Compensation for damages
Civil Code amendments enacted in March 2015 and July 2016:
- substantially improved the legal basis for compensation for damages and contractual penalties; and
- permitted the establishment of an obligation to compensate for losses irrespective of a breach of contract (ie, indemnity).
In Order 7 of March 24 2016, the Supreme Court Plenum provided its interpretation of the March 2015 amendments.
The amendments and Order 7 should:
- make damages claims easier to assert;
- clarify the limitations of liability;
- define the criteria for the reduction of penalties; and
- establish contractual means of protecting creditors against loss and damages.
The aim of the obligation to compensate for damages is now clearly defined: following compensation, the claimant must be in the same position in which it would have been if the obligation had been duly performed. This means that the injuring party must provide for full restitution of the claimant's position in the case of due performance of the relevant obligation.
Facilitation of proof
It will be easier in future legal proceedings to prove damages suffered and the existence of a causal connection between the breach of an obligation and the damages suffered. Courts can no longer refuse claims for compensation for damages merely because the amount cannot be determined. Instead, courts must determine the amount (including lost profits) based on all circumstances and the principles of justice and adequacy. In particular, this means that:
- the claimant must provide only evidence which establishes to a reasonable extent:
- the plausibility of the amount of the damages; and
- the existence of a causal connection between the non-performance or defective performance and the damages; and
- if the damage for which compensation is claimed is a customary consequence of the breach of the obligation, the existence of the causal connection will be assumed.
The amendments contain improved rules on damages compensation in the event of an agreement's termination. In particular, these rules apply if the purchaser of goods terminates a sale and purchase agreement due to a seller's breach of the agreement. Under these rules, compensation can be claimed for the difference between:
- the price of goods, works and services under the terminated agreement; and
- a new agreement into which the claimant enters which replaces the terminated agreement.
If the claimant has not signed a new agreement and a current price for analogous items exists, the difference between the price under the terminated agreement and the current price can be claimed. Previously, the rules existed only for supply agreements between individual entrepreneurs and commercial entities; they now extend to all sale and purchase, service and contractor agreements. The new provisions of the Civil Code and Order 7 stress that the claimant must act in good faith.
Conducting negotiations in bad faith
A person who has conducted negotiations in bad faith must compensate the other party for damages suffered. Order 7 contains substantial clarifications in this regard.
It is assumed that the parties to negotiations are acting in good faith, even if a party terminates negotiations. Therefore, the claimant bears the burden of proving that the defendant did not act in good faith.
As a result of compensation, the claimant must be returned to the position in which it would have been if it had not started negotiations (Section 20 of Order 7, referring in particular to Article 434.1(3) of the Civil Code). Therefore, it can claim:
- costs incurred when preparing to enter into the agreement; and
- losses caused in connection with the loss of opportunity to enter into an agreement with a third party.
If the claimant entered into an agreement based on incomplete or incorrect information, it can claim court recognition of the agreement as invalid and compensation for damages caused by the invalidity if the injuring party:
- caused the claimant to make a substantial error; or
- deceived the claimant.
Protecting the claimant in force majeure
Under Order 7's interpretation of the amendments, a claimant enjoys better protection if the debtor refuses performance by referring to force majeure circumstances. In such cases, the following rules apply:
- Circumstances that depend on the will or action of the debtor (eg, lack of financial means, a breach of contract by its contractual partners or unlawful actions by its representatives) do not constitute force majeure.
- Force majeure does not cancel the debtor's obligation if performance is still possible after force majeure has ended. However, the claimant can terminate the relevant agreement if, due to the delay caused by force majeure, it has lost its interest in performing the obligation.
- The debtor is not liable for damages caused by the delay, but must take reasonable action to reduce damage caused to the claimant by force majeure – in particular, by notifying the claimant of the occurrence of force majeure and, in the event of non-compliance, reimbursing the claimant for damage suffered.
Penalties for delayed payments
The amendments provide for a non-mandatory penalty for delayed payments that is equal to the Central Bank's key rate at the relevant time (10% at present). However, if the penalty provided for by an agreement is clearly unreasonable in relation to the consequences of the payment delay, a court can reduce the penalty (but not below the rate established by law).
If the claimant's losses exceed the penalty, it can claim excess losses from the debtor. Unless otherwise provided by an agreement, penalties for delayed payments provided by law cannot be claimed if the agreement provides for a penalty for the payment delay. Interest on delayed payments does not affect contractual interest (eg, on loans or deferred payments).
Limitation of liability
As it will be easier to assert damages claims under Order 7, it will be more important for investors to limit their liability. Russian law is more tolerant than many other jurisdictions in this regard.
