The Case of the Cuban Debt in the UK Court: Observations

Since the Cuban Revolution in 1959, Cuba has borrowed heavily in the international markets, including from Spain, Japan, France and Russia.  In 2020, Cuba’s foreign debt was estimated to equal U.S. $19.7 billion^[i].  Cuba has not repaid most of this debt when due.  It does, however, monitor who holds its debt, consents to most assignments of its debt and reconciles its records with the commercial bank holders.

This article describes the decision taken by the High Court of Justice Business and Property Courts of England and Wales King’s Bench Division Commercial Court (the “Court”)^[ii] in a dispute regarding the assignment of Cuban debt in the secondary market.  It includes a description of the Court’s rendition of the facts and general observations about the dispute between the parties.

The Secondary Market for Sovereign Debt

The secondary market for sovereign debt among commercial banks has been used for many years by companies seeking to invest in a country.  The company can purchase the debt at a discount and swap the discounted debt for local currency with the government of the country in which it is seeking to invest, using it to finance the investment in the country.  By this method, the investor obtains a discount - swapping discounted debt for the necessary local currency and the recipient country achieves a a benefit by retiring the discounted debt at its face value.

In recent years, a new type of secondary market debt purchaser has emerged who purchases a country’s sovereign debt with the goal of maximizing the debtor nation’s amount of payoff. These so called “vulture funds” do not seek to use the sovereign debt to invest in the debtor country, but instead may insist on an payout far in excess of the current market price for the debt.  If the debtor country balks at making such a payment, which it typically does, the vulture fund continues to hold the debt until a point at which it has greater leverage, such as when the debtor nation seeks to restructure its total debt, and thus holds out for an extraordinary payout for the fund investors. 

The case before the Court involves one of these new type of debt purchasers – one seeking a judgment against the defendants to force payment on debt with a current market value of approximately US $77 million of loans (the “Cuban Debt”).

The Parties to the Lawsuit

The Cuban Debt was purchased in tranches as they became available in the secondary market, by CRF I Limited, the plaintiff in the lawsuit.  CRF I Limited, is a registered mutual fund (no. 16954) in the Cayman Islands, organized in 2009 to purchase defaulted Cuban debt (the “Fund”).  As described in the Court opinion, the Fund stated in its 2012 prospectus soliciting investors that it sought to obtain a much higher return than the face value of the debt – up to 1,000%, “or even higher”.  Also, in its prospectus the Fund promised that all Cuban debt that it purchased would be government guaranteed.

The Cuban Debt was originally issued in the 1980s by the Cuban National Bank (the “National Bank”) in two separate borrowing transactions, respectively, from Credit Lyonnais and Instituto Banco Italiano.  In the second borrowing transaction from the Italian bank the Cuban government issued a separate guarantee of the loan (the “Guarantee”).  The National Bank and the Cuban government were the two defendants in the lawsuit.

As is generally the case, both original loan agreements and the Guarantee were fully assignable with consent (which was not to be unreasonably withheld) and were governed by U.K. law.  While the debt issued to the Italian bank had the Guarantee, in an earlier transfer, prior to its acquisition by the Fund, the debt initially issued to the Italian bank was transferred to an intermediary holder without the Guarantee.  As a result, none of the debt acquired by the Fund had an explicit government guarantee.

While the National Bank routinely provided consent to assignments of the Cuban Debt between commercial banks in the years 2005 to 2009, it refused to consent to the assignment of any of its debt to the Fund on two prior occasions in 2014 and 2015.

Then, in October 2019, the Fund’s agent, Jeetkumar Gordhandas, flew to Cuba with hard copies of the documentation. In November 2019, the Fund finally obtained consent from the National Bank of the assignment to it of approximately US $77 million in debt and the assignments were recorded in the National Bank’s records in December 2019.

Promptly after obtaining the assignment, the Fund sent a demand letter to the National Bank and the Cuban government and commenced the litigation in the U.K. before the Court.

The Lawsuit

The decision in the lawsuit before the Court was rendered in a preliminary hearing covering two questions: whether the Court could hear the case and whether it had jurisdiction over the defendants. The first question the Court considered was whether it could hear the dispute presented by the the Fund.

Does the Court have Subject Matter Jurisdiction?

