Ukraine's Odious Bonds: Part I
Ukraine's debt payments over the next two years could easily eat up most of the pledged aid from the United States and the European Union. Russia holds one of the biggest claims coming due in 2015, for $3 billion in Ukrainian bonds it bought to throw a lifeline to President Viktor Yanukovych. Ukraine should not pay the $3 billion. The United Kingdom should make the bonds unenforceable under English law. It took similar measures in 2003 to protect Iraq and in 2010 to protect heavily indebted poor countries from creditor lawsuits.
This approach draws on a concept known as Odious Debt but avoids its practical pitfalls. The term was fittingly coined by a Russian émigré living in Paris in the 1920s, mulling over recent wars and revolutions. Under the Odious Debt theory, Ukraine has no obligation to repay money borrowed by a despotic government that was not used in the interest of the Ukrainian people when the creditors knew the debt was tainted.
Therein lies the problem. As a doctrine of international law, Odious Debt is narrow, messy, and far from established. It would not apply to a simple change of government: President Bush's borrowing certainly binds President Obama. Ukraine might have an easier time repudiating if it were to break up, with some of its territory changing hands. This is what happened with Cuba during the Spanish-American War in 1898, when the question of apportioning obligations between Spain and Cuba arose directly.
Another snag is that "odiousness" is in the eye of the beholder. Is China's lending in Africa odious because some say it exploits the borrower? Does it matter if Mr. Yanukovych stole all the money he borrowed from Russia or spent some of it on state hospital equipment?
Private creditors are no fans of Odious Debt; they worry about the unpredictable way in which it would be applied. Western powers have resisted invoking it as a legal doctrine. With US support, Iraq wrote off nearly all its Saddam Hussein-era debts but refused to justify it on legitimacy grounds. No one wants to give up the option of financing a useful dictator down the line.
Yanukovych's good-bye bonds would not have to get bogged down in the doctrinal mess of Odious Debt precisely because they took the form of simple English-law contracts, freely tradable in the capital markets and enforceable in English courts. The contracts are mostly standard form, though very favorable to Russia—thanks to a clever covenant, they are now callable at the creditor's whim. Even so, English courts may not have much sympathy for Russia. They may decide that invading a country, bankrupting it, and trying to collect would be too distasteful with or without Odious Debt. Supreme Court Chief Justice (and former President) William Howard Taft offered similar reasons when he refused to enforce claims by private creditors complicit in the escape of another kleptocrat in an international arbitration against Costa Rica in 1923.
A bigger obstacle might arise if Russia decided to sell its bonds to a private investor, who would not be responsible for Russian government actions. Private creditors would have an easier time in the courts, as in the case of one offshore fund that bought an old Romanian loan to Zambia, sued on it in England, and collected millions from the impoverished African country.
To stop the debt from migrating to private hands and showing up in court, now is the time for the UK government to make the Yanukovych bonds unenforceable under English law. If the British parliament chooses to pass a law to this effect, it would have ample precedent. In 2010, the parliament reacted to the case against Zambia with a law capping the amount private creditors can collect from poor countries that got debt relief from taxpayers. Since 2003, the United States, the United Kingdom, and others have taken measures to prevent creditors from seizing Iraq's oil and gas revenues.
Using a similar tool in Ukraine should be easier. Unlike 2003, there is less need for multilateral action—the measure would target a discrete, easily identifiable bond issue governed by English law. Unlike 2010, there should be little opposition from private creditors, who have long complained that politically-motivated government lending is treated on par with their profit-seeking IOUs. Here Russia's failed attempt to rescue Yanukovych may gain advantage over all other creditors by dressing up as private contracts (a phenomenon I discuss in an earlier paper and apply to Ukraine in an upcoming post).
Finally, since the UK law would narrowly target an egregious bit of debt as part of an international sanctions package, London's reputation for respecting private contracts would not suffer. And as there would be no need for Ukraine to invoke domestic law or contract maneuvers to wiggle out of paying its creditors, Ukraine too would emerge with its market reputation intact.
An "odious bond" law could be criticized as a biased power play—but in that, it would be no different from traditional sanctions, though it would probably be more effective than most traditional sanctions. Might Russia retaliate with a law against US and European loans to Ukraine? It would be too embarrassing. None of the other governments lend under Russian law, and this would only serve to highlight the fact that even Mr. Putin prefers English law when it comes to debt contracts.