Mitu Gulati: Ukraine’s odious debts

Mitu Gulati, the world’s expert on the odious debt doctrine, writes in:

It is a treat to guest post here at  It is an even bigger treat to be invited to disagree with Eric on the pages of his own blog! Eric has been blogging about the Ukraine situation, but has yet to engage the question of what is to become of the Ukraine’s debt, a large portion of which is likely owed to Russian entities. Of particular interest are the debts owed by Ukraine directly to the Russian state.  This includes Ukraine’s most recent Eurobond issue (December 2014) for roughly $ 3 billion that was purchased entirely by the Russian state as part of its subsidization of the prior Ukrainian regime.

However, Ukraine may have an argument for escaping liability on that last $ 3 billion (and likely more).  That argument comes from an antiquated doctrine of international law, the doctrine of Odious Debts, that briefly got resuscitated about a decade ago in the context of Iraq’s post-Saddam era debt restructuring. The relevant bit of international law here is the doctrine of state succession.  Under this doctrine, democratic governments that succeed dictators are not allowed to disclaim the debts of the prior regime, no matter how odious it may have been.  There may be a narrow exception, however, for what one might call Corrupt Debts.

That is where the lender knew or should have known that the money it was lending was going to line the personal coffers of a state leader.  There, the lender can fairly be said to have made the loan to the personal account of the corrupt leader, rather than to the state.  In the case of Ukraine, the current regime has vociferously accused Mr. Yanukovych and members of his regime of stealing the proceeds of prior state borrowings.

Assuming that is true, it should not be difficult to argue that the Russian lenders knew or should have known of the kleptomaniacal tendencies of Mr. Yanukovych’s government.  In that case, Uncle Vlad would no longer be able to collect from the Ukraine; instead, he would have to look directly to his friend, Mr. Yanukovych, for recovery of the $3 billion.

The case law is sparse. But there is a famous case on point, involving a 1923 arbitration between Great Britain and Costa Rica.  Cribbing now from an article with the godfather of sovereign debt, Lee Buchheit, “The Dilemma of Odious Debts”:

In 1917, the government of Costa Rica was overthrown by Frederico Tinoco. Tinoco’s government lasted two years.  Before he left the country, Tinoco borrowed some money from the Royal Bank of Canada. That money also left the country . . . in the company of Mr. Tinoco.

In a subsequent arbitration, Great Britain claimed that the successor government of Costa Rica was bound to honor the loans. US Supreme Court Justice (and former President) William Howard Taft refused to order Costa Rica to repay the Tinoco loans. These were, Taft said, not transactions “in regular course of business” but were “full of irregularities.” Taft explained that “[the] bank knew that this money was to be used by the retiring president, F. Tinoco, for his personal support after he had taken refuge in a foreign country. It could not hold his own government for the money paid to him for this purpose.”

Sounds an awful lot like Uncle Vlad’s purchase of Ukrainian Eurobonds a couple of months ago. The question may eventually come down to this — will the new administration in the Ukraine feel itself obliged, as a matter of law or morality, to repay a loan extended to a prior regime that they have already branded as kleptomaniacal by a lender (Russia) that they have already accused of lopping off a large part of Ukrainian territory (the Crimea) in violation of international law?

Eric, what do you think? You’ve been skeptical of the doctrine of odious debts in the past.  Would you consider the scenario above to be an exception?  One where that doctrine should apply to excuse the Ukrainians?

[Since you asked: Without knowing more facts, it is hard to know what will happen, but my guess is that Yanukovych skimmed off only a part of the proceeds, most of which ended up in the Ukrainian treasury—if so, the bill must be paid, while Ukraine would have a (no doubt unenforceable) claim against Yanukovych personally. – EP.]