28 Mar 2023

States, take note: Law Debenture v Ukraine

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In The Law Debenture Trust Corporation plc v Ukraine [2023] UKSC 11, the Supreme Court dismissed – with Lord Carnwarth dissenting in part – a summary judgment application made by the Law Debenture Trust Corporation plc (the "Trustee") in a breach of contract claim brought against Ukraine for the non-payment of sums due under notes with a nominal value of US$3 billion (the "Notes"). The Trustee, acting on the instruction of and for the benefit of the Russian Federation, issued proceedings against Ukraine in the High Court in February 2016 after Ukraine failed to make payment of the principal amount of the Notes and the final instalment of interest in December 2015.

The key issues which arose on appeal to the Supreme Court were:

  1. Whether Ukraine had capacity to issue the Notes or enter into the relevant contracts.
  2. Whether the Notes were issued or the relevant contracts entered into without the requisite authority.
  3. The significance of Ukraine's contention that the Notes were issued as a result of duress exerted by the Russian Federation.
  4. Whether it is open to Ukraine to maintain that non-payment of the sums due under the Notes is a lawful countermeasure.

The only issue that will proceed to trial is that of duress: the Supreme Court held that Ukraine should be permitted to defend the claim on this basis alone, and only to the extent that it is grounded on threats of physical violence or damage to property.

Background

The Notes were issued by Ukraine and constituted by a trust deed dated 24 December 2013 (the "Trust Deed"), which is governed by English law and which provides for the exclusive jurisdiction of the English courts (subject to the Trustee's right to elect to arbitrate). The parties to the Trust Deed were Ukraine – acting by its Minister of Finance who in turn acted on the instructions of the Cabinet of Ministers of Ukraine (the "CMU") – and the Trustee. The sole subscriber of the Notes was the Russian Federation.

At first instance, Blair J rejected all of Ukraine's defences (including lack of capacity), found there was no compelling reason for a trial, and entered summary judgment against Ukraine. However, Blair J concluded that, had he found for Ukraine on the capacity argument and had the Trustee been required to rely on its alternative argument of ratification and affirmation, this would not have been a suitable issue for summary judgment. The parties were therefore granted general and unconditional permission to appeal, and a stay was imposed on the execution of the summary judgment pending outcome of any appeals.

Both the Trustee and Ukraine appealed. The Court of Appeal (Dame Elizabeth Gloster and Sales and David Richards LJJ) allowed Ukraine's appeal from summary judgment on the grounds that it had an arguable and justiciable defence of duress and that, even if that defence had not been justiciable, the Court would have stayed the Trustee's claim.

The Court of Appeal found in favour of the Trustee, and upheld Blair J's findings, in respect of (i) Ukraine's contractual capacity (i) the usual or ostensible authority of the Minister of Finance (iii) the implied terms submitted by Ukraine (iv) the doctrine of countermeasures and (v) the fact that there was no other compelling reason for trial.

The judgment of the Supreme Court

Capacity

Ukraine maintained that it did not have capacity to issue the Notes owing to "flagrant breaches of fundamental requirements of Ukrainian constitutional law", which meant that the transaction was a nullity under Ukrainian law. States do not, Ukraine submitted, have unlimited capacity to contract in breach of their own constitutional laws. Ukraine also sought to draw an analogy between the status of foreign states and foreign corporations under English law, arguing that the former's capacity – like that of the latter – is governed by both the constitution of the corporation and by English law.

The Supreme Court disagreed. Citing Reparations for Injuries Suffered in the Service of the United Nations case [1949] ICJ Rep 174, the Court held that sovereign states enjoy the fullest capacity afforded by international law. Crucially, however, the capacity of states on the international plane is entirely distinct from the question of whether a state has capacity under English law. Under English law, this question is determined by reference to whether it is recognised by the UK government (see United States of America v Wagner (1867) LR CH App 582). It was therefore concluded that it was not arguable that Ukraine lacked the capacity to issue the Notes under English law.

Authority

Ukraine submitted that, even if it had capacity to issue the Notes, the Minister of Finance who signed the Trust Deed did not have authority to do so. This was on the grounds that the sums borrowed pursuant to the Notes breached the level permitted by the Budget Law of 2013 (which was set out in publicly available legislation) and that the CMU did not validly authorise the borrowing.

The Court proceeded on the assumption that the Minister of Finance did not have actual authority to procure the issuance of the Notes and stated that the "critical question [was] whether Ukraine nevertheless represented by conduct or in some other way that the Minister of Finance did have such authority". The Court concluded that the Court of Appeal's position on this issue – that there was "no doubt" that the Minister of Finance and the CMU had the requisite ostensible authority – was correct.

Duress

Ukraine argued that the Notes, and the agreements pursuant to which they were issued, were procured by duress and therefore that its purported consent to them was vitiated under English law. The threats and pressure exerted by the Russian Federation were said to have included illegal trade restrictions and threats to Ukraine's territorial integrity and independence. Those threats are said to have been intended to deter Ukraine from entering into an association agreement with the European Union (the "Association Agreement") and to induce it to instead accept Russian financial support.

