New Provisions of the Russian Contract Law in the Light of the Supreme Commercial Court’s Plenum Decree “On Contract Freedom and Its Limits”

Kuznetsov Mark V., Candidate of Law, BBH Legal, Associate, Associate Professor, Civil Law Department, Tula Branch of the Russian Law Academy, Tula, Russia

The article considers certain issues of the Russian contact law through analysis of relevant provisions of the Supreme Commercial Court’s Plenum Decree “On Contract Freedom and Its Limits”. The author emphasizes on typifi -cation of mandatory and provisional norms.

Key words: contract freedom, mandatory norm, provisional norm, indemnity, unreasonable conditions, contra preferentem.

The Supreme Commercial Court of the Russian Federation (the SCC) has finally adopted recommendations for lower courts regarding contract freedom and its limits. The SCC Plenum Decree as of March 14, 2014 “On Contract Freedom and Its Limits” (the Decree) accommodates multiple rules elaborated by the SCC judges within everyday practice. These rules have provided for the resolution of certain contract law issues that had been the subject of heated debates for the last decades.

The SCC rulings represent new legal norms directed primarily at dismissing any uncertainty as to the status of the norms contained in  the Russian Civil Code  (the Civil Code) that regulate contract obligations. The SCC establishes several principles to be used in determining whether a particular norm is mandatory or provisional. 

The Decree formulates specific rules for conducting contract negotiations, including subsequences of insertion of unfair terms and conditions into contracts. . It is worth noticing that the Russian law is now supplemented with the provision that all doubtful contract provisions should be construed against the party that proposed them, provided that all other tools of contract construction failed to clarify its provisions (a “contra preferentem” rule).

Finally, the SCC clarifies certain principles of particular contract institutions, e.g. non-typified agreements and contracts provisions of which are based on standard documentation. 

The new SCC recommendations are expected to have a dramatically positive impact on the Russian contract law, especially on its commercial part.

 

Mandatory and Provisional Norms

The possibility of in-contract reformulation or alteration of many of the Civil Code provisions was unclear for the practitioners prior to the Decree recommendations on that question. The main issue was to ascertain a certain rule as mandatory or provisional and thus determine the ways of incorporation into the agreement of particular provisions agreed upon by the parties. The result of false determination was declaring the inserted provision (or even of the contract in full) invalid. Currently lawyers have received clear rules of legal norms assessment as to their mandatory nature.

According to the Decree, mandatory and provisional clauses may be classified into several types:   These types are not named by the SCC. However, they may be structured as shown above.

The SCC sets forth a general principle for the construction of the Civil Code provisions on contract rights and obligations. Under this principle, such norms should be assessed and considered by the courts in compliance with the meaning and goals of legislative regulation, i.e. the court is taking into account not only the literal meaning of the words but also the meaning implied   while creating a particular rule. Clauses stipulated further in the Decree and describing the differences between mandatory and provisional norms are all subject to that general principle.

 

Mandatory Norms   

Mandatory norms can be classified into: (i) direct norms, (ii) limited norms and (iii) implied norms.

Direct mandatory norms

Norms determining contract rights and obligations should be assessed as direct mandatory if they expressly forbid contract provisions distinct from those stipulated in the norm. The SCC does not limit the ways by which the prohibition is made. Although, several examples of possible ways are described in the Decree. For instance, the agreement changing regulation may be found invalid, forbidden or not admissible. Alternatively, a norm can provide the right to alter its prescriptions within a specified scope. The prohibition might be unambiguously stated in the norm otherwise.  

Altogether, the prohibition contained in the norm may be considered as limited, following the goals of legislative regulation.

Limited mandatory norms

Once the court reasons that pursuant to the goals of legislative regulation the scope of application of mandatory provisions should be reduced, the parties are allowed to set out alternative rules in the contract, but in a specified area only. The court might also exclude the prohibition in favor of the party to whose benefit the mandatory norm was initially established.  

Such norms can be defined as limited mandatory norms.

The Decree provides for examples of limitation of that kind. In particular, the rule set out in Article 310 of the Civil Code can be regarded as a limited mandatory norm subject to the following: this rule grants the right to formalize in the contract grounds for its unilateral out-of-court repudiation provided this right is applicable to   commercial contracts only, i.e. to contracts parties to which both exercise commercial activities. Whereas the purpose of this norm is to provide the weaker party with appropriate protection, the SCC alleges that in the case only one party exercises commercial activities, the norm should not prevent the parties from laying down   in the contract the right of its out-of-court repudiation for the party not engaged in such activities. 