The matter of a court’s “subject matter jurisdiction” is the question of whether it is entitled to hear the dispute before it – i.e., that there are there sufficient facts alleged to cause the court to conclude it has the legal authority to proceed to consider the substance of the dispute between the parties 

In arguing that the Court had subject matter jurisdiction, the Fund pointed to the fact that the notes representing the Cuban Debt were physically held in U.K. banks and that the loan agreements under which the Cuban Debt was issued were governed by U.K. law. 

The defendants contended that the Court did not have subject matter jurisdiction.  They had two principal arguments.  First, they claimed that there had not been a proper assignment of the Cuban Debt to the Fund and therefore the clauses that gave jurisdiction to the Court in the loan agreements were not applicable.  Second, they argued that the Fund could not take advantage of the contractual waivers of sovereign immunity in the loan agreements and so both Cuban defendants were immune from the jurisdiction of the English courts pursuant to the State Immunity Act of 1978.

Thus, in order to reach its conclusion on subject matter jurisdiction, the Court had to assess the validity of the assignments.

The Cuban parties alleged that:

• The Fund’s claimed consent was provided by Raúl Olivera Lozano only after being promised a bribe by the Fund’s agent and led to the unusual fact that the relevant assignment documents did not have the second signature appearing in all other consents to assignments of Cuban debt.

• Moreover, the defendants pointed out that the while the National Bank had consented to various assignments of one or both of the loans in the years  2005 to 2009, it had twice previously refused to consent to an assignment to the Fund when it was revealed the Fund would be the ultimate creditor upon assignment. National Bank policy, the defendants claimed, was to only consent to assignments to commercial banks and not to creditors who would seek to enforce the obligations immediately and that this assignment was inconsistent with past practice and outside the scope of the signatory’s authority, as reflected in new regulations adopted in 1998 for bank signatures and assignments.^[iii]

The judge concluded that the Court had subject matter jurisdiction, as the assignment to the Fund was proper. 

• The judge pointed to the course of correspondence between the parties, involving several employees of the National Bank, including the law department, of over six months regarding documents necessary for assignment, their proper form and notarization^[iv] without raising a concern about the nature of the Fund as creditor.

• Moreover, she said that correspondence from the president of the National Bank, Rene Lazo Fernández, to the Fund subsequent to the assignment did not challenge the validity of the assignment but, instead, said that Cuba did not have the means to satisfy the debt and a pari passu clause in a 1984 refinancing agreement to which the Cuban Debt was subject did not allow it to negotiate with one creditor without satisfying the others.

• Whether the signatory had been bribed, the Court said, was a matter of Cuban law for a Cuban court to consider^[v].

Does the U.K. Court have Jurisdiction over the Cuban State as Guarantor?

The next issue the Court considered was whether what it concluded was a valid consent of the National Bank could also bind the Cuban government as a guarantor.  If the Cuban government was not a guarantor, it would not be a party to loan agreements under which the Cuban Debt was issued and then the Court would not have personal jurisdiction over it.

The judge reviewed the legislative history of the National Bank from 1976 onwards and concluded that the National Bank was not authorized after that date to create indebtedness that was backed by the Cuban government.  When the National Bank was established in 1948, it was clear that the debt it issued enjoyed a Cuban government guarantee.  However, the Court decided that in 1976, the National Bank ceased to be an organ of the Cuban State but remained as a central bank, while some of its functions were moved to other governmental actors.  In 1997, the government created the Cuban Central Bank and gave it the powers previously held by the National Bank.

The Court concluded that while the National Bank could and did properly consent to the assignment of the Cuban Debt, that it was not backed by the full faith and credit of the Cuban government, as the Cuban government had not implicitly or separately guaranteed it and the National Bank did not have authority to bind the Cuban State.  In its reasoning, the Court noted that the Guarantee was not transferred in an earlier transaction and thus it did not accompany the documentation assigning the Cuban Debt to the Fund.  Therefore, the Court ruled that it did not have jurisdiction over the Cuban State.

What Comes Next?

These findings by the Court conclude the preliminary phase of the lawsuit and effectively released the Cuban State as a party.  The remaining Cuban defendant, the National Bank, could ask for leave to appeal the decision, but this seems unlikely, since many months have passed since the decision was rendered and the National Bank paid the Fund’s attorney’s fees, as required by U.K. law of the loser in litigation.

