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By John Helmer, Moscow

In a three-day hearing in the UK High Court, which wound up on Monday of this week, Russian state shipping company Sovcomflot faced cost, indemnity and compensation claims for an estimated $180 million, filed by Yury Nikitin, Dmitry Skarga (right image), and Tagir Izmailov. They were the three defendants in the six-year court battle waged in London by the Sovcomflot shipping group, its chief executive Sergei Frank (left image), and Sovcomflot’s successive board chairmen, Deputy Prime Minister Igor Shuvalov and Chief of Staff of the President, Sergei Naryshkin.

Since the judgement was released, lawyers for Sovcomflot have been emphatic that Frank did not act alone. Rather, they say, it was the boards of the parent company and its subsidiaries which authorized the High Court litigation and approved it to the end. That admission puts the spotlight on Shuvalov and Naryshkin, who moved on to the board in 2008.

High Court Justice Andrew Smith ruled on December 10 to exonerate Skarga and Izmaylov, former chief executives of Sovcomflot and Novorossiysk Shipping Company; and to dismiss most of the claims against Nikitin, a former vessel chartering partner with Sovcomflot. Nikitin was exonerated of the allegations of wrongdoing in eight cases of vessel purchase, financing or operating commissions; in six cases of commissions the judge ruled that he was liable. The Sovcomflot claims totaled up to $880 million, according to the company’s own count; the part of the ruling which went against Nikitin set a potential liability of between $32 million (Nikitin’s calculation) and $60 million (Sovcomflot’s calculation).

The 421-page judgement is the most precise, comprehensive and independent study ever conducted of how Russian government officials and appointees run their shipping fleets, bank accounts, and company balance-sheets, as well as build, buy and sell the tankers which carry Russian oil to market. Thousands of documents presented in evidence to the court, presentations to the judge by several teams of lawyers, and testimony under cross-examination of Frank and other witnesses reveal multiple corruption and fraud schemes, including bribery to create the evidence which Justice Smith ultimately rejected. According to the High Court ruling, “there is no support for the evidence of Mr. Frank, whom, for reasons that I shall explain, I do not regard as a reliable witness,” Smith ruled at section 201 of the ruling, which can be read in full here.

Under the laws and regulations of the UK determining who is a “fit and proper person”, this judgement of Frank may disqualify him to run an English football club or charity, not to mention an international shipping company seeking to sell bonds and shares on the London Stock Exchange.

The three defendants in the Sovcomflot trial have now applied to the High Court for Frank’s company to pay the costs of their defence, plus indemnity and compensation for their funds which were frozen for years at Sovcomflot’s demand. The legal fees for Skarga and Izmaylov top ₤13.5 million ($22 million), their lawyers said in court on Monday. Justice Smith responded that he acknowledges the enormous financial burden which has been placed on them by the Sovcomflot tactics.

Nikitin is seeking leave to appeal against payment orders Smith’s ruling requires against his companies, and for compensation for the injunctions which have tied up his bank accounts and assets for the duration of the case.

Sovcomflot has told the court it wants leave to appeal against the rulings by Justice Smith, claiming he made mistakes in interpreting the evidence and misunderstood the meaning of the dishonesty alleged, but then dismissed in the December ruling. The company has also asked the judge to make a supplementary ruling to decide on issues they claim his December judgement did not address.

In disputing the size of the indemnity and compensation claims, Sovcomflot’s lawyers argue that because of the collapse of the global shipping market since 2008, it is open to question that the freeze orders Sovcomflot took against Nikitin, Skarga and Izmaylov would have caused the financial losses now submitted to the court. That’s the question which Justice Smith must now decide. The risk that Sovcomflot will have to pay up is high.

Skarga’s counsel, Graham Dunning QC, told the judge Sovcomflot lacks the grounds for appeal under UK law, and that in the patchwork of claims which have been revived in court, there is no real prospect that the Court of Appeals will review the evidence differently. He charged that Sovcomflot is seeking to rewrite the history of the case, changing its interpretation of the alleged dishonesty as the evidence failed to substantiate earlier claims. Dunning has also requested the judge to issue a supplementary ruling to reinforce the legal authorities for his conclusions against the Sovcomflot claims. Justice Smith has reserved his rulings on these issues.