Implied mandatory norms

Until now it was admitted that a norm should be defined as mandatory if it directly determines that its provisions cannot be modified or altered by the agreement. Additionally, the provisional nature of any norm was presumed provided that such a norm had no express mandatory prescriptions.

The Decree has changed this practice. According to the SCC recommendations, three situations may prove the mandatory nature of a particular norm. The norm is deemed mandatory if this is necessary for purposes of legislative regulation, in order to defend crucial legal interests, including interests of the weaker party and public interests. Based on the goals of legislative regulation, the norm may receive mandatory status if this is necessary for the prevention of a gross violation of the parties’ interests. The mandatory status of the norm may also come from the essence of legislative regulation of a particular contract form.     

If this is the case, the court declares the norm mandatory and the parties are not allowed to abolish the norm’s application or to alter its provisions in the agreement. As a result, all contract provisions stipulating such abolition or alterations are invalid.

Provisional Norms 

These are classified by the SCC as: (a) [general] provisional and (b) with limited permissiveness (limited provisional norms).

[General] provisional norms are defined using a contrario principle. If they cannot be described as mandatory  norms, which means the absence of  mandatory features (such as express prohibition to state a contract rule   different from that stipulated in the  norm or characteristics  attributed to implied mandatory norms), they shall be deemed provisional.

Giving examples of provisional norms, the  SCC actually introduces new rules pertaining to some very controversial issues of the Civil Code.

First, based on the provisional nature of the rules in Article 475 of the RF Civil Code,  the SCC entitles parties to sale contracts to contractually alter consequences of the transfer of goods of improper quality. For example, the contract may stipulate new consequences (damages or penalty (“neustoyka”)) for the said breach on the part of the vendor. This right is not new for   commercial and state arbitration practice (commercial courts practice). Both Federal Districts Commercial Courts and the SCC previously ruled in favor of purchasers who had sought for damages or penalties from the failed vendor. But such rulings depended upon the assessment of the connection between the infringement and its result, thus making it doubtful whether the respective contract rule would survive in court. Since under the Decree the reimbursement of damage incurred by the purchaser becomes strictly enforceable, taking into account, of course, the right of court to reduce the amount of penalties under Article 333 of the Civil Code, commercial risks are more predictable now.

The new rule also contains an implied possibility to compensate specific losses of the new owner of the company to the parties to share purchase agreements, namely, using Anglo-Saxon instruments of warranties and indemnities, the application of which is the only reason for subjecting share purchase agreements to the English jurisdiction in the overwhelming number of cases. I am not asserting that the implementation of warranties and indemnities into the Russian civil law was the precise objective of the SCC judges. But if we ask ourselves about  consequences that now can be set forth in a  purchase and sale contract, we would  hardly find any of those likely to be  that  forbidden had the Decree never been adopted. The previous court practice regarding damages and penalties prior to the Decree adoption did not add anything to the general rules of damages reimbursement (Articles 15 and 393 of the Civil Code) and contractual penalties recovery (Article 330 of the Civil Code). According to the contract liability provisions of the Civil Code and its doctrinal interpretation[1] apart from damages, penalties and payment of interest (Article 395 of the Civil Code) the contract breach also calls for “other effects of the contract breach”. But many of such effects are “well known” as stipulated in Articles of the Civil Code, including Article 475. Moreover, they are usually determined by the law, not by the contract[2]. At the same time, according to the former Deputy Chair of the SCC, one of the developers of the Civil Code, Doctor of Law, Prof. V.V. Vitryansky,  a contract may provide for other (not previously listed) consequences of the contract breach, but if they do not contradict  the law[3].

It would be absolutely inconsistent with the goals of the SCC decrees to adopt the rules well known to lawyers and the courts. Pursuant to the competent view, “Plenum and Presidium decrees of the highest court instances can never lie in reproduction of certain law provisions. One should proceed from the opposite – the decree offers such application of a well-known norm that allows to resolve certain issues raised in practice”[4]. Hence, the SCC, while entitling parties to all types of purchase and sale agreements to set forth in their contract other consequences of the vendor’s breach of the obligation to transfer goods of  proper quality, meant all those consequences that  (i) are not stipulated by the law and (ii) do not contradict  it. Thus, warranties and indemnities could be concealed in the established rules among others consequences. The opposite viewpoint should be undoubtedly proved under mandatory provisions of the Civil Code.