The Fund could move forward to trial against the National Bank to determine the damages on its debt claims and obtain a final judgment from the Court.  The National Bank could again present evidence and defend itself, for example, on the grounds that the pari passu clause in the refinancing agreement of the Cuban Debt prevents it from settling any debt claim subject to that agreement without settling all of its debt claims under the agreement.  This was the argument made by the president of the National Bank in his correspondence with the Fund after the assignment.^[vi]

If and when the Fund obtains a final judgement, it will have to collect from the National Bank. Its challenge would be to find National Bank assets in a jurisdiction that would recognize the validity of the U.K. judgement and a court in that jurisdiction willing to enforce it. This is no easy task. The Cuban Central Bank has Cuban government assets in the Bank for International Settlements in Switzerland.  However, the Court concluded it did not have jurisdiction over the Cuban State and so it is unlikely that the Fund would be able to attach those Cuban Central Bank assets.  

In reaching its decision, the Court also did not reach the question of whether the Cuban Central Bank had “successor liability” for the debt issued by the National Bank and therefore its assets could be attached with a final judgment received by the Fund.  Successor liability is a doctrine recognized in the Anglo Saxon legal system and applied when an entity assumes the assets and carries on the activities of a prior entity.  It is imposed by the courts to prevent a debtor from reorganizing and transferring its assets to a successor in interest in order to avoid paying its creditors^[vii]. So, if the Fund obtains a final judgment that it is owed the face value of the debt, it may well try to sue on this theory to satisfy that judgment, if the principle is applicable in this case, notwithstanding the loan agreement terms to the contrary.

Larger Lessons

The Court’s decision represents a victory for Cuba, as it does not need to pay the “vulture fund” the face amount of debt of the Cuban National Bank.  But it may be less significant in another regard.  Sovereign debt is usually renegotiated in connection with a restructuring of a significant part or all of a country’s outstanding debt.  The principal motivating factor for the debtor country to settle is that it needs to access the international credit markets and to do so, it needs to convince potential creditors of its good faith.

From this point of view, the fact that the Court found that the Cuban Debt owned by the Fund lacks both a Cuban government guarantee and any kind of implicit government backing is unlikely to matter if the time comes when Cuba wishes to renegotiate its outstanding debt.  Should Cuba seek to avoid including in its debt restructuring all of the debt issued by the National Bank since 1976, as lacking an explicit government guarantee, under the theory that the debt lacks any kind of government backing, it would likely not succeed in demonstrating the good faith necessary to regain access to international credit markets.

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[i] Marc Frank and Nelson Acosta, Western creditors and Cuba pledge to salvage debt deal, Reuters, September 1, 2023, 2:52 PM EDT

[ii] Case No: CL-2020-000092, between CRF I Limited, Claimant, and Banco Nacional de Cuba and the Republic of Cuba, Defendants, before MRS JUSTICE COCKERILL, April 4, 2023.  The facts describing the dispute are taken from the court opinion.

[iii] BNC Rules were enacted by Resolution 10 of 2016 of the BNC President pursuant to Articles 15 and 17(a) of Decree Law 181 of 1998.

[iv] For approximately six months, National Bank officials exchanged email correspondence with the Fund and its agents regarding identifying the documents necessary for assignment, which needed to be notarized or legalized and by whom at the Cuban embassy in London and by notaries in Cuba, and how they should be transmitted, as the courier had refused to deliver them to Cuba.  Finally, Mr. Gordhandas delivered them in person to the Fund counsel in Havana, Ernesto Caballero of Bufete Internacional.

[v] Several of the bank officers were found guilty in criminal trials on various charges in early 2020, including Raul Olivera Lozano, who was sentenced to 13 years in prison.

[vi] It is not clear what position the U.K courts would take with respect to the operation of the pari passu clause and the Court in this case does not comment on it.  It is a double-edged sword: if it is interpreted as the President of the National Bank proposes, then it could prevent a country from renegotiating its debt on different terms with different groups of creditors until all creditors can be satisfied.  That gives power to creditors seeking to extort.

[vii] An interesting question is whether under applicable choice of law rules, successor liability is determined according to the law of the preceding corporation’s jurisdiction of incorporation, in this case, Cuban law under which both the National Bank and the Central Bank of Cuba were organized, or the law specified in the contract giving rise to the obligation, in this case in the loan agreements for the Cuban Debt.  In the U.S. at least, veil piercing (ignoring the separate corporate existence of the prior entity as related to the successor in interest) is determined by the law of the jurisdiction that incorporated the corporation whose veil the plaintiff wishes to pierce (in this case, Cuban law), regardless of the law governing the contract or where the tort occurred.