For the purpose of the determination of its summary judgment application, the Trustee did not dispute the facts cited by Ukraine in support of its pleaded defence of duress, nor did it question the fact that the resultant pressure put on Ukraine compelled it to enter into the contracts in question. The Trustee instead only denied that these facts amounted to duress. This was on the basis that the international obligations relied on by Ukraine do not form part of English law and so cannot ground an "unlawful act" duress defence, and that the breach of international obligations is not sufficient to ground a defence of "lawful act" duress (citing Times Travel (UK) Ltd v Pakistan International Airlines Corpn [2021]). The Trustee also argued that it would be beyond the competence of the English courts, under the foreign act of state doctrine, to denounce the conduct of the Russian Federation as unlawful on the plane of international law.

The Supreme Court explained that the relevant test is whether the pressure exerted by the Russian Federation is of a kind that English law regards as "illegitimate" for entering into a contract. The Court acknowledged that this standard is not particularly clear but pointed to its rejection, in Times Travel, of the broad standard expressed by Steyn LJ in CTN Cash and Carry Ltd v Gallaher Ltd [1994] 4 All ER 714 – that the "critical inquiry is…whether the conduct…is morally or socially unacceptable" – and its drive towards a renewed emphasis on "the link between duress and equitable doctrines, particularly the concept of unconscionability". In essence, the question is whether the behaviour in question would be judged in equity to "render the enforcement of a contract unconscionable".

The Court held that, to the extent Ukraine's defence of duress is based on threats of physical violence or damage to property, it cannot be determined without a trial. The economic pressure pleaded by Ukraine, however, was not a sufficient basis for a defence of duress as it cannot be deemed "illegitimate" under English law. The Court emphasised that the economic pressure exerted by the Russian Federation was nevertheless relevant and important context and may be considered to have bolstered the effects of the threats of violence. Lord Carnwarth dissented in this regard, maintaining that Ukraine should be able to proceed to trial with its defence of duress as pleaded for the purpose of the summary judgment application.

Countermeasures

In the alternative to its case on duress, Ukraine submitted that its non-payment of the sums due pursuant to the Notes constituted a lawful countermeasure, justified by its aim to induce the Russian Federation to desist from its wrongful conduct. The specific conduct on which Ukraine relied was the invasion and annexation of Crimea. The Court was not asked to consider events which took place after the hearing of the appeal, which concluded prior to the invasion of Ukraine in February 2022.

The Court set aside what it deemed as "possible obstacles" to Ukraine being able to successfully plead a defence of lawful countermeasures. These included the fact that lawful countermeasures are limited to the non-performance of international obligations owed to a state committing an internationally wrongful act. Here, the contract in question was governed by English law and the obligation was owed to an English corporation, rather than the Russian Federation.

Leaving those "obstacles" aside, the Supreme Court held that the question of whether Ukraine had a right as a matter of international law to take legitimate countermeasures against the Russian Federation is not justiciable before the English courts. This is because English law does not recognise such a defence: it "has no foothold in domestic law". Further, the Court also concluded that the subject matter of inter-state disputes involving countermeasures are "inherently unsuitable for adjudication" by our domestic courts.

Lord Carnwarth also dissented on this point, holding that Ukraine should be able to put forward a countermeasures defence at trial. Lord Carnwarth accepted the principles set out by Lord Wilberforce in Buttes Gas and Oil Co v Hammer (No 3) [1982] AC 888, on which the majority relied in concluding that countermeasures were not suitable for adjudication under English law, but maintained that those principles could be departed from in exceptional cases, such as in response to clear breaches of international law which were "uniformly condemned" by the international community.

Conclusions

The Supreme Court's judgment sets out a clear restatement of fundamental principles of both English and international law and emphasises the strict boundaries between the two. The capacity of a state under English law, the Court concluded, is not determined in accordance with any principles of international law: it is instead entirely a matter of English law, and specifically is determined solely by reference to whether a state is recognised by the UK government. Similarly, the principles underlying lawful countermeasures and the inter-state actions underlying them are inherently unsuitable for adjudication by the English courts: they have, the Supreme Court stated, "no foothold in domestic law".

The Supreme Court also provided clarity on an English law concept: that of illegitimate pressure in the context of duress. The Court reiterated the position it took in Times Travel, and emphasised the need to shift away from equating illegitimate pressure with pressure that is morally or socially unacceptable. The key question is instead whether the conduct in question would be judged in equity to "render the enforcement of a contract unconscionable".

The Law Debenture Trust Corporation plc (Respondent) v Ukraine (represented by the Minister of Finance of Ukraine acting upon the instructions of the Cabinet of Ministers of Ukraine) (Appellant) The Law Debenture Trust Corporation plc (Appellant) v Ukraine (represented by the Minister of Finance of Ukraine acting upon the instructions of the Cabinet of Ministers of Ukraine) (Respondent) [2023] UKSC 11

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