UK COURT RULES ON DONEGAL "VULTURE FUND"

UNCLAS SECTION 01 OF 02 LUSAKA 000209

SIPDIS

SENSITIVE BUT UNCLASSIFIED

SIPDIS

E.O. 12958: N/A
TAGS: PGOV KCOR ZA
SUBJECT: UK COURT RULES ON DONEGAL "VULTURE FUND"

REF: 06 LUSAKA 985
06 LUSAKA 280
05 LUSAKA 603


1. (SBU) SUMMARY. On February 15 a UK judge ruled that the
Government of Zambia is liable for a debt owed to Donegal, a British
Virgin Islands-based investment fund that is partly owned by a U.S.
company. Although the ruling received much negative publicity in
the international media, some Zambian Government officials viewed it
positively, primarily because the ruling suggested that Zambia will
not be liable for accrued interest on the outstanding debt. They
are also pleased that the case has exposed corruption surrounding
the Donegal deal and has raised public awareness of--and aversion
to-"vulture fund" practices. END SUMMARY.

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Background
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2. (SBU) In 1979 the GRZ borrowed approximately USD 14 million to
purchase Romanian tractors but subsequently failed to service the
debt. In December 1998, the GRZ negotiated an agreement with the
Romanian government to liquidate the debt for USD 3 million. Before
this arrangement could be completed, Donegal International purchased
the non-performing debt for USD 3.2 million (approximately 11
percent of its face value). There were allegations that the British
Virgin Islands-based Donegal, which is partly owned by a U.S.
company, Debt Advisory International, engaged in corrupt practices
to secure the deal (Ref C).


3. (SBU) In 1999, the value of the unpaid principle plus interest
(accruing at an annual rate of 8 percent) was USD 29 million.
According to a settlement agreement that the two parties reached in
London in early 2004, Zambia agreed to pay Donegal USD 42 million,
reflecting a balance of USD 29 million plus an additional USD 13
million in accrued interest. Allegedly the agreement also
stipulated that in the event of a dispute, the matter would be
litigated in UK courts.


4. (SBU) However, in March 2004, after the Task Force on Corruption
found evidence of fraud in Donegal's acquisition of the claim, the
GRZ stopped servicing the debt (Ref B). Donegal subsequently
launched a civil case in the UK, suing the GRZ for the outstanding
balance. Donegal also applied to the UK courts for an injunction,
freezing about USD 50 million in Zambian government assets.


5. (SBU) The court case began in February 2006 in a UK civil court
and ran through July 2006 (Ref A). DLA Piper, the UK law firm
representing the GRZ, built its defense on the contention that
Donegal acquired the debt through fraud and therefore had no claim
against the GRZ. The legal team--led by William Blair (Prime
Minister Tony Blair's brother)--provided evidence on a series of
bribes, including one to former President Chiluba, that were used to
acquire the debt as well as to facilitate Zambian payment on the
debt.

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The Ruling
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6. (SBU) On February 15, a UK judge ruled against the GRZ's
application to dismiss Donegal's claim. The judge, Andrew Smith,
reportedly found Donegal's actions to be "reprehensible but not
illegal." Nevertheless, he proposed to end a freeze of Zambia's
assets secured by the fund, and indicated that Zambia would not be
liable for the entire outstanding amount (which by 2007 had reached
USD 55 million, according to Donegal's calculations),but rather
would be required to compensate Donegal for the original debt (USD
14 million) plus damages. Embassy contacts estimate that "damages"
will include some legal fees, less the USD 2.2 million that Zambia
already paid to Donegal. The total is likely to be between USD 10
and 20 million.


7. (SBU) The case will reconvene on March 9, and a final ruling on
Zambia's liability is expected in April. Embassy contacts point out
that there is no precedent in UK courts and that it is possible that
Judge Smith will further reduce Zambia's liability. They also
speculate that Judge Smith has little sympathy for Donegal, whose
witnesses the Judge reportedly found to be "dishonest and
deliberately evasive."


8. (SBU) A representative from the Attorney General's office and
other informed sources told P/E officer that they viewed the ruling
positively because it has exposed the corruption behind the Donegal
deal, and because it has raised public awareness of--and aversion
to--so-called "vulture funds" (companies that buy debts of poor
nations at reduced rates, and then sue for the full value of the
debt plus interest). They expressed relief that Zambia would not be
liable for the unpaid interest, which by 2007 has dwarfed the
original loan amount. They also opined that the Donegal case was

LUSAKA 00000209 002 OF 002


the most challenging of the three high-profile Zambian cases before
UK civil courts (Ref A).


9. (SBU) A representative from the UK's Department for International
Development (DFID),which has provided substantial budget support to
the Task Force on Corruption, told P/E officer that DLA Piper
attorneys were "delighted" by the ruling. She also described as
"ridiculous" media reports that attempt to link the Donegal ruling
to debt relief. (NOTE: A local consultant to Oxfam has made this
link, which has reverberated in international media. END NOTE.)

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COMMENT
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10. (SBU) In 2006, Zambia benefited from almost USD 3.9 billion in
debt relief. Those who claim that Zambia's Donegal liability is
somehow equal or comparable to 2006 debt relief are hugely mistaken.
The liability is perhaps more easily likened to Zambia's
anticipated 2007 foreign debt service of USD 34 million (compared to
a pre-debt relief figure of USD 373 million).


11. (SBU) In many ways the ruling could be considered a small
victory to the Task Force on Corruption, insofar as the Task Force
succeeded in exposing the shady dealings behind the Donegal debt
agreement, and inasmuch as its UK attorneys succeeded in reducing
Zambia's liability. Zambia's liability, however, is still likely to
be larger than the amount that had been agreed upon with the
Government of Romania in 1999. Unfortunately, much of the local
media coverage has lacked clarity and has focused on the liability,
rather than the alleged corruption that surrounded the Donegal deal.
Attempts in the local and international media to make linkages to
debt relief (an entirely unrelated matter) only muddy the waters
further by making the issue about poverty rather than corruption.

MARTINEZ