An Arbitration Between Russia and Ukraine?

Russia has threatened to take Ukraine to arbitration unless the country pays its $3 billion bond in full. As Anna notes, the bond gives the holder the option to sue in English court or to arbitrate under the rules of the London Court of International Arbitration (LCIA). The LCIA is a preeminent international arbitration institution, but the choice of arbitration over litigation is an unusual one in this context. Non-consumer lenders typically prefer litigation to arbitration. As I've shown elsewhere, sovereign lenders share this preference. Arbitration clauses rarely appear in sovereign bonds unless (i) the issuer's internal law forbids it to submit to foreign court jurisdiction (e.g., Brazil, El Salvador) or (in English-law bonds) (ii) the issuer has not agreed to enforce English court judgments but has signed on to the New York Convention, which requires it to enforce foreign arbitration awards. Ukraine falls into the latter camp, and its bonds have traditionally given bondholders the option to arbitrate. (Technically, it's the trustee's option; bondholders cannot demand arbitration. But Russia owns 100% of this issue, and I presume the trustee will do what Russia wants.)

I have not seen the trust deed for the Russian bond so I can't say with 100% certainty how the arbitration clause operates. From the prospectus, however, it seems that the clause is identical to the one in Ukraine's other debt (see par. 25.4-25.7). There is a panel of three arbitrators; each party nominates one, and the parties jointly nominate the third. Most lenders prefer judges in New York or London to this kind of arrangement, which arguably ensures at least one arbitrator receptive to the borrower's arguments. From the lender's perspective, there's nothing to argue about. I lent money; you didn't repay it. (Party-appointed arbitrators are formally independent of the appointing party - see LCIA Rules 7.1 and 5.3-5.5 - but some suspect bias nonetheless.) So why does Russia prefer to arbitrate?

One possibility is that arbitration awards are more easily enforced than court judgments, but I am not inclined to give this much weight. (See pp. 23-27 of this paper - also linked above - for an explanation). Basically, arbitration's enforcement advantages are overstated in the context of sovereign debt. The value of a court judgment or arbitration award is that it lets a creditor impose an embargo on the sovereign's foreign commercial and financial activities. As Argentina's experience has shown, a determined creditor can impose a potent embargo without holding an arbitration award. Arbitration's enforcement advantage is even more attenuated here, as Russia's primary leverage is military and economic.

In her last post, Anna implicitly raises another possibility: that Russia hopes to benefit from the confidentiality of arbitration. For instance, if Russia fears public disclosure of information showing that it exercises complete control over its sovereign wealth fund, or disclosure of information about Russian activities in Crimea and eastern Ukraine, it might rely on arbitration to keep these matters out of public view. LCIA rules (linked above) indeed require the parties to keep the arbitration award confidential, along with all materials produced in the arbitration (see Art. 30). But the rules don't really have in mind disputes involving sovereign nations, and the exceptions are big enough to drive a truck through. These include exceptions allowing disclosure of material already the public domain and disclosure when required "by legal duty." It wouldn't be too hard for Ukraine to claim, or even create, a legal duty obliging it to make arbitration materials public.

Perhaps a more compelling explanation is that LCIA rules give Ukraine very limited ability to demand information about these matters in the first place. As I noted in an earlier post, I'm skeptical that the disclosure rules applicable in English court give Ukraine a significant tactical advantage. Still, to the extent Ukraine might have used those rules to embarrass Russia, arbitration may significantly reduce that potential advantage.

Arbitration image courtesy of Shutterstock.com.