Russian courts question the validity of foreign bank loans

November 2013 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

Russian state commercial courts in different regions have recently considered whether a non-Russian bank can make a loan to a Russian borrower. Surprisingly, these courts unexpectedly declared such loans void. One of those decisions has been cancelled at the appellate level, but it remains to be seen what position will be taken by the higher courts.

In 2005, People’s Bank of Kazakhstan (‘Khalyk Bank’) extended two Russian law-governed loan facilities (US$35m and US$25m) to several Russian corporate borrowers within the same group of companies. In 2012, when these borrowers defaulted on the loans, Khalyk Bank sued them in the state commercial courts in Moscow and Novosibirsk seeking recovery of the respective loan facility principal, accrued interest and penalties.

The borrowers made counterclaims alleging that the loan facilities should be deemed void because Khalyk Bank is a non-Russian bank and has no licence from the Russian Central Bank to undertake any banking activity on the Russian market.

Quite surprisingly, the trial courts, first in April 2013 in Novosibirsk and then in June 2013 in Moscow, rendered very similar decisions rejecting Khalyk Bank’s claims against the borrowers and accepting the borrowers’ arguments that since Khalyk Bank is not a Russian licensed banking institution, its loan facilities are void. As a result, the borrowers were ordered to repay only the loan principal, but were released from payment of the accrued interest and penalties.

When Khalyk Bank appealed against the trial court decisions in August of this year, the 7th Appellate Court in Tomsk upheld the Novosibirsk court’s decision while the 9th Appellate Court in Moscow cancelled the Moscow trial court decision and ruled on the merits in favour of Khalyk Bank. As a result, at this moment there are two opposing court decisions based on similar facts and on almost identical loan facilities between the same parties.

Now the parties have the opportunity to bring their appeals up to the third (cassation) level courts later this year. If controversy continues, the cases may be elevated for consideration at the Russian Supreme Arbitrazh Court in 2014, which considers precedent-setting disputes in situations where there is a contradiction in the ‘uniformity of court practice’ of the lower courts.

Interestingly, according to the Russian press Khalyk Bank obtained official written explanations from high ranking officials at the Russian Central Bank, the Ministry of Economic Development and the Ministry of Finance who confirmed that there are no restrictions or prohibitions for non-Russian bank to lend funds to Russian borrowers. Khalyk Bank attempted to rely on these explanation letters in the courts, but they were reportedly ignored by the Russian judiciary.

Although these two cases are still far from making their way through the Russian court system, they have attracted plenty of attention from the Russian press and are actively being discussed within the Russian banking and financial industry, as well as in the legal community. Certain lessons and considerations may be taken from the cases at this stage.

First, both loan facility agreements were governed by Russian law and provided for dispute resolution in the Russian state commercial courts. This resulted in a very broad and discretional interpretation of the contractual provisions by the Russian judiciary. This is not a common situation, as most loans issued by non-Russian lenders to Russian borrowers are governed by non-Russian law. Hence, non-Russian banks now have even less of an incentive to subject their loan documents to Russian governing law and the jurisdiction of Russian courts.

Second, Russian courts in their analysis indicated that their authority to interpret Khalyk Bank’s standing as a non-licensed banking institution was triggered by the fact that the loan facility agreements in question provided for its performance in Russia. In particular, it was alleged that the Russian borrowers were to repay their loans and accrued interest via Russian correspondent banks acting as settlement agents for Khalyk Bank. As a result, based on the Russian courts’ position, it may be reasonable to provide that the Russian borrowers should settle their payment obligations directly to their lenders abroad – i.e., without the involvement of any Russian settlement agent banks.

Regardless of the ultimate outcome of the Khalyk Bank case through the Russian courts, major financial market players are now likely to be even more cautious and unwilling to entrust their lending documents to Russian law and Russian courts.

Sergei Volfson is Of Counsel at Jones Day. He can be contacted on +7 495 648 9200 or by email: svolfson@jonesday.com.

Sergei Volfson

Jones Day