Interest rate swap agreements: draft information letter of the Russian Supreme Commercial Court

This alert discusses the recently published ¹ Draft Information Letter of the Presidium of the Russian Federation Supreme Commercial Court (the “SCC”) entitled “Dispute Resolution Issues Arising out of Interest Rate Swap Agreements” (the “Draft”). The proposed recommendations of the SCC relate to such aspects as the formation, amending and termination of interest rate swap agreements, conformity of their performance to the purpose of their conclusion, pre-contractual disclosure concerning the nature and intended effects of such type of agreements.

Current interest in these matters is explained by the outcome of two recent cases considered by the Russian courts (the Agroterminal and Hermitage Development cases²) in which the unilateral termination of interest rate swap agreements without any payment or compensation by the terminating party to the other party was found to be lawful. In addition, the interest is due to the numerous foreign court decisions related to the principle of protection of non-professionals’ rights in the financial market.

The Impact of Recent Disputes concerning Derivative Transactions on the Legal Position of the SCC

Interest rate swap agreements concluded under the Russian law are regulated by the legislation on the securities market ³ and general provisions of the Civil Code of the Russian Federation (the “Civil Code”) on the making of agreements (Articles 432 and 433 of the Civil Code) and on the termination of obligations (Articles 408 and 407 of the Civil Code). For example, the courts applied these general provisions of the Civil Code in the Agroterminal and Hermitage Development cases.

The Draft provides for the introduction of a requirement whereby early termination of a master agreement (general agreement) made with respect to swap transactions is only possible where the parties do not have a continuing legal relationship arising out of swap transactions. Early termination of certain swap transactions is permitted either by agreement of the parties or on grounds provided for under applicable law or contract (Clause 2 of the Draft).

This approach does not conflict with current regulation on the procedure for terminating derivative transactions as laid down in the standard documentation for derivative transactions on financial markets, with due regard for the amendments approved in December 2012⁴ The Draft states that if an interest rate swap agreement is terminated early, the parties are to calculate the final amount (close-out amount) in accordance with the procedure provided for under the agreement. Such calculation is to be made on an early termination date. The debtor identified as a result of such calculation is to pay the final amount (close-out amount) to its counterparty. The obligation to make the final payment can be terminated either by proper performance or on the basis of other grounds under the applicable law or contract.

This provision aims to resolve the key issue of the existence of payment obligations between parties to an interest rate swap agreement, not only on but also prior to the payment date.The Draft implies a positive answer to this question. This differs from the position taken by the courts previously in the Agroterminal and Hermitage Development cases, in which the courts deemed it possible to terminate interest rate swap agreements prior to the payment date without making calculations between the parties. This was on the basis that there was a contractual provision that either party may terminate the agreement unilaterally at any moment provided that there are no outstanding contractual obligations.

The Draft confirms the statutory ⁵ right of the parties to apply to their legal relationship the standard terms of agreements concerning derivative transactions in financial markets (Clause 3 of the Draft). This provision is complemented by the rule that amendments made to the standard terms shall only apply to the relations arising out of the agreement if this is directly agreed by the parties. Therefore, the amendments to the standard terms as published in December 2012 do not automatically alter the terms of agreements made based on and referring to the previous version of the standard terms. Nor are such agreements subject to the arbitration clause provided for under the latest amendments to the standard documentation.

Pre-contractual Disclosure by Financial Market Professionals

The Draft requires financial market professionals (“professionals”) to disclose to their non-professional clients information concerning the forthcoming transaction and its likely economic and legal consequences (Clause 4 of the Draft). This requirement fits with the principle of protecting the weaker party to a transaction. This is not expressly provided for in the Civil Code but is applied in the interpretation of provisions relating to accession agreements, public agreements, as well as statutory provisions on consumer rights and other provisions. According to the latest trends of the SCC’s practice, this principle may be taken into account by the courts when considering dispute resolution cases ⁶.

The new requirement is not fully embodied in statute, nor is its legal nature clear, as it concerns pre-contractual relations which, as a general rule, are not afforded the protection of the law.

As noted above, this requirement only applies to professionals. According to the Draft, these are persons who either enjoy the status of a qualified investor as per Article 51.2 of the Securities Market Law or may be so qualified in accordance with the criteria specified in Clauses 4 and 5 of the above article (criteria of the total amount of obligations, quantity, amount and deadline of the transactions, the amount of equity, earnings, total assets, etc.).

A professional failing to comply with disclosure requirements faces a potential claim from a non-professional client for termination of the agreement and for damages. According to the Draft, for the Claimant to be successful in such instances, it must prove the following complex of facts: first, the Respondent is a professional; second, the Respondent acted in bad faith; third, the Respondent concealed the degree of risk involved and that the degree of risk was higher than was objectively prepared for; and, forth, the outcome of the transaction failed to meet the Claimant’s reasonable expectations.