In general, the parties to an agreement can limit the liability of the injuring party. However, an agreement on the limitation of liability is not permitted and is therefore invalid if:
- a legal prohibition is breached (eg, an accession agreement or other consumer agreement if the scope of liability for the relevant type of activity or breach is determined by law and the agreement is entered into before the circumstances which caused the liability arise);
- the essence of the laws on the relevant type of activity are contravened (eg, a clause in an agreement on security services or transportation limiting the liability of the professional provider of the services); and
- a previously agreed exclusion or limitation of liability for an intentional breach of obligation exists.
Under Russian law, an agreement which – in general – excludes or limits liability and does not exempt intentional breach from the limitation is valid. However, in legal proceedings, the injuring party bears the burden of proof that the damage was not caused intentionally and can provide evidence that it applied a minimum level of diligence in performing the obligation.
A penalty can be specified by agreement for the non-performance or defective performance (in particular, the delay) of an obligation. The penalty can be a fixed sum or periodical payments. To be valid, the agreement on the penalty must be entered into in writing, irrespective of the form of the main agreement. The claimant cannot claim a penalty if the injuring party is not at fault regarding the non-performance or defective performance of the relevant obligation.
In general, the claimant can claim compensation for damages which exceeds the penalty. However, the penalty agreement can specify that:
- only a penalty (and no compensation for damages) can be claimed;
- compensation for damages can be claimed in full, in addition to the penalty; or
- the claimant can choose a penalty or compensation for damages.
Court reduction of penalties
The amendments and Order 7 have clarified and limited the courts' right to reduce contractual penalties.
A reduction can be granted only in exceptional cases if it is obviously unreasonable and may lead to an unjustified profit for the claimant. If the debtor is a commercial organisation or an individual entrepreneur, the penalty can be reduced only if the debtor has applied for a reduction.
The debtor bears the burden of proof for the unreasonableness of the penalty. In assessing the reasonableness of a penalty, the court must consider that:
- nobody should benefit from unlawful behaviour; and
- the unlawful use of third parties' financial means should not be more profitable to the debtor than lawful use.
As justification for the penalty amount, the following average rates may be invoked:
- for businesses – average rates for short-term loans granted by banks for supplementing working capital; or
- for private individuals – average rates for short-term loans granted by banks.
As an example of unreasonableness, Order 7 mentions the case in which the possible amount of damage is substantially lower than the penalty. Order 7 expressly states that one of the following circumstances in itself is insufficient to reduce a penalty:
- the debtor's difficult financial situation;
- the existence of a debt with other creditors;
- seizure of the debtor's money or other property;
- a lack of financing from the budget;
- non-performance of obligations by contractual partners;
- voluntary performance of the obligation on the day of court review;
- the debtor's performance of socially significant functions; or
- the debtor's obligation to pay interest.
With regard to the claimant's objections to a penalty reduction, Order 7 states that:
- no evidence is required regarding the fact that damage has occurred; and
- the claimant can provide evidence of the consequences of the breach for a reasonable and careful claimant acting reasonably and carefully in analogous circumstances (eg, a change in average market indicators, such as loan interest rates or the market price of certain goods).
The extent of liability and therefore the penalty can be reduced if:
- the non-performance or defective performance of the obligation was caused by the injuring party and the claimant;
- the claimant intentionally or carelessly contributed to increasing the penalty; or
- the claimant acted in bad faith.
However, the claimant's failure to make the main claim over a long period of time after the relevant obligation has become due may not, in itself, be considered a contribution to increasing the penalty.
An indemnity is an agreement in which one party must compensate the other party for certain losses arising in certain circumstances which are somehow connected with the performance, amendment or termination of an obligation or its subject, but not necessarily with breaches of the agreement. Unlike compensation, indemnity arises independently from:
- a breach of the agreement; and
- causality between the injuring party's behaviour and the damage.
An indemnity agreement can be entered into only by parties that are:
- conducting commercial activities;
- party to a shareholders' agreement; or
- party to an agreement for the sale and purchase of shares.
Compensation for losses
The indemnity agreement must provide for the amount of losses to be compensated or rules for determining the amount. The indemnity agreement can provide that all losses caused by the circumstances in question or any part thereof must be compensated, which is sufficient to determine the loss amount.
The claimant can claim compensation for losses if it proves:
- losses which the claimant has already suffered or will unavoidably suffer in future; and
- causality between the occurrence of circumstances and the losses suffered.
If the claimant has caused the circumstances to occur in bad faith, they will be deemed not to have occurred.
The indemnity agreement must be clear and unambiguous. The conclusion and validity of the indemnity agreement will be considered separately from the conclusion and validity of the agreement in connection with which the indemnity agreement was signed.
If the losses were caused by a third party, the claimant's compensation claims against the third party will pass to the debtor that has satisfied the claimant's indemnity claims. The amount of compensation claims against the third party cannot exceed the amount of the compensation claims under the general rule of law.
For further information on this topic please contact Thomas Mundry or Ekaterina Kalinina at Noerr by telephone (+7 495 799 56 96) or email ([email protected] or [email protected]). The Noerr website can be accessed at www.noerr.com.