States have unlimited capacity: Law Debenture v Ukraine

Background: Ukraine’s alleged USD3 billion Eurobond default

It is important to appreciate that this was a summary judgment application and that the facts raised by Ukraine were assumed for the purposes of the appeal. In late 2013, Ukraine was on the verge of signing an Association Agreement with the European Union. It did not ultimately do so: Ukraine contended that Russia applied “massive, unlawful and illegitimate” economic and political pressure to force the Ukrainian administration into accepting Russian financial support instead. The financial support was structured as a standard Eurobond issue by Ukraine (represented by its Minister of Finance) for USD 3bn with Russia as the sole subscriber. The transaction documentation was typical of that for Eurobonds: the documents were governed by English law and The Law Debenture Trust Corporation was appointed as independent trustee. The notes were listed on the Irish stock exchange and fully tradeable instruments, although Russia never in fact sold them.

In early 2014, Russia invaded Crimea, impeding Ukraine’s ability to meet its obligations under the notes due to adverse effects on tax revenues. Following Ukraine’s failure to repay the Eurobond at maturity, the trustee (acting on the direction of Russia) brought proceedings against Ukraine in England.

Did Ukraine have capacity under international and English law?

Ukraine claimed that it did not have capacity to enter into the bonds for two reasons, both based on domestic Ukrainian law: a prohibition on external borrowing, which the bond issue caused it to exceed, and breaches of certain national procedural rules (described further below).

The Supreme Court noted that Ukraine is a sovereign state that is subject to international law and derives its legal personality from international law. Capacity, however, is different from personality. Being a legal person means you exist legally. Capacity is about what you can do: whether your acts have legal consequences. As a matter of international law, drawing from International Court of Justice case law, the Supreme Court observed that a sovereign state, by contrast with certain other subjects of international law, enjoys the fullest capacity afforded by international law.

When it comes to the personality and capacity of a state under English law and before English courts, the Supreme Court held:

• Since the nineteenth century, personality has turned on whether the UK government has recognised the state. Once it has, the state has legal personality.
• Just because a state has legal personality, that does not automatically mean it has legal capacity.
• Any analogy between a foreign corporation and a foreign state as regards questions of capacity is a false one. A state is not like a company: its legal personality is sui generis or unique and it does not derive its personality or capacity from the sovereign power of the state to create legal persons (such as companies). A company is a creature of state law whereas a state is not a creature of its own laws.
• Again, it is the recognition of the state by the UK Government as executive which creates the capacity under English law and that capacity is unlimited for English law purposes irrespective of the provisions of the state’s own domestic constitution and laws.

Did the Ukrainian Minister lack authority under English law?

Ukraine alleged that the Minister of Finance lacked authority under Ukrainian law to enter into the bonds. The facts Ukraine relied on were the same as for lack of capacity: (a) Ukrainian law imposed a (publicly available) limit on external borrowing, which the issue of the notes had caused it to exceed; and (b) the Cabinet of Ministers of Ukraine (CMU) failed to give valid authorisation to the Minister of Finance because (i) the CMU was not provided with the expert opinion required for it to deliberate on whether to approve the transaction; and (ii) it was not aware of and did not consider all the relevant terms of the borrowing (including terms which were allegedly oppressive) and invalidly delegated that consideration to the Minister of Finance.

The Supreme Court gave a textbook summary of the law on authority:

• The authority of an agent may be actual or apparent.
• Actual authority, which may be express or implied, “describes a legal relationship between principal and agent created by a consensual agreement to which they alone are parties, and pursuant to which the principal grants to the agent the right to enter into legal relations with third parties on the principal’s behalf”. The third party contractor is a stranger to this arrangement and may have no knowledge of any authority granted; but if the agent enters into a contract pursuant to its actual authority, it creates contractual rights and liabilities as between the principal and the contractor.
• Apparent (or ostensible) authority describes a relationship between the principal and a contractor which arises from a representation (including by conduct) made by the principal to the contractor that an agent has authority to enter into contracts within the scope of that authority on the principal’s behalf. The representation creates an estoppel, preventing the principal from asserting that it is not bound by the contract. Apparent authority cannot be relied on if the contractor fails to make the inquiries that a reasonable person would have made in all the circumstances to verify that the supposed agent does indeed have authority.
• Apparent authority will often coincide with actual authority but sometimes exceeds it. In other words, apparent authority can sometimes cure a lack of actual authority.

The Supreme Court proceeded on the assumption that the Minister of Finance did not have actual authority to enter into the transaction under Ukrainian law, because this was not something that could be determined without a trial (which has not yet happened in this case). The critical question, therefore, was whether Ukraine represented by conduct or in some other way that the Minister had apparent authority. The Supreme Court took a practical approach to this and looked at all of Ukraine’s words and conduct as a whole to decide whether they constituted an express or implied representation as to the Minister’s authority.