In the meantime, the collapse of Sovcomflot’s prosecution and the revelations of corporate and government malpractice and corruption create an unexpected problem for the three international banks who managed Sovcomflot’s bond issue last October, and hope to lead an initial public offering in London sometime this year. The banks are JP Morgan, Deutsche Bank, and state-controlled VTB Capital. The charge they are now facing is that they have misled bond buyers and under-estimated Sovcomflot’s liabilities in the case.

Sovcomflot’s first international prospectus for $500 million in bonds was issued last October, and reported here. In the 333-page document, just one page of text deals directly with the London litigation, only to dismiss the likelihood that Sovcomflot would lose. But since Justice Smith ruled against the company, Sovcomflot’s lawyers have claimed that the prospectus referred to the case on eleven pages. This number counts footnotes in the auditor’s notes to the company accounts, which repeat or paraphrase the single text reference. Sovcomflot also justifies this limited disclosure to bond buyers by saying that it had been cleared by Cleary Gottleib Steen & Hamilton, as well as by Linklaters. How much those lawyers knew of the High Court evidence against the Sovcomflot allegations cannot be guessed.

There is no reference in the main text of the prospectus or in the included auditor’s notes to the costs of the High Court litigation (more than $50 million for the claimants and almost as much for the defendants), and no reference to the case in the Provisions section, at page 90 of the prospectus. There a careful definition of when a provision should be declared evades the danger to Sovcomflot now looming from the High Court. Such references as the prospectus makes to legal costs do not identify the core litigation claims against Nikitin, Skarga and Izmaylov, and were too low to be credible in the light of what has now been presented to Justice Smith over the past week.

Instead, the prospectus obscures from bond buyers what Frank was spending in prosecution of Nikitin et al. In an auditor’s note for 2009, for example, at page F-44, there is this cryptic note: “Included within casualty and other claims is an amount of U.S.$68.5 million (2008 – U.S.$16.7 million) representing legal fees and securities placed to the court for legal costs connected with the claims described in note 39. In the opinion of management the above balances will be fully recovered in the foreseeable future.”

There is no reference to the risk of litigation going against Sovcomflot in the summary Risk Factors section of the prospectus, although there is mention on page 16 that “maritime claimants could arrest the group’s vessels”. This had already been attempted in the US courts by Nikitin’s companies. The possibility of liability claims of $180 million now pending against Sovcomflot was never raised.

Between telling investors in October that it would win the High Court case, losing in December, and arguing this week against having to pay the sizeable penalties, lawyers were instructed by Frank to threaten this correspondent with trumped-up charges. Sovcomflot representatives have also attempted to publicize the claim that whatever potential liabilities Sovcomflot might now face in the High Court are not material for a company with more than a billion dollars of annual revenue, and assets worth more than $6 billion. It is doubtful that buyers of Sovcomflot’s debt last year, or shares later this year, would accept such a salutary interpretation of the material risk for their own outlays. This is beside the predicament which faces Frank, other board directors of the company, the auditor Moore Stephens, and the underwriting banks in front of the listing regulators of the London Stock Exchange. No Russian company which has applied to list and trade its shares in London has ever approached the Listing Authority with a burden as weighty as the one Justice Smith has delivered already, not to mention the one he is preparing now.

Throughout the October bond prospectus, JP Morgan, Deutsche Bank and VTB emphasized the quality and strength of Sovcomflot’s management. The risk that the High Court ruling would expose the management to the reproof of a High Court judgement, plus penalties; or to civil and criminal charges which may now follow against them for perjury, bribery, and fraud ought to have been identified to bond buyers and investors, since there was ample testimony and argument to this effect in course of the trial. Spokesmen for the banks were asked accordingly to say whether they believe their prospectus fully and appropriately disclosed the extent of Sovcomflot’s liabilities and risks of losing the UK High Court case.

The JP Morgan spokesman in Moscow refused to comment. The spokesman for Deutsche Bank said: “Unfortunately, we can’t comment on your questions as we don’t comment on details related to clients. We recommend you to contact Sovcomflot directly with these questions.” VTB Capital promised to answer, but didn’t.

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