Sovereign Bonds: Key questions on capacity, authority and duress addressed by UK Supreme Court

What is the background?

In 2013, Ukraine issued the Notes with Russia as sole subscriber. The Notes were governed by English law and the courts of England and Wales had exclusive jurisdiction. Ukraine failed to repay the Notes at maturity and the Trustee originally issued proceedings in the High Court in 2016. The Supreme Court was considering whether the High Court’s granting of summary judgment in favour of the Trustee (on the basis that Ukraine’s defence had no real prospect of success) should be upheld.

Ukraine’s appeal was based on four grounds:

1. it lacked capacity to issue the Notes as a matter of Ukrainian law
2. the Minister of Finance of Ukraine lacked authority to enter into the transaction on behalf of Ukraine
3. Ukraine was entitled to avoid the Notes because of duress arising from Russia's unlawful and illegitimate threats and pressure inducing it to issue the Notes
4. Ukraine was entitled to rely on the public international law doctrine of countermeasures to decline to make payment under the Notes

What were the key findings?

Capacity

The Supreme Court (agreeing with the Court of Appeal and High Court) rejected Ukraine's submission that it lacked capacity because of its inability to enter into contracts under Ukrainian domestic law. The Supreme Court confirmed that the capacity of a sovereign state in English law is not restricted in this way because the capacity of a sovereign state derives from the UK government’s recognition of that state (unlike the capacity of foreign corporates which is governed by the law of the place in which the corporate is registered). The court concluded:

“Para 34 - ...that a foreign state which is recognised as such by the executive in the United Kingdom is considered, for the purposes of municipal law within the United Kingdom, to be a legal person with full capacity. In particular, a recognised foreign state does not lack capacity to make and perform a contract governed by a system of municipal law, irrespective of the provisions of its own domestic constitution and laws. In the present case, it is not arguable that Ukraine lacked the capacity to issue the Notes in the eyes of English law…”

Authority

For the purposes of considering whether summary judgment should have been given on this issue, the Supreme Court assumed that Ukraine's Minister of Finance did not have actual authority. However (again agreeing with the findings of the Court of Appeal and the High Court) the Supreme Court held that there had been ostensible authority to sign the contractual documents and to issue the Notes. By way of background, actual authority describes a legal relationship between principal and agent by which the principal grants to the agent the right to enter into legal relations with third parties on the principal’s behalf. Apparent or ostensible authority, on the other hand, describes a relationship between the principal and another party which arises from a representation (which may be made by conduct or implication) made by the principal to that party that an agent has authority to act. Importantly, the representation must be one upon which the other party could and did reasonably rely.

Ukraine argued that breaches of constitutional process and its budgetary limits meant that the Minister of Finance did not have authority to bind the state. The Supreme Court held that, even assuming there was no actual authority, the combination of events leading up to the issuance of the Notes, which involved the President of Ukraine, the Cabinet of Ministers of Ukraine and the Minister of Finance, demonstrated a coordinated and consistent approach to the borrowing. It was reasonable for the Trustee to rely on such actions and accordingly there was ostensible authority.

Duress

Duress is where a party's consent to a contract is induced by threats or pressure. The contract is voidable by the aggrieved party provided that: (i) the threat or pressure was illegitimate under English law; and (ii) there is a sufficient causal connection between the threat or pressure and the decision to enter into the contract. The Supreme Court held that the alleged threats to security and territorial integrity by Russia did arguably constitute duress and accordingly – as this is a question of fact - should be decided at trial.

Doctrine of countermeasures

The Supreme Court held that English law in this context does not recognise the defence Ukraine put forward as regards the rights of states to take countermeasures, and so such matters are generally not justiciable by the English courts.

Conclusions

The Court summarily rejected Ukraine’s defence on issues of capacity, authority and countermeasures, but held that the claim could not be decided without a trial because Ukraine had an arguable and justiciable defence of duress.

The Supreme Court’s statements serve as helpful reminders on some first principles in sovereign debt transactions. First, that capacity in the context of a state is not the same as in relation to a private entity. The capacity of a sovereign state in English law derives from the state's recognition by the UK government, not from the state's internal law. Second, authority can be both actual or ostensible. Of course, those documenting transactions must always seek to diligence and demonstrate actual authority on a transaction, but the case serves as a reminder that it may not be the only source.