The Supreme Court concluded that there was “no doubt” that those activities constituted such a representation. Specifically:

• By adopting the relevant provisions of its budget code, Ukraine authorised the Minister and the CMU to borrow on behalf of Ukraine, subject to certain limitations. By publishing those provisions, Ukraine represented that the Minister and the CMU were authorised to act.
• The transaction was familiar to the parties and conformed to Ukraine’s history of borrowing in 31 prior Eurobond issuances in which the trustee had acted before the issuance of these notes. This properly informed the trustee’s attitude to the proposed transaction and the trustee’s view as to its enforceability.
• The events leading up to the issue of the notes supported this view. Among other things, the then President of Ukraine had met with President Putin to agree the package and announced it publicly, the CMU had passed a resolution approving the notes, which was made publicly available, and at no stage did anyone suggest that the Minister had no authority.

The Supreme Court then considered whether the trustee was put on inquiry as to the Minister’s alleged lack of actual authority, finding that:

• It was wrong to say the trustee could be taken to know of the existence and meaning of the budget law or the limit on borrowing simply on the basis that it was publicly available. The question was whether a reasonable person in the position of the trustee would have made inquiries which would have revealed the limit and, if they would, that the issue of the notes would or might lead to a breach of it. The Supreme Court’s view was that the trustee was entitled to assume that the Minister had authority, considering the role played by the Ukrainian President, the Parliament, the CMU and the Minister of Finance, the terms of the prospectus and the content of the legal opinion from Ukraine’s legal advisers as provided to the trustee (which stated that Ukraine was authorised to execute the relevant documents and issue the notes).
• The alleged inclusion of unusual and onerous terms in the transaction was not sufficient to put the trustee on notice of the Minister’s alleged lack of authority.
• It could not be inferred from the resolution that the CMU had improperly delegated decisions on the terms of the notes to the Minister, nor would it have been apparent to a reasonable person in the trustee’s position that delegation of decisions on the terms might breach Ukrainian law or deprive the Minister of authority.

The Supreme Court’s view was that there was also no merit in Ukraine’s argument that the trustee had adduced no evidence as to whether it had relied on any representation by Ukraine. The evidence that the trustee had no reason to doubt the authority of Ukraine, and would not have agreed to contract had they had such doubts, was sufficient.

Could the notes be avoided for English law duress?

A further argument made by Ukraine was that the notes were voidable and had been avoided by reason of duress. Specifically, Ukraine alleged that it had entered into the notes because of economic pressure, including Russia's threat to impose trade restrictions and to use force to destroy Ukraine’s security and territorial integrity.

The Supreme Court held by a majority that the use of trade restrictions to exert pressure upon other states, and thereby achieve political objectives, has been part of the armoury of states since classical times, so this part of Ukraine’s case could not stand.

However, the majority distinguished between what were described as more traditional methods of statecraft and Ukraine’s claims relating to Russia’s threats to use force. The Supreme Court referred to reports that more than 9,000 people had died and 21,000 people had been injured because of Russia’s invasion of Crimea and Eastern Ukraine in 2014, making the threat of violence a reasonable inference. This also extended to the destruction of Ukrainian property. The Supreme Court concluded that the question of whether that threat had unlawfully induced Ukraine to enter into the transaction was a question that should be determined at trial rather than on a summary basis.

The Supreme Court sidestepped the potentially difficult legal question of whether the alleged unlawfulness of Russia’s acts in this regard were justiciable by English domestic courts by reason of this being a question of international law. The Supreme Court concluded it did not need to investigate whether the acts were unlawful under international law; rather, it had to determine whether the facts were such as to constitute duress under English law.

Comments

The Supreme Court’s decision confirms that once a state is formally recognised by the UK government, that state has unlimited capacity to contract under English law. Capacity is not limited by the constitution of the state or its own internal laws. This is excellent news for those contracting with states (and their lawyers) since it means capacity can be taken as a given for all English law purposes, provided the state has in fact been recognised in the UK. From an English law perspective, there is now no need for a local law opinion on the capacity of a recognised foreign state. An analysis of capacity from a local law perspective may still be relevant where jurisdictions outside England are in play, however.

Authority, however, remains an area requiring further investigation from an English and local law perspective to determine whether a person or entity executing a contract on behalf of a state has authority to do so. This analysis will inevitably involve questions of fact. It may well also involve consideration of the same factors as are typically assessed in relation to capacity. So, in practice, local law opinions may not become much more straightforward as a result of this judgment.

The Supreme Court’s judgment is certainly helpful in confirming that, if a principal represents that an agent (in this case the Minister) has authority to contract, a counterparty may be able to rely without further inquiry on that representation provided a reasonable person in the counterparty’s position would have done so. Again, this finding should provide comfort to those contracting with states and more generally.

Judgment: Law Debenture v Ukraine