Derivatives under Russian law – a new risk area?
15 July 2013
For many years there were serious doubts as to the viability of derivative transactions under Russian law. Despite various obstacles, the derivatives industry succeeded in creating a Russian language equivalent of the ISDA Master Agreement, governed by Russian law (RISDA). In addition, new legislation was enacted in the course of 2011-2012 to make netting provisions enforceable under Russian law. Just when it appeared that there may be a firm legal foundation in Russia for derivative transactions, the decision reported below has once again threatened to undermine their status.
The facts of the case are as follows:
The Russian subsidiary of UniCredit Bank (UniCredit) and a Russian company, LLC “Hermitage Development” (Hermitage), entered into an interest rate swap under the Master Agreement on General Conditions of Performing Derivative Transactions governed by Russian law (the Master Agreement). Hermitage subsequently requested that UniCredit amend the terms of the interest rate swap. When UniCredit refused to do so, Hermitage filed a law suit in Russia against UniCredit, requiring the unilateral termination of the Master Agreement.
The court of first instance accepted Hermitage’s claim and subsequent appeals filed by UniCredit to the higher courts, including to the Supreme Arbitration Court of the Russian Federation, were denied.
The courts placed emphasis on a clause in the Master Agreement which provided for “a right of any party to terminate the Agreement at any time if there are no outstanding obligations”. Having analysed the terms of the interest rate swap, the courts concluded that until the next payment date when the reference interest rate is identified and the amounts payable by each party are calculated, each party does not have any payment obligations to the other. Further, if there is no payment obligation at all, there is certainly no “outstanding obligation”, thus the Master Agreement could be terminated unilaterally, as requested by Hermitage.
The Russian courts did not appear to appreciate that, under a derivative contract, parties undertake obligations for the “life” of the transaction, so even if there is no outstanding specific payment obligation, the nature of a derivative transaction is such that there are always future obligations which bind the parties for its full duration.
This unfortunate court decision has created a risk that a party to a derivative transaction which is “out-of-money” may simply “walk away” from a contract which has become commercially unattractive to it, leaving its counterparty with losses.
The simple way to mitigate this risk is to avoid derivative contracts governed by Russian law. However, there may be legal and commercial reasons why such an approach is not practicable for those who do business in Russia. In such case, it’s important to ensure that a derivative contract based on the RISDA does not have any vague or ambiguous provisions which may “inspire” Russian courts to take decisions that shake the market and frustrate market participants.
Contributed by Igor Gorchakov