Analysis: As Russia faces potential default, investors weigh legal options

  • Russia in 30-day pardon on $649 million debt payments due April 4
  • The US Treasury has banned the use of frozen funds for debt payment
  • Moscow says Western sanctions blocked payment in US dollars
  • Litigation can be expensive, time-consuming

NEW YORK/LONDON, April 21 (Reuters) – With Russia on the brink of a historic default, foreign investors in the country’s debt have few acceptable options to get their money back: betting on costly lawsuits, trust bilateral agreements or sit on their hands.

Foreign creditors would generally try to unite to negotiate, go to court or, in some cases, seek arbitration in the event of default, but Western sanctions following Moscow’s invasion of Ukraine and the peculiarities of Russian sovereign bonds make these options difficult at the moment. , the lawyers said.

Some $40 billion of Russian sovereign debt issued in dollars and euros is outstanding, about half of which is held by foreigners. Under the terms of most of this debt, Moscow must pay investors in the currency in which the bonds are denominated.

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Western sanctions cut off Moscow’s access to some $300 billion in gold and currency reserves it held in banks abroad. This means that Moscow must either use the hard currency it has to pay investors or default on its obligations.

Russia says it has the money and is ready to pay, but can’t because of sanctions imposed in response to what it calls a “special military operation” in Ukraine. He said he would use his own currency if he could not pay in foreign currencies until his reserves were unfrozen.

He made a $649 million payment that was due April 4 on two of his bonds in rubles rather than the dollars he was obligated to pay under the terms of the debt, a decision that a body of derivatives watchdog deemed it a “potential failure to pay”.

Ratings agencies have said Russia could default because payment must be made in dollars or because of a perceived lack of willingness to repay, with S&P lowering its currency ratings to “selective default”. Read more

Once a 30-day grace period for April 4 bond payments passes in early May, investors would have three options, said Dennis Hranitzky, head of sovereign litigation at law firm Quinn Emanuel.

They could wait and see what happens, sue Russia in court or seek arbitration under bilateral treaties Russia has with dozens of countries, he said.

With the sanctions situation evolving as the war rages on, the first option is the most likely, said Hranitzky and other lawyers who are in contact with the bondholders.

“I don’t think we know enough about how this is going to play out, we don’t know how long the war is going to last,” Hranitzky said.

The situation with Russia is unprecedented.

A lawyer says the closest historical parallels, where geopolitics is the main driver of a potential default scenario, is when US President Jimmy Carter halted Iran’s oil sales and froze its assets in Iran. foreigner in response to the 1979 hostage crisis at the U.S. Embassy in Tehran. , and when Britain encouraged banks to declare Argentina in default following the 1982 Falklands War.

In both cases, the crisis eventually subsided, as did the political pressure, said veteran debt lawyer Lee Buchheit.

“It’s been 40 years since we’ve seen anything like this,” said Buchheit, who has worked on sovereign debt restructurings such as Greece and Argentina. “It’s not a financial problem, it’s a purely political problem.”

Bondholders can try to go to court, but this is often a long and expensive process to either seek compensation or seize assets. In Russia’s case, the lawsuits will be even heavier, the lawyers said.

On the one hand, the contracts of the bonds in question do not define jurisdiction in the event of a dispute, which will make it more difficult for the bondholders to decide on the place they will use to bring an action.

Lawyers also expect Moscow to mount a defense blaming the sanctions on its failure to pay after Finance Minister Anton Siluanov said Russia would take legal action if the West forced it to default. Read more

The bond contract is bound by English law, under which the frustration of purpose argument could be made, meaning Moscow could argue that it tried to pay but the West didn’t. left to do because of the sanctions.

“Russia is going to argue that,” said Mitu Gulati, a University of Virginia law professor and debt restructuring expert. However, he expected Moscow to have limited success. “Yes, it’s a war, but it’s a war caused by Russia.”

Another option for investors would be to seek arbitration directly against Russia. Investor-state arbitration allows creditors in jurisdictions that have entered into bilateral investment treaties to file claims and seek monetary damages and other relief directly against the state.

Russia has dozens of such treaties, including with most European Union countries, the United Kingdom and Canada, according to the United Nations Conference on Trade and Development.

An arbitration award like this could be enforced in US courts, said Hranitzky, whose firm also represents the Ukrainian government in financial disputes with Russia.

“The nightmare scenario is that the situation in Ukraine is not resolved and the sanctions remain in place for months, maybe longer,” Buchheit said.

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Reporting by Karin Strohecker and Rodrigo Campos; additional reporting by Jorgelina do Rosario; edited by Paritosh Bansal and Emelia Sithole-Matarise

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