Russia is poised for a bond default that could unleash years of courtroom chaos. A debt expert breaks down what happens next.

• A Russian debt default is looking increasingly likely, and could unleash years of wrangling between the government and bondholders.
• The Ukraine conflict and Western sanctions greatly complicate the issues, meaning discussions could drag on.
• Insider spoke to sovereign bond expert Mitu Gulati, who broke down what the next steps could be.

Russia has come closer to a default on its foreign-currency bonds than at any time since 1918, after the US Treasury banned the government from making dollar payments using American banks.

Russia failed to make $650 million of bond payments on Monday. Instead, it transferred the money to its National Settlement Depository in rubles, despite the contracts demanding payment in dollars.

A default would likely unleash a long and complex battle between bondholders and the Russian state, although the Ukraine war and Western sanctions complicate matters.

Those bondholders are not just swashbuckling hedge funds. Retail investors are exposed to Russian debt — often through giant firms such as BlackRock — as are pension funds. Asset-manager capitalism is being tested by war.

Mitu Gulati, a law professor at the University of Virginia, is a world expert on sovereign debt. He told Insider the situation is a “giant mess” that could result in years of “litigation chaos.”

Here, he gives his thoughts on what might happen next. The interview has been edited for clarity.

Insider: Is Russia now going to default?

Mitu Gulati: It depends on what we mean by “default”. I think that Russia is surely not going to be able to get the money to bondholders. The question is whether that counts as a default or not.

Russia presumably is going to say, “Look, we are happy to pay. It’s just our money is frozen by these horrible Western governments.”

I think the counterargument is: “Well, this is not an external event that you didn’t have control over. If you just would keep your grubby hands off of Ukraine, you could pay”.

I: If bondholders try to sue Russia for their money, how long might this drag on?

MG: This will be more complicated. Because usually, just the bondholders would form a committee, and they would negotiate with the country, and the IMF would make an estimation of how much they can pay. Now this time, we’re going to have to figure out, essentially, war reparations like who’s going to pay for Ukraine’s reconstruction.

This is three-dimensional chess. There’s only a limited amount of assets, and now the Ukrainian reconstruction bill is increasing every day by millions of dollars.

Russia has a lot of foreign assets, but the number of claimants on those foreign assets is multiplying at an exponential rate. Legally, you will have an advantage over others if your claim is first.

Now on the flipside of that, Western governments understand that this game is afoot. I will bet everything in my very small bank account that they are making plans to deter people from chasing these assets, saying, “Look, nobody’s going to get ahead of anybody else by getting judgements”.

I: Will Western governments have much sympathy for bondholders who invested in Vladimir Putin’s Russia?

MG: They’re going to have to have sympathy. I mean, much of the debt is held by BlackRock and Pimco, and through them, it’s held by pension funds or mutual funds. We all — you and I — probably have our retirement accounts in institutions that hold this stuff. It was highly rated, safe government debt.

I: What have you found most interesting about this debt crisis?

MG: I study bond contracts, that’s really my specialty. These are the worst-written contracts I have ever seen on the international markets. They give so many advantages to Russia.

If I were an investor, I would just be like, “Oh, my goodness. How is it possible that I have a debt contract that says Russia has the option to pay me in rubles? I didn’t mean to agree to that.”