Russia’s default tussle with bondholders is just beginning

If sanctions force Russia into a historic default, bondholders could be in for a messy web of legal, financial and political wrangling.

Moscow has so far been able to navigate the restrictions to service its international loans. However, that could change after the US shut down another avenue for creditors. This will affect about $100 million of payments due May 27. The European Union also sanctioned Russia’s central depository. It stated that it would suspend transactions in euro-denominated currencies.

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Russia’s capital controls and sanctions mean that the next steps are unlikely to be in line with the traditional strategy of debt restructuring, negotiations with creditors, currency devaluation, and debt restructuring. It is not clear how or if any default will be declared.

Following the developments, lawyers have provided some suggestions for possible next steps.

Russia is headed for default?

The country has a grace period of 30 days to resolve the late payments on its 2026 and 2036 dollar bonds and euro-denominated bonds. It doesn’t matter if the grace period runs out, it is possible to resolve the default.

Russia claimed that its accounts at National Settlement Depository were already debited. Moscow claims it has done its part. Bondholders will likely claim that the money doesn’t matter unless they receive it.

Darshak Dholakia a partner at Dechert LLP, stated that Russia is able to and willing to make payments. This could help Russia to argue to investors, and possibly in court if the default was declared, that the bonds are not in default due to US government actions.

Russia stated that it will use rubles to pay in foreign currency if it is unable to pay in foreign currencies. It’s listed in the prospectus of the 2036 bond as an “alternative currency payment currency”, but bondholders must be notified 15 business days prior to the payment. It cannot do the same with the 2026 bonds. While euros, British pounds, and Swiss francs may be options, Russia must notify investors at the least five business days prior to making the payment.

Russia is trying to avoid default yet again, but it’s also developing a bond payment mechanism in order to circumvent US sanctions. Anton Siluanov, the Russian Finance Minister, stated that this would allow investors access to funds without restrictions. It is not clear when and if it will be available.

Who calls the default?

If the grace period has expired and bondholders remain out of pocket, the declaration of default would normally be made by rating firms. However, the European Union has prohibited them from covering Russia. If 25% of outstanding bonds are held by bondholders, they can call one for themselves if an “Event of Default”, as defined in the prospectus.

Creditors don’t have to act immediately. They can instead wait to watch the situation in Ukraine and the impact of sanctions. The bond documents state that the claims are not voidable until three years after the date of payment.

Dennis Hranitzky from Quinn Emanuel, who heads the sovereign litigation practice, stated that bondholders should expect to call defaults and then bring legal action to clarify their claims. This will help them be better prepared for what’s coming. “But I expect that all of this will unfold in a gradual, thoughtful manner.”

Who is going to sue?

Yannis Manuelides is a partner at Allen & Overy. He suggested that Russia may be better off waiting for bondholders, who will then choose a jurisdiction and either accept it or reject it. Even if creditors initiate proceedings, Russia would still be able to present its arguments. Given the current sanctions, it might be more difficult for the sovereign to find a court willing to hear its case.

Russia’s Siluanov still says that it is open to legal action. Manuelides says that if it does, it will submit to a judicial procedure and provide a forum for discussion of the circumstances that led to the sanctions.

Christopher F. Graham, a White and Williams bankruptcy and restructuring partner in New York, said that a legal proceeding could be initiated by any of the banks involved in the payment chain.

If the money is in the hands of an intermediary, the “inter-pleader” (or indenture trustee) could open, deposit the money with a court and say to the court: “We have this money, this indenture and now all these sanctions. Please tell us what we should do,” he stated.

Does Russia have a case?

According to two lawyers based in London, Russia could claim that it has fulfilled its obligations under English law. They spoke on condition of anonymity because they are currently in discussions with the parties. Although the bonds are governed under English law, there is no jurisdiction clause in the documentation.

“Russia could attempt to argue that the sanctions rendered its performance of contract ‘impossible’ in such a case,” stated Elena Daly founder of EM Conseil, a Paris-based advisory company specializing in sovereign credit management.

Another angle is force majeure. Although sanctions have never fallen under this category historically, the sovereign or its legal counsel may still try it. One counterargument is that Russia created the circumstances that prevented the contract from being fulfilled by attacking another country’s sovereignty.

How do you enforce a ruling?

According to Deborah North of Allen & Overy, an Allen & Overy partner, investors will consider where it makes strategic sense to start proceedings, what Russia’s assets are, and how much recognition will occur. England could be the best choice. Then there’s enforcement.

The central bank’s assets have greater protection than diplomatic assets. They are also protected by the Vienna Convention. Investors will need to search for planes, shareholdings and real property assets. They also need to locate them in jurisdictions that would allow for a ruling, such as an English or US court.

The problem is that the documents do not contain a waiver of sovereign immunity. This will make it difficult to enforce any ruling.

Is there an Alternative?

Bondholders can initiate an arbitration claim based upon investment treaties (bilateral and multilateral) between Russia, the country where investors are based. These international agreements protect investments against violations of investor rights. Where a court judgement is not, the award of that dispute settlement may be enforced.

An alternative option is to consensually and out-of-court restructuring Russia’s sovereign bonds. However, this would be difficult due to all the reputational issues bondholders would face.

What are Bondholders doing Now?

According to Bloomberg sources, although they have not yet organized themselves, bondholders have spoken to different law firms about their options, according to people familiar with the matter who spoke to Bloomberg under the condition of anonymity.

Paul Marquardt, a Davis Polk & Wardwell LLP partner, said, “The more speculative queries we’ve been getting are: ‘Do you want to buy this play as a distressed loan play?'” “Who knows when this will be resolved. It is difficult to price and size this risk.

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