ridden Ukraine. On the one hand, the IMF could have thrown Kyiv’s much-needed reform and debt-reduction plan into disarray with the decision to classify the $3 billion bond purchased by a Russian sovereign wealth fund as a bilateral, official sector loan. Doing so meant that Ukraine would run afoul of the IMF’s policy of nontolerance of arrears to official sector (i.e. state) creditors if it failed to pay off the maturing notes on December 20 (which it obviously has since done). Because of the of the Fund’s nontolerance of such defaults, the $40 billion IMF program would have to be suspended.
Fortunately for the fledgling governments of President Petro Poroshenko and Prime Minister Arseniy Yatsenyuk, the IMF also decided to modify the aforementioned policy concerning arrears owed to sovereign lenders. Prior to this policy shift, default on bilateral debts owed to another country would automatically disqualify a government from IMF funding. Now such failure to pay triggers a review as to whether the program should be allowed to continue despite the nonpayment. The Fund made this change in an effort to ensure that “where a restructuring is deemed necessary, collective action among official bilateral creditors is encouraged and the provision of Fund support is not held up by the unwillingness of hold-out creditors to join an effort that is supported by an adequately representative group of creditors.”
The altered policy, however, is not merely a blank check to avoid official sector obligations. The IMF made tentative tolerance of such arrears contingent upon three criteria: (1) the belief that prompt support from the Fund is considered essential and the state is pursuing appropriate policies; (2) the debtor making “good faith efforts” to agree with the bilateral creditor; and (3) the decision to provide financing despite the arrears does not negatively affect the IMF’s ability to finance relief packages in the future.
Even though the IMF may have thrown Kyiv a lifeline, the characterization of the Moscow-held bond as official sector debt will certainly upset the financials underlying the IMF program agreed to earlier in 2015. Inclusion of the Russia’s $3 billion worth of bonds in the pool of debts subject to restructuring was key to making the numbers work. I have not gone through the figures excluding the Russian bond myself yet, but earlier this summer there seemed to be a consensus that Ukraine’s debt would not fall anywhere close to sustainable levels if the Russian debt was not included in the restructuring.
2) The likelihood of Yukos shareholders seizing any eventual award in favor of Russia as partial satisfaction of Yukos’s $50 billion arbitration award
This notion seemed to be a very popular one among the FT commenters not particularly well disposed towards Moscow. Despite my own research into how to collect on that massive arbitral judgment, I do not think there is much of a chance for this to happen. First, neither Russia nor even the sovereign wealth fund that purchased the Ukrainian notes is the one suing Ukraine. According to the prospectus, the Trustee is the only one empowered to bring suit against Ukraine for failure to pay. Therefore, any eventual award will technically be in the name of the Law Debenture Company, not Russia. Thus, there’s at least one extra layer of transactions that the Russian government can likely use to prevent forced collection of its Yukos arbitration debt.
Second, because the notes were purchased by one of Russia’s sovereign wealth funds (which should have been set up as a separate legal entity from the government), a court would have to “pierce the corporate veil” in order to impute the debts of the government to state-owned entities. As the UK Privy Council said in the Gecamines case, “[W]here a separate juridical entity is formed by the state for what are on the face of it commercial or industrial purposes, with its own management and budget, the strong presumption is that its separate corporate status should be respected, and that it and the state forming it should not have to bear each other’s liabilities.” Thus, barring some rather egregious abuse of the corporate form, a court is rather unlikely to find the conditions necessary to pierce the veil. Absent such imputation, the court would not be able to hold the sovereign wealth fund accountable for the debts owed by the Russian state to Yukos shareholders.
Third, absent express consent to waive executional immunity for sovereign property (here, a judgment in Russia’s favor), the UK’s State Immunities Act only extends to property used “for commercial purposes.” While it is certainly arguable that the lending of money is such a commercial act, the IMF’s recent decision to categorize the Ukrainian notes as official sector debt could be used as evidence that the loan was not commercial, but instead was a sovereign act.