The second fundamental rule established by the Decree is the right under  Article 782 of the Civil Code to determine, in  a contract for commercial services,  a  certain lump sum to be paid by the party exercising its contractual right to unilaterally and out-of-court  withdraw  from the contract.

I should note parenthetically the essential growth of contractual provisions granting certain compensation to the counterparty in the case of unilateral repudiation of the contract in everyday practice. Such amount is agreed as a compromise when one of the negotiating parties does not want to vest its counteragent with the right to “withdraw from the contract”. However, the enforceability of that provision was unclear. As the Decree confirms “unilateral withdrawal penalty” clauses for a commercial services contract, the same logic may be used while drafting other types of agreements, provided that the respective Civil Code provisions contain no mandatory rules preventing from including such penalty in the contract. Moreover, the continuing reform of the Civil Code may result in implementation of a general norm granting parties to all contracts a right to include “unilateral withdrawal penalty” clause[5]. 

Finally, the SCC classifies Article 410 of the Civil Code dealing with the set-off of obligations as a provisional norm. The said norm, thus, does not, according to the Decree, prohibit the creditor and the debtor to enter into an agreement regarding the set-off of heterogeneous or non-mature obligations.

I would like to emphasize that the legal effect of this rule is twofold. On the one hand, commercial entities have received convenient instrument to bring their interrelationships “to one denominator” mitigating multiple disbursements by such means. But, on the other hand, one should be very careful while purchasing rights of action (i.e. receivables) – by the moment of their “birth” they might have been already terminated.

Norms with limited permissiveness (limited provisional norms).

Even if a norm directly provides for the possibility to alter its rules in the agreement, the court based on the essence of the norm and legislative goals may construe such a provision as limited within a certain scope. So permissibility of conduct within these norms is restricted, limited within certain borders.

As one may see, grounds for defining norms as implied mandatory or limited provisional are mostly similar (legislative goals, essence). Furthermore, to distinguish such norms, the SCC specifies definite criteria   identical for both types. Actually, these criteria follow the general idea of the Decree – to construe a norm based on its essence and the legislative goals. According to the SCC, in the case of a dispute arising as to whether the norm in question is mandatory or provisional, the court shall justify its decision by using the following provisions: the contract’s legislative regulation, the necessity to defend some concrete significant interests secured by the law; the prevention of gross violation of the parties’ interests balance.

In sum, it should be stressed that the grounds for revealing implied mandatory norms substantially affect provisional norms in a negative way, make them dependent on permanent disclosure by the court of the actual position of the parties to the contract,  disclosure which is not absolutely clear to every prudent and reasonable person and which requires  upper intermediate knowledge of civil law, its doctrine.

For instance, Article 610 (2) of the Civil Code is interpreted in such a way that parties to a lease contract concluded for an indefinite term are not entitled to eliminate the right of unilateral withdrawal from the lease. The SCC is absolutely right in the proposed argumentation for the offered rule – leases are contracts with limited time of usage that will disappear if the lease prohibits any type of refusal under Article 610 (2). That conclusion is based on the essence of the lease’s legislative regulation. In other words, one should know the civil doctrine to apply the mentioned article properly. Using the principle of interest balance protection, the SCC construes Article 462 (1) of the Civil Code in the same manner as the previous norm. The parties to a sale contract shall not preclude the purchaser from contract termination in the situation when the vendor has refused to transfer goods to him. 

These are examples of implied mandatory norms determined in the course of the above-mentioned differentiation of norms. The Decree does not contain any example of limited provisional norms – the fact that shows real difficulty in differentiating among the said types of norms. 

 

Specific Rules Regarding Application of Mandatory and Provisional Norms Application in Respect of Innominate Contracts 

The Decree reveals issues concerning regulation of the innominate contracts. The first issue established by the SCC is the general rule of a contract’s content prevailing over its name/definition. Thus, the name given to the contract by the parties may be disregarded by the court if it discovers that the subject-matter of that contract, the real substance of the parties’ rights and obligations or risk allocation speak against a contract type contained in the Civil Code, with the name of the contract  given to it by the parties involved The rule of the subject-matter or content prevailing is not new to the SCC. The Court has previously adopted  an even more general principle of contract law according to which contract classification is determined by the contract’s content, but not by its name[6].

