Russian Federation: Protection Of Bond Holders´ Rights In Russia - What Could Be Done In Case Of Default?

Last Updated: 4 March 2009
Article by Andrey Novakovskiy

The Russian corporate bonds market traces its history from 1999 when Lukoil and Gazprom launched their pilot bonds issues intended primarily for those foreign investors whose money was "locked" in Russia as a result of the 1998 default. Since that time, the market has come a long way and demonstrated essential increase of the market volume, more developed structures for the bonds issues and expansion of second and third tier borrowers into the corporate bonds market. Respectively, the market could be characterized as mature except for the lack of practical conduct by the issuers and the investors in the crisis times since until recently this market never survived any default! From the practical standpoint, this means that either of the investors, governmental bodies or courts have no idea of the actual problems which the market may be faced with when certain actions are to be undertaken thereby. This article contains a brief analysis of the legal nature of the relations between borrowers and investors and describes alternative patterns of investors' conduct when a default occurs providing for that end some practical recommendations for the investors .

According to the analysts' forecasts, Russian companies will have to pay $15.5 billion as bonds' principal and accrued interest in 2008 – 2009. In the light of the financial crisis many borrowers are likely to fail with the proper and due performance of their obligations thus provoking numerous defaults.

Unfortunately, defaults on bonds have already come true. Up to now 14 defaults on Russian bond market were noted.

Legal Framework for Corporate Bonds

Àny company is entitled to place bonds for the total value not exceeding the amount of its charter capital. Historically Russian companies do not have substantial charter capital and respectively are to provide some additional collateral with the view to issue bonds in the needed amount.

The list instruments, which can serve as collateral, is set by law and includes bank guarantee, government or municipal guarantee, surety and pledge.

As a rule, pledges are used for the purposes of getting the loans from the banks, guarantees not accessible for the borrowers with a lower credit risk ratio; therefore, surety is the most widespread form of collateral for corporate bonds of Russian companies.

The most simple and effective form of borrowing structure for bonds is a bond issue secured by surety.

As a matter of fact, this scheme enables any borrower to place its debt backed only by its own credit risk, without providing investors with any additional "outside" collateral. For that end formally the bonds are issued by a special purpose company, usually a wholly owned subsidiary of the ultimate borrower, which is granted with no assets and is not expected to pursue any business activities. Since Russian law sets no specific requirements for the financial condition of the surety although prescribes for any issued securities to be backed by respective collateral, such a subsidiary places the bonds secured by the suretyship of its shareholding company, thus formally complying with the referred rules.

Default as It Is

Default is defined as a failure by the borrower to perform its obligations towards the creditor as to the due and proper payment of interest and/or the principal.

Legal nature of relations between the creditor and the borrower in connection with the bonds circulation and with regard to the performance of a loan agreement seem to be almost the same, whereas the status of the creditor in the both cases will be substantially different.

The discrepancy is mainly predetermined by the set of remedies immediately available to the lender on the basis of a loan agreement when the financial condition of the borrower starts worsening. Particularly, the lending bank can demand an early loan repayment in the event that the borrower attracts new funds on the more advantageous conditions for the new creditors or if the borrow fails to comply with any of the covenants, which according to the loan agreement trigger the early redemption.

Whereas, Russian bonds generally grant no similar rights for the bond holders for claiming early bonds redemption before maturity.

As a result, corporate bond investors in many respects lack the preventive remedies against worsening financial condition of the borrower.

In this connection, an investor may successfully handle with the defaulted bonds only when it has the capability to forecast and reveal any signs of such a default so that as soon as the default actually occurs it can immediately react being far beyond all the other creditors.

There are several sources of information indicating that the crisis is approaching. Default could be forecast by using methods of technical analysis, tracking information published by specialized news agencies (e.g. CBonds), monitoring news lines and the corporate Internet sites of bonds issuers (mandatory channels for providing the market with information on issuers, e.g. www.akm.ru, www.interfax.ru). Notwithstanding this requirement to promptly disclose information on the essential events affecting financial condition of the issuer, including default, in the mass media (within one day) and at the web site of the issuer (within two days), it shall be taken into account that the issuer may not fulfill such prescription since the obligation is binding on the issuer rather than on its officials, which in no way can be held criminally liable or similarly punished once the delayed disclosure takes place and are not mandatorily motivated to follow the disclosure rules in such cases.

