Corporate Bond Default on the Russian Capital Market

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According to Article 2 of the Federal Law "On the Securities Market," a bond is an issued security, i.e. a security, including both certified and uncertified securities, having the following features at the same time: it formalizes the aggregate of property rights (for instance, the right to the interest rate (coupon) that will be paid and the loaned funds (bond principal) are to be returned) and non-property rights which are subject to certifying, assignment and unconditional realization in compliance of form and order provided by law; it has equal volume and terms of realization of the rights within one issue regardless of the time of such security acquisition. According to Article 816 of the Russian Civil Code, а bond is a way of entering into a loan contract (however, we may determine a bond as a way of entering into a complex contract with a significant part of loan and some elements of other obligations).

In practice, corporate bonds are issued in uncertified form, i.e. units of a security could be evidenced otherwise than by a certificate and transferred otherwise than by a written instrument.

The term "defaulted bonds," now frequently used, means a breach of obligations under debt security by an issuer. Starting from Q4 2008, there has been an avalanche of Russian bond issuers defaulting on their debt. About 98 companies have broken their bond obligations. In the same time, Russian legislation is not able to cover such events as well as it covers bond issuance.

Provisions on issuer's default and investor actions in case of such a default shall be set in Article 9.7. of any issuer's Decision on bond issuance.

According to Article 6.2.10. of the Standards of Issuing the Securities and Registration of the Security Prospectuses, dated January 25 2007 and approved by Order No. 07-4/pz-n of the Federal Financial Market Service ( the "Issuing Standards"), failure by an issuer to fulfill its obligations under bonds is a material breach of the terms and conditions of the concluded loan agreement (default) if:

•payment of regular interest (coupon) under the bond is overdue more than seven days, or the issuer refuses to fulfill such a payment obligation;

•repayment of the bond principal is overdue more than 30 days, or the issuer refuses to fulfill such an obligation.

Fulfillment of the payment obligations with delay but within the time frame established by the Issuing Standards constitutes a technical default.

The above provisions must be contained in Decision on bond issuance of any issuer being a Russian legal entity since these provisions are imperatively established by the Issuing Standards.

We would like to consider second default ground on the example of one of the standard situations.

As a rule, a Decision on bond issuance includes the issuer's obligations of early redemption of all bonds or a part of bonds in the issue in the following cases:

•there is a direct statement period established in Decision on bond issuance for redemption of the bonds by the issuer (for example, within the last five days of the 3rd and the 6th coupon periods);

•there are certain possible events established in Decision on bond issuance with the occurrence of which the issuer shall redeem the bonds (for example, in case if after the announcement of coupon rates there are still undecided rates in respect of at least one of the subsequent coupons the issuer determining rates for such a coupon shall buyback the bonds at the request of the bondholders within the last seven days of the last determined coupon period).

The above cases are considered as a public obligatory offer. In practice there are concerns whether an issuer's failure to perform its obligations under a public obligatory offer to bondholders accepting such an offer will result in the right of bondholders of the same issue who did not accept the offer on early repayment.

Answer on the above can be given only after detailed review of terms and conditions of Decision on bond issuance. Without such a review there can be a situation when an investor not accepting a public obligatory offer will not receive right on early repayment in case of a breach of issuer's obligations under contracts entered into upon the public obligatory offer. As a result, such a bondholder will be owner of de facto default bonds without effective legal defense mechanism.

Therefore, we would like to advise you the following if you decide to buy Russian corporate bonds:

1) carefully study Article 9.7 of Decision on bond issuance.

2) remember that:

all necessary information should be disclosed by an issuer in order to comply with conditions of Article 11 of Decision on bond issuance;

•all information about guarantor on bond obligations is described in Article 12.1. of Decision on bond issuance;

•all guarantee information is described in Article 12.2. of Decision on bond issuance;

•if your rights are broken you can make a complaint against an issuer in court and to the Federal Financial Market Service.