It seems to me that the said “classification” rules may be applied to a part of a contract, too. For instance, if under Russian law a share purchase agreement contains a clause about liquidated damages,  which, in fact, is an indemnity clause, the court must properly classify it  and apply  in accordance with its meaning and goals  the parties pursued while including it in the contract.

The next step made by the SCC is the rule that provisions of the Civil Code regarding nominate contracts should not apply to innominate ones, except for application by analogy of law. If so, we should answer a more specific question. If we use such analogy, what happens with mandatory norms? The SCC establishes applicability of such norms in respect to innominate contracts. Such applicability is stipulated by conditions similar to those determined in the Decree for implied mandatory norms, i.e. the purpose of legislation is to seek for the restriction of freedom in order to protect the interests of the weak or third party, public interests, or to prevent gross violation of the parties’ interests balance.

Hence, application of mandatory norms in regard to innominate contracts, on the one hand, is stipulated by unified provisions common for all mandatory norms. But, on the other hand, such application may be even more justified, once we apply implied mandatory norms in relation to innominate contracts.

Application in Time

Based on provisions of Article 4 (2) and Article 422 (2) of the Civil Code in their systematic  interconnection, the  SCC ruled that both mandatory and provisional norms comply with the well-known principle – unless otherwise provided  by the implementation law, newly established norms do not regulate obligations under contracts entered into prior to such law. So, in general, both norms have no “retroactive effect”.

Abuse of Rights

The Decree covers a rather ambiguous situation of the abuse of rights in the course of performing provisional or mandatory contract provisions.     

As the SCC stipulates, appeal for protection may be dismissed by the court in the event the claimant has abused his/her rights arising as a result of alteration/exclusion of a provisional rule or based on a mandatory norm. This new determination mostly affects the freedom of contract. One may never be sure that his right will be enforced, especially while performing commercial obligations. In most cases one party’s profit is the other party’s intentional loss. Following the SCC rule, the court may allege that this is the result of the provisional norm abuse and transform the claimed right into the so-called “bare right”, i.e. right without court protection.

It is clear, of course, that the abovementioned rule of the Decree is not designed at to prevent normal commercial activities, but to mitigate possible negative influence of introducing implied mandatory and limited provisional norms. This may be achieved only through proper interpretation of the SCC rulings by commercial courts. Otherwise, uncertainty as to enforceability of many commerce-related provisions may negatively affect business in Russia.

New Negotiating Means of Protection

For many years, there was no protection for the weaker party in contract negotiations. The Decree aims to change negative practices by way of introducing new protection instruments.

Unreasonable Conditions

Parties to commercial contracts seldom have strong negotiation positions. Although organizations may engage legal counsel to protect their rights, in any case initial “economic” interests and opportunities will affect the lawyers’ chances to ensure observance of their client’s interests within the process of negotiation. The mere fact that one of the negotiators is in a weaker position does not grant him/her any rights or preferences. The other (“strong”) party should use its position to include unfair contract provisions.

This well-known problem has had prior little potential for solution. The Decree finally adopts necessary and long-due rules. According to the SCC, a weak contractual party is entities and individuals that have been put in a position impeding mutual agreement about the content of a particular contract provision different from that pressed upon by the “strong” party. Furthermore, the weak party may claim the contract alteration or cancellation based on the rules governing contract of adhesion. Such a right is available only if the “strong” party that   has submitted the draft contract imposed such contract conditions on the weak party that are both evidently burdensome for the weak party and substantially affecting the parties’ interest balance. Such provisions are defined as unreasonable conditions.

I need to add one important remark – the abovementioned conditions should affect the weak party in a way clearly visible within the negotiations, i.e. prior to the contract conclusion, and should be known to the “strong” party. I suppose also that if the “strong” party knew that the submitted provisions would affect the weak one in the course of contract performance (in the future), they may be also treated by the court as an example of unreasonable conditions. Conversely, no  protection shall be granted if the agreed condition affects  the interest balance within the performance of the obligations due to unforeseeable reasons, or if it was not clear for the “strong” party – this party did not actually use it while negotiating, or it is a normal risk disbursement within the used contract form.