Along with the concept of "default", the bonds legislation operates with the "technical default" concept, which is believed to be a delay of payment of an accrued interest or principal for the term of up to 7 and 30 days respectively (upon the expiration of that period the default ceases to be deemed technical and turns into an actual one). Bond investors should be well aware that legally the conduct of an issuer who fails to honor its payment obligations within the terms set by the prospectus is considered to be a breach of contractual undertakings irrespective of the delay duration, which immediately makes available for the investor all the accessible remedies inclusive of the claim service to the court of jurisdiction.

As a form of default there can be specifically mentioned a failure of the issuer to redeem the bonds presented for the early repurchase by the bondholders at the terms specified in the prospectus. Such a failure represents a default on bonds and it shall be distinguished from the seemingly similar situation when the offer for the redemption of bonds is made and not duly performed by a third party (not by the issuer). In the first case, the consequences of a non-performance are similar to the issuer's default on redeeming its bonds, whereas in the second case it comes to the breach of contractual obligations by the offeror resulting in no recourse by the bondholders to the issuer whose bonds were promised to be repurchased.

Alternative Actions of the Investors Upon the Default Occurrence

It is only natural when the investor tries to sell its bonds after learning about the default. Obviously, low liquidity and decreasing quotes will hinder this process. Being unable to sell the bonds at any acceptable price, the investor should attempt to satisfy its claims by using some alternative methods.

Obviously, bringing of a claim to the court is a basic one. Alternatively there can be reached an acceptable solution with the debtor without resorting to the court proceeding. Arrangements in the latter case can vary from the consideration to be provided by the issuer up to the entry by the bondholders into the equity of the debtor and joint operative management of its business.

However, for the purposes of either the effective litigation or of the extrajudicial negotiations the investor has to combine the maximum amount of claims since otherwise the investor risks to remain an unnoticed creditor. Besides, it is important to understand that sometimes litigation and enforcement procedure costs could be rather significant which means that in the case of minor claims for small amounts, legal costs might be comparable in size with the claimed amount.

Unfortunately, at present all the possible methods of claims consolidation (provision with the respective powers of attorney for the court proceeding, transfer the bonds in trust management or conditional sale of bonds with the deferred payment performance upon the receipt of the due proceeds from the issuer) are not absolutely effective since the person who is trying to consolidate the authorities shall gain the trust of the bondholder and to the extent that the claims consolidator depends on the will of bondholders the combination of claims may not always attain the sought result.

Russian legal system is not familiar with the institution of the class action suit known in the Anglo-Saxon legal system. Whereas this institution enables a preliminary appointed process agent in the event of default to bring a claim in the court in the name and on behalf of all the holders of defaulted bonds.

A close analogue of such a tool can be found in the Russian Federation Law "On Protection of Rights and Legitimate Interests of Capital Market Investors". According to Article 14 of the said Law, the Federal Financial Markets Service of the Russian Federation (FFMS) has the right to take legal action to protect investors' interests. However several factors prevent the realization of this legal opportunity, the main one being the lack of any judicial practice of the referred law rule application, specifically, it is not clear who will be the plaintiff in such a claim (according to existing practice, only a concrete person can be the plaintiff, but not a class of persons as in our case all the bondholders of a concrete bonds issue would serve on the part of the plaintiff), in whose name the writ of the court award enforcement will be issued, etc. It looks like the FFMS as the stock market regulator should work out the amendments to the legislation which will ensure the practical application of the referred provision of the Law.

Investors expecting to actually receive funds as a result of litigation should clearly understand that such actions can be successful only when a favorable court judgment is issued before the debtor is declared bankrupt. Otherwise, the claims of the bondholders will be added to the bulk of other third priority claims and will compete with the unsecured claims of all other creditors thus making the full redemption of such claims to be not likely.

Considering other difficulties to be faced with by the investor in any litigation (including different jurisdictions of courts considering claims raised by individuals and by legal entities, substantial timing needed for the hearing of cases in the courts of general jurisdiction, extended period of the enforcement proceeding, prohibition for new plaintiffs to join the existing process, remote chances to consolidate cases containing similar claims to the same issuer), the timing factor acquires paramount significance for the success of any actions in the view to the recovery of debt.

Therefore, our main recommendation to investors experiencing a default of the held bonds' issuer is to seek legal action against the issuer immediately after the technical default occurrence.

Additional recommendations are as follows:

  • claims should be presented to all parties who are liable (i.e. the surety), not just to the issuer;
  • to file an application to engage the FFMS as a third party in the litigation because the FFMS position will simplify the understanding of the case by the court;
  • to apply to the court for the injunction measures such as the arrest of the funds or other property of the issuer and other liable parties;
  • to involve professional organizations (law firms, investor rights protection associations, etc.) to protect your interests.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions