By Rodrigo Campos and Karin Strohecker

NEW YORK/LONDON – With Russia on the verge of a historical default, investors are left with few options. They can either bet on expensive legal action or trust that bilateral agreements will hold, or they can just sit there.

Lawyers said that foreign creditors might try to group together and negotiate with each other, or even go to court. Arbitration in default cases is possible in certain cases, however, due to Western sanctions, the invasion of Ukraine by Moscow, as well as the particularities of Russian sovereign bond, these options are difficult.

About $40 billion in Russian sovereign debt is still outstanding. The rest of it has been issued in euros or dollars. Moscow is required to pay foreign investors the currencies in which most of the debts are denominated.

Western sanctions cut off Moscow’s access to some $300 billion in gold and foreign currency reserves it held in banks abroad. Moscow is now forced to either pay back investors with the hard currency it holds at home or use that money for its own purposes.

Russia asserts it has the cash and would pay, but it cannot due to sanctions that were imposed to stop it from paying for what it refers to as “special military action” against Ukraine. The Russian government stated that it will use its currency to pay foreign currency payments until it has unfrozen its currency reserves.

The $649 million payment it made on its two bonds due April 4, in roubles instead of dollars, was deemed a failure by a derivatives regulator.

Rating agencies have said Russia may be in default because the payment must be made in dollars or due to a perceived lack of willingness to repay, with S&P lowering its foreign currency ratings to “selective default”.

Investors will have three choices once the 30-day grace period for April 4 bond payments has expired in May.

They can either sit back and wait, file legal action against Russia, or request arbitration under bilateral treaties Russia has made with dozens more countries, he stated.

Hranitzky, along with other bondholder lawyers, stated that sanctions are changing and the first choice is most likely.

Hranitzky stated, “I don’t believe we have enough information about the unfolding of this war. We don’t know how it will end.”

LEGAL ACTION

Russia’s situation is unique.

A lawyer stated that the closest historical parallels in which geopolitics play a major role in any potential default scenario are when the U.S. president Jimmy Carter stopped Iran from selling oil and frozen its assets overseas in response the 1979 hostage crisis at Tehran’s American Embassy. This was also the case when Britain encouraged banks and other financial institutions to declare Argentina bankrupt in the aftermath of the 1982 Falklands/Malvinas War.

Lee Buchheit, an experienced debt lawyer, says that in both of these cases the crisis ended as well as the political pressure.

Buchheit said that it has been forty years since anything like this was seen. He worked with such sovereign debt restructurings in Argentina and Greece. This is not a problem of financial magnitude; it’s purely a political issue.”

Although bondholders have the option to go to court, this can be costly and time-consuming. The goal is to get compensation or to seize assets. Russian lawyers warned that the legal process will be more complicated.

First, bonds contracts do not establish a place of jurisdiction for disputes, making it harder for bondholders choose the location they want to sue.

Lawyers expect Moscow also to file a defense, blaming sanctions as to its inability pay. Anton Siluanov, the Finance Minister of Russia said that Russia will take legal action against any West force it to default.

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

Mitu Gulati (a University of Virginia professor of law and expert on restructuring debt) said, “Russia will argue that.” But he was confident that Moscow would be unsuccessful. This is not a Russian war.

An alternative option is to directly seek arbitration against Russia. Investor-state arbitration is a way for creditors in countries with bilateral investment treaties, to file claims against Russia and claim monetary damages.

According to United Nations Conference on Trade and Development, Russia is a party to dozens of these treaties. This includes with the majority of the European Union and the United Kingdom.

Hranitzky stated that such an arbitral award could be applied in the United States courts. Hranitzky’s firm also represents Ukraine in financial disputes with Russia.

Buchheit stated, “The worst scenario is that Ukraine’s situation isn’t resolved” and said sanctions could remain in effect for several months or even longer.