One may see again a thin border between the normal business risk implemented in  unfair contract conditions unjust for the counterparty but in line with the essense of commercial activities, and business risk abuse unhidden  in unreasonable conditions. In such circumstances, the role of court discretion receives an overwhelming role in enforcing contract provisions.

The SCC goes further. It alleges that in the case of inclusion of unreasonable conditions in the contract and their consequent performance, the “strong” party benefits from its unreasonable behavior. Such things must be forbidden. Thus, the weak party may ask the court for inadmissibility of an unreasonable condition or even claim to declare it invalid. This rule can afford the weak party to circumvent the limited remedies of the Civil Code rules regarding contract of adhesion, which grant protection only in relation to   future performance.

The Decree gives examples of unreasonable conditions that may be declared invalid by the court based on the thorough analysis of particular dispute circumstances. The provided examples are from cases of contract damages. The court may disregard limiting a debtor’s liability to cases of intentional breach. A provision granting exemption from liability in the event the breach is grounded in the debtor’s counterparty (the third party) default may become unenforceable in the court, too. The SCC calls lower courts to carefully analyze the amount payable by the party that has used its unilateral right to withdraw from performing the contract. If the amount is obviously inconsistent with the other party’s losses incurred because of such contract termination, the court should dismiss the respective claim for recovery of such amount.               

As long as courts’ declaring unreasonable contract provisions   invalid   or altering them  may seriously affect  the freedom of contract principle, the Decree contains  directions to lower courts that disputes on unreasonable conditions must be held based on the comparison of the unreasonable conditions with all contract conditions and other case circumstances (e.g. actual negotiation potentials of the parties, market competition, existence of other contractual commitments between the parties, etc.).       

Contra Preferentem Rule

 In practice, there are plenty of cases when courts cannot find out the parties’ intention while construing contract terms and conditions on the basis of  Article 431 of the Civil Code. The SCC has finally adopted the European principle of “contra preferentem” for the purposes of contract construction. Provisions are interpreted against the party that has submitted the respective provision. Unless proved otherwise, such (“contra”) party is deemed to be a professional in a particular area (a bank in a credit agreement, insurer in the insurance contract etc.)[7].

Conclusion

The Decree analysis carried out above shows that the SCC used the “essence” approach in determining the scope and limits of the freedom of contract principle. Lawyers should be more careful as of the Decree adoption while drafting commercial contracts. Not all “advantageous” provisions may be further enforced in commercial courts. At the same time, new remedies against abuse and pressure on a weaker party are available. These means may be used both while drafting, negotiating and performing contract provisions.

Bibliography:

1. A.G. Karapetov. Protiv proiznesshego kak metod interpretatsii kontrakta [Contra Preferentem As a Method of Contract Interpretation] // Vestnik Vysshego arbitrazhnogo suda [The Bulletin of the RF Supreme Commercial Court]. 2013.
2. K.I. Sklovsky. Kommentarii postanovleniia plenuma Verkhovnogo suda Rossiiskoi Federatsii i postanovleniia plenuma Vysshego Arbitrazhnogo Suda Rossiiskoi Federatsii o nekotorykh voprosakh, voznikayushchikh v sudebnoi’ praktike pri razreshenii sporov, sviazannykh s zashchitoi’ prava sobstvennosti i drugikh veshchnykh prav № 10/22 [Commentary to the Supreme Court of the Russian Federation Plenum and the Supreme Commercial Court of the Russian Federation Plenum Decree “On certain Issues Arising Within the Court Practice Regarding Property and other in Rem Rights Defense Dispute Resolution” No. 10/22]. April 29, 2010. Kommentarii’ k stat’e 43 [Commentary to clause 43]. 2011.
3. M.I. Braginsky, V.V. Vitryansky. Kontraktnoye pravo. Obshchie voprosy [Contract Law. General issues]. 2002, pp. 694 – 702.
4. V.V. Vitryansky. Razrabotka novykh obshchikh polozhenii’ ob obyazatel'stvakh v ramkakh reformirovaniia grazhdanskogo zakonodatel'stva [Projectable New General Obligation’s Provisions Within Reforming the Civil Legislation] // Aktual'nye voprosy chastnogo prava: stat’ia, posviashchennai’a godovshchine Pavla Vladimirovicha Krasheninnikova [Relevant Issues of Private Law: Paper Devoted to Pavel Vladimirovich Krasheninnikov’s Anniversary]. 2014.