Some hedge funds are refusing to join Greece's bond swap, threatening legal action if the government does not come up with a better offer and complicating efforts to restructure the country's debt.

Greece's private creditors have until Thursday night to decide whether to take part in a bond swap, aimed at avoiding a disorderly default that would drag other countries further into the euro zone crisis.

But several hedge funds are expected to hold out, having bought up small amounts of foreign-governed Greek bonds, estimated to be about 10 percent of the 200 billion euros being restructured.

Hedge funds alone are unlikely to derail the swap but if their strategy works and they agree a better deal it would infuriate other creditors and use up Greek resources. If not, it could drag the Greek government into a lengthy and expensive legal battle just as it needs to focus on bringing back economic growth.

I'm aware of several investors actively considering all of their options, including litigation, said Steven Friel of Brown Rudnick, among the law firms talking to investors about their legal strategies in Greece.

The hedge funds favor the bonds governed by more investor-friendly foreign jurisdictions which limit a country's ability to impose losses. The Greek legal system is seen as likely to be more sympathetic to the government.

Bingham McCutchen, another law firm, said on Monday it was advising holders of a Greek 650 million Swiss franc ($707 million) bond. Bondholders holding a material portion of the bonds had grouped together and were exploring ways to address (their) concerns and to protect the rights of holders, Bingham said.

INTERNATIONAL COURTS

Hedge funds may now hold a quarter or more of the Swiss franc bonds and of another small 450 million euro bond falling due in May, which is enough to block the government imposing a loss, several bankers and lawyers say.

It is quite clear that those who hold that bond are not well disposed to participate, said a source close to the Greek debt negotiations.

They are hoping the government may prefer to reach a settlement before May rather than default on the payment altogether despite Greek officials saying no better offer will be forthcoming.

Friel at Brown Rudnick said the documents accompanying Greece's bond swap offer left room for bilateral negotiations between Greece and holdout creditors, meaning the country has given itself leeway to negotiate despite its tough stance now.

If there is no settlement, funds may pursue legal avenues - preferably outside Greece. For English law bonds, this could be in the relevant British court for instance, like the High Court in London.

Investors could also think of ways of suing Greece if they are ultimately forced to take losses. If local court challenges fail, some could pursue other high-profile avenues, like appealing to the European Court of Human Rights on the basis investors' property was unlawfully taken.

Legal challenges can be a lengthy and costly business for investors too, however.

Hedge funds have been known to pursue cases against countries in default across all kinds of jurisdictions until they hit on one that works for them. Elliott Management, a fund specializing in these tactics, managed to get money out of Peru via Belgian courts 12 years ago.

Funds will often have to follow a money trail, trying to seize a country's assets abroad, though this can take years. Argentina, which defaulted on its debt a decade ago, has still not settled with some creditors that held out during its restructuring.

IMPRACTICAL

The Greek case might also be more complicated than previous sovereign defaults like in Argentina or Peru, putting some investors off.

One hedge fund that had earlier told Reuters it was considering legal options said it had now decided to agree to the swap, even though that would mean a small loss.

Hedge funds trying to get money out of Argentina for instance were able to appeal to bilateral investment treaties the country had with the United States. Under these treaties, investors can fight losses being imposed on them in international courts, making appeals to panels such as the specialist International Centre for Settlement of Investment Disputes (ICSID) easier.

Other avenues include the International Chamber of Commerce or UNCITRAL, a body that regulates international trade in cooperation with the World Trade Organization, lawyers said.

Greece has bilateral investment treaties with 39 countries but many of these are impractical, said Michael Nolan, a litigation partner at Milbank Tweed Hadley & McCloy in Washington.

It has treaties with countries such as Syria and Vietnam, with the only really relevant country being Germany - where the treaty is so ancient it does not have the necessary arbitration provisions, he said.

Greece's economic recovery may also not be as certain as in Argentina's case as it cannot devalue and does not have such a strong export market to boost its coffers.

Argentina historically has had a boom and bust economy. If you brought an international legal claim, it may be in part because you thought that, by the time the case was over, Argentina could have the money to pay an award against it, said Nolan from Milbank Tweed Hadley & McCloy.

With Greece's economic situation, one has to wonder if the game is worth the candle.

($1 = 0.9190 Swiss francs)

(Additional reporting by Tommy Wilkes; Editing by Anna Willard and Mark Potter)

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