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The People vs. Russia

Angry individuals and companies hit hard by the government's debt default are suing--a ground-breaking step there and a test of the country's young judiciary system.


MOSCOW — It was not just that the Russian government had defaulted on its short-term treasury notes, or that by doing so it had stripped Gleb Shestakov's Cossack Investment Fund of 70% of its value in scarcely more than a day.

What finally provoked Shestakov to sue the government was the way it dealt with the victims of its foolhardy fiscal policies.

"They were completely Communist" about it, he said, invoking a favored epithet among this country's once-highflying business elite.

He was alluding to the Russian central bank's initial proposal to pay off investors with IOUs that many analysts valued at between 5 and 10 cents on the dollar.

"They said investors who didn't accept the offer were 'stubborn and super-greedy,' and said they'd get nothing," Shestakov said with a snort. "Even banana republics usually offer you a better deal than 5 cents on the dollar. So I decided to make that point with them by taking them to court."

Shestakov's lawsuit, seeking redress from what is widely regarded as illegal government fiscal directives issued Aug. 17, is a bold test of the independence of Russia's judicial system--bound to be closely watched here, if only because the notion of suing the government is such a novel one in Russia.

In the United States, the right of the people to petition the government for redress of grievances is enshrined in the Bill of Rights. Lawsuits against the government, including those asserting financial damages, are heard by the U.S. Claims Court, which was established in 1855.

No such tradition exists in Russia, but the inclination to hold the government legally responsible for its deeds is growing.

Signs are mounting that Russia, already staggering under the triple plague of devaluation, default and stagnation, is about to be run over by a scourge of a distinctly Western character: litigation.

Foreign and Russian lawyers in Moscow say they have been inundated with queries from victims of the double-barreled financial disaster that struck here in August, when the government in effect defaulted on about $55 billion in ruble-denominated treasury securities and allowed the ruble to fall in value.

Because the treasury notes were theoretically the safest short-term investments available to businesses and bankers, the actions led to a virtual collapse of the country's banking system and a freeze on the banks' payments to domestic and Western creditors.

"Our capital markets and banking people are very stressed out," said Bruce W. Bean, a Moscow-based partner in the London law firm of Clifford Chance. "But it's our litigation people who are going crazy."

Thousands of citizens with rubles and dollars in Russian bank accounts have filed claims against their banks, which since Aug. 17 have been unable to return the money on deposit. That leaves those accounts at the mercy of the deteriorating ruble, which has lost more than half its value in two months. There are so many claims, in fact, that some bankers have stopped counting.

"After the first two or three," said Alexander Zurabov, chairman of the bankrupt Bank Menatep, "you just have to say they're 'numerous.' "

The action is unfolding not only within Russia. Aggrieved investors in the defaulted treasury bills, as well as those who have loans or currency deals outstanding with Russian banks, have embarked on a worldwide quest to seek out and freeze Russian assets parked abroad.

Several have succeeded. Lehman Bros., the New York investment bank, persuaded a London judge to temporarily freeze, or "arrest," European assets belonging to three Russian banks--SBS-Agro, Inkombank and Uneximbank--on Lehman's claim that those banks had broken foreign-exchange contracts or defaulted on loans worth $110 million.

In a separate case, Germany's Deutsche Bank moved in September against a Russian government-owned institution called Eurobank, freezing its assets in Europe. Deutsche Bank claims it lost $30 million in mid-September when Russian finance officials undermined its currency hedge by manipulating the ruble's value upward against the dollar over a period of several days.

Whether those legal actions are wise has become a topic of considerable debate among investment analysts here. Given the delicacy of the country's fiscal situation, suing Russian institutions is a political as well as commercial decision. This is true especially because intense negotiations are going on between central bank officials and a select group of European commercial and investment banks over the restructuring of $10 billion of debt held by the foreigners. Observers say the overseas lawsuits have already hardened the Russians' positions.

"I don't think any of this is particularly useful," remarked Eric Kraus, head of the Moscow fixed-income desk for investment firm Dresdner Kleinwort Benson. "Attempting to sue strikes me as a relatively American mentality. A lot of lawsuits are not going to improve the situation."

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