The Russian state arbitrazh courts harecently considered a number of disputes between the owners of bonds issued on Russian stock exchanges and the issuers and guarantors of such bonds, with many issuers having defaulted onpayments during the financial crisis. Before the financial crisis, very few bond disputes reached Russian courts, which, as a result, have not yet adopted a consistent approach to the resolution of such disputes. In addition, Russian securities legislation is still relatively underdeveloped and has not kept pace with market practice, putting investorsin an awkward position.
In particular, court practice in disputes involving third party guarantors of bonds (mainly in the form of suretyships) has been very inconsistent. Recently, Dechert’s Moscow office successfully represented a foreign investor in the Russian state arbitrazh courts in a bond dispute with a major Russian agro-industrial holding. The decision, which has influenced other decisions in subsequent cases, was the first time in Russian court practice that an arbitrazh court:
- ruled that a guarantee of the bond obligations of an issuer may be executed without the guarantor signing either the bond resolution (i.e., the decision to issue the bonds) or the bond prospectus, and without including the terms of the guarantee into the issue documentation;
- declared valid a guarantee of an issuer’s bond obligations which was sent as a public offer, with a notice to such effect posted on the internet;
- acknowledged the possibility of executing a guarantee of an issuer’s bond obligations after the state registration of the bond resolution and bond prospectus.
The Facts of the Case
In 2006, Derzhava-Finans LLC (the “Issuer”) (a company which is part of a major Russian agro-industrial holding ‘Derzhava’) agreed to issue bonds in certificated form and on September 26, 2006, the Russian Federal Financial Markets Service registered the bond issue and bond prospectus, the bond issue having a total nominal value of RUB 1 billion.
To guarantee the performance of the obligations of the Issuer with respect to the bond issue, a number of legal entities from the Derzhava group of companies executed a guarantee in the form of a suretyship. Three guarantors signed the bond resolution, bond prospectus and bond certificate and their offers were included into the text of the issue documentation. However three other guarantors (Pavlovsky Zavod Metallicheskikh Konstruktsij JSC, Group of Companies Derzhava JSC, and SelProm-NN LLC) (the “Late Guarantors”) issued public offers which were sent to the issuer after the state registration of the bond issue and prospectus. Their offers were not included into the text of the issue documentation, but were rather posted on the website of the Information Agency “CBONDS” on the internet (www.cbonds.info). The Late Guarantors did not sign the bond resolution, bond prospectus, or bond certificate.
In 2007, the bonds were floated on the Moscow Interbank Currency Exchange (MICEX). Beginning from September 2008, the Issuer defaulted on scheduled principal and interest payments. Dechert’s client, a foreign investor (the “Investor”) which purchased the bonds in April 2009, applied to the Moscow State Arbitrazh Court with a claim against the Issuer and the guarantors (including the Late Guarantors) for the cost of the bonds, accumulated interest and penalty payments (case No. А40-99098/09-83-674).
Legal Analysis of the Case
In the course of the court proceedings, the Late Guarantors disputed the claim, arguing that the guarantees they provided were invalid due to a violation of the Law “On the Securities Market” (the “Securities Law”).
In accordance with Clause 2, Article 27.2. of the Securities Law, if a guarantee is issued in favor of a bond, the terms of the guarantee must be referred to in the bond resolution, must be included in the bond prospectus, and in the case of a certificated form of issue, also included in the bond certificates. Clause 3, Article 27.2 of the Securities Law provides that if a bond is guaranteed by a third party then the bond resolution, bond prospectus and bond certificate (if relevant) must be signed by the guarantor. Similar requirements are included in paragraphs 6.2.12. and 6.2.15. of the Russian Standards of Securities Issue and Securities Prospectus Registration which were in force at the time the decision was made by Derzhava-Finans LLC to issue the bond.
It should be noted that the position of the guarantors was also supported by then-existing court practice, in particular, by a decision of the Federal District Court of Moscow region No. КG-А40/818-06 of 03.03.2006 and a decision of the State Arbitrazh Court of the city of Nizhniy Novgorod of 14.07.2009 on case No. А43-9731/2009-11-241.
Notwithstanding the above past precedents, we argued on behalf of the Investor2 that such decisions were contrary to certain principles of Russian law. In particular, we argued, inter alia, that:
- Article 27.2 of the Securities Law should only apply to guarantees which are provided before the issue of the securities, because after the bond resolution and the state registration of the issue and the prospectus, a guarantor has no possible way of signing the issue documents; and
- pursuant to Article 361 of the RF Civil Code and the position of the Presidium of the RF Supreme Arbitration Court in Resolution No.7261/09 of 28.07.2009, a guarantee is regarded as a method of ensuring the performance of obligations and may be created at any time during the performance of a principal obligation and not only at the start of the issuance procedure as argued by the guarantors.
The Moscow State Arbitrazh Court in its ruling of 20.10.2009 agreed with our arguments and awarded the disputed amounts in full to our client, including the cost of the bonds, the accumulated interest and penalty payments. The Ninth Arbitrazh Court of Appeal in its Resolution of 20.01.2010 upheld the judgment of the court of the first instance and agreed with the reasoning as set out above.
Consequences of the Decision for Russian Court Practice with regard to Bond Disputes
A court decision is not recognized as a source of law in the Russian Federation, however, as in many other civil law jurisdictions, court judgments are acquiring greater significance in Russia (especially the decisions of the appeal and cassation courts and the resolutions of the Presidium of the RF Supreme Arbitration Court).
The resolution of the Ninth Arbitrazh Court of Appeal in case No. А40-99098/09-83-674 will hopefully be an important judicial decision in terms of the defense of investors' interests in the Russian securities market and the enforcement of guarantees of corporate bond issues.
In several subsequent cases, the Russian state arbitrazh courts have, in similar circumstances, begun satisfying claims of investors (e.g. in the judgments of the State Arbitrazh Court of the city of Nizhniy Novgorod of 05.02.2010 in case No. А43-9736/2009-27-85/32 and of 12.02.2010 in case No. А43-19794/2009-27-183/8, as well as in the ruling of the Ninth Arbitrazh Court of Appeal in case No. А40-101091/09-57-468).
However, there is still some way to go before the courts adopt a universal approach to this issue and in several other cases the courts have continued to dismiss similar arguments made by bondholders in terms of the obligations of guarantors (e.g. in the judgment of the Tenth Arbitrazh Court of Appeal of 11.03.2010 in case No. А41-28545/09).