• Meinl Vitas Flags Risk in Foreign Collateral Arrangements
  • July 30, 2014
  • Law Firm: Dentons Canada LLP - Toronto Office
  • A recent (and still pending) case involving insolvent Russian OOO Vitas Bank (Vitas) and Austrian Meinl Bank AG (Meinl) reminds us that creditors in foreign collateral arrangements with Russian legal entities (in particular, Russian banks) do face risk, and probably more than often thought. Lenders must be diligent when considering and structuring such arrangements, as well as enforcing rights thereunder.

    Foreign Cash Collateral Arrangements: Trouble on the Road Ahead?

    Foreign collateral arrangements (i.e., security located outside Russia and pledged to a creditor) involving Russian pledgors have become relatively common in Russia. One frequent structure is where a Russian licensed bank enters into collateral arrangements involving cash or securities belonging to it held on an account abroad, pledged to a creditor (often foreign) to secure loans granted by that creditor to the Russian bank’s affiliates or clients for investment activities. Until now many creditors took the view that accepting and enforcing against such collateral had a relatively modest legal risk, notwithstanding the potential future insolvency of the pledgor. The security was located abroad, usually governed by a foreign-law security instrument choosing foreign arbitration or courts and allowed the creditor swiftly to cover its exposure when needed. Why worry about insolvency in Russia, when the assets were already in hand abroad? Like they say, possession is nine-tenths of the law.

    In late 2013, the Russian Central Bank (RCB) started an unprecedented clean-up of the Russian banking sector. Since 20 November 2013, when one of the top 50 Russian banks (Master Bank) lost its license, the RCB has revoked roughly 50 banking licenses on various grounds. Consequently, many medium-sized banks and several large banks in Russia have been eliminated from the market entirely. Others remain under the RCB’s ominous watch.

    There are also signs the regulator’s shift toward a more aggressive regulatory policy may be affecting the way administrators of insolvent Russian banks (usually representatives of the RF Deposit Insurance Agency) and the courts view insolvencies. Administrators appear to be implementing all possible measures to claw back assets of failed banks. One popular tool has been to invalidate transactions of the insolvent bank entered into during the relevant hardening period for preferential or suspect transactions. Usually, this affects security given by the banks over assets in Russia. However, the Meinl-Vitas case demonstrates that invalidation may be sought in respect of foreign collateral arrangements, e.g., foreign cash or securities located abroad. Furthermore, administrators may not limit themselves to chasing hard-to-get-at foreign assets of the offending creditor, when there are low-hanging fruits in Russia such as Ruble correspondent accounts.

    The Meinl-Vitas Case

    According to the records1, on 18 October 2011, Vitas, as pledgor, and Meinl, as pledgee, entered into a cash collateral arrangement whereby Vitas pledged RUB 328,400,000 to Meinl. The agreement, governed by Austrian law, secured obligations of Titanium Group Ltd. of Belize, as borrower, under a RUB 500,000,000 loan from Meinl.

    On 8 August 2012, insolvency proceedings were opened against Vitas in the Moscow Commercial Court. It appears by that time Meinl had already enforced its rights under the collateral arrangements. The administrator petitioned the Russian court to find Meinl’s enforcement invalid as a suspect transaction, a preference, or both (the record does not indicate the alleged bases).

    After making an initial appearance in the action, Meinl objected to the court’s jurisdiction, arguing that the matter should be heard under Austrian law and in Austrian arbitration: the collateral agreement was (as mentioned above) governed by Austrian law and contained an arbitral clause referring disputes to arbitration in Austria. The court rejected Meinl’s argument on two grounds. Firstly, it found it had the general authority to make determinations on whether a debtor’s transactions constitute preferences or suspect transactions under the Russian Bankruptcy Law2,  irrespective of whether the contract with the counterparty contains a jurisdiction or arbitration clause. Secondly, the court found Meinl’s objection was made too late in any event: Meinl had already made an initial appearance in the case (prior to raising the arbitration argument). Thus it forfeited its arbitration rights altogether3.  The court further ordered both Meinl and its Russian correspondent account bank, ZAO Raiffeisen Bank, to produce various documents in discovery relating to the administrator’s claim. 

    The court has thus far decided in favor of the administrator on various procedural issues. Both the 9th  Appellate Court and the RF High Commercial Court4  upheld these procedural decisions. The records do not yet reflect a decision on the substantive merits. If the court ultimately decides in favor of the administrator on the substantive merits of its claim, this would allow the administrator inter alia to chase Meinl’s assets, including funds in the correspondent Ruble accounts with ZAO Raiffeisenbank. Indeed, the court paid substantial attention in its decisions to the existence of that account, whether the transfer of the funds to Austria was in breach of Russian foreign exchange regulations, and the role the account played in the foreign collateral arrangements. So far it does not appear from the record that the correspondent account (or any other property of Meinl for that matter) has been frozen or attached of yet.

    As the jury is still out, lenders and their counsel will want to keep a close eye on developments in Meinl-Vitas as the case proceeds.

    What Does This Mean for Us?

    Creditors must remember that collateral arrangements outside Russia with Russian entities are not 100 percent risk-free. These transactions (or the exercise of enforcement of rights thereunder) may be invalidated by Russian courts as preferential or suspect transactions in Russian insolvency proceedings.  As more Russian banks face the winds of the current, a harsher regulatory climate, the risk of counterparty insolvency grows.

    Where foreign collateral arrangements (or their enforcement) are found to be preferential or suspect, this will give rise to claw-back rights by the administrator and could lead to statutory subordination of the creditors’ rights in respect of those amount(s) clawed back. Depending on the facts and findings in the particular case, the claw-back (and possible subordination) could be from 20-100 percent of the amount(s) received from the creditor’s enforcement of the arrangements.

    Moreover, any assets a creditor may have in Russia, such as correspondent accounts, may be subject to attachment in support of administrators’ claw-back actions. Indeed, administrators are likely to look to these assets first in support of their actions.  Depending on the size of the amount sought, administrators may also ultimately seek recognition and enforcement of the court decision and/or assistance in preserving rights abroad if available (e.g., as a matter of treaty or domestic law of the jurisdiction in question). 

    1 Order of Moscow Commercial Court dated 19 August 2013; Order of 9th Appellate Commercial Court dated 2 December 2013 No. 09An-33772/2013; Decree of Federal Commercial Court of Moscow Region, Case No. A40-93565/12.

    2 Art. 61.2-61.3, RF Federal Law dated 26 October 2002 No. 127-FZ “On insolvency (bankruptcy).”

    3 Art. 247.1, RF Code on Arbitration Procedure dated 24 July 2002 No. 95-FZ.

    4 Order of 9th Appellate Commercial Court dated 2 December 2013 No. 09An-33772/2013, Case No. A40-93565/12; Order of High Commercial Court dated 21 March 2014 No. BAC-1997/14.