Default, liability and remedies in shipbuilding in Russia

Default, liability and remedies

Do courts consider defective design to fall within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause of the contract?

The builder may only be held liable for defective design where he or she undertook to provide such design to the customer and not in cases where the customer itself provided design documents and other technical elements to the builder.

Are there any remedies available to third parties against the shipbuilder for defectiveness?

As a general rule, remedies for defectiveness will be available to the customer only. Third parties who may have sustained losses when the ultimate cause of such losses is a confirmed misperformance on the part of the shipbuilder will need to claim, depending on the circumstances, against the owner or the operator of the vessel in question, and the latter may be entitled to a recourse against the builder.

If the contract contains a liquidated damages clause or a penalty provision for late delivery or not meeting guaranteed performance criteria, must the agreed level of compensation represent a genuine link with the damage suffered? Can courts mitigate liquidated damages or penalties agreed in the contract, and for what reasons?

Russian law recognises the right of the parties to include in the contract a provision on penalties (as sanctions) for non-performance or improper performance of obligations. To a certain extent the obligation to pay a penalty is independent of the obligation to compensate losses: the injured party is neither obliged to prove that it sustained losses owing to improper performance nor the extent of such losses. However, if the injured party demands compensation of losses in addition to the payment of a penalty, losses shall be compensated to the extent in which they are not covered by the penalty, unless the contract explicitly provides otherwise. The courts are entitled to reduce the amount of a penalty due if that penalty is manifestly disproportionate to the consequences of the violation of an obligation.

If the building contract contains a liquidated damages provision, for example, for late delivery, is the buyer then precluded from claiming proven higher damages?

In accordance with the general rule, an injured party may claim for losses that exceed the amount of the penalty (see question 26). However, the parties may also contractually agree to a different regime under which, for example, losses may not be claimed in excess of the contractual penalty, or when losses can be claimed in full in addition to the penalty.

Are the parties free to design the force majeure clause of the contract?

Yes, the parties are relatively free to design the force majeure clause, provided that they do not clearly depart from the general definition of force majeure as provided in the law (ie, ‘extraordinary and unavoidable circumstances’).

Is certain ‘umbrella’ insurance available in the market covering the builder and all subcontractors of a particular project for the builder’s risks?

Such insurance is technically possible. Note that in accordance with Russian law, insurance of the risk of non-performance of the party’s own contractual obligations is not possible, unless it is explicitly provided for by the law and currently the law does not provide such a possibility for construction contracts. Therefore, risks related to performance of the contract may be insured to the extent of risks relating to the safety of the object under construction and damage to third parties.

Will courts or arbitration tribunals in your jurisdiction be prepared to set terms if the parties are unable to reach agreement on alteration to key terms of the contract or a modification to the specification?

In cases of an adverse change of circumstances, the parties may, inter alia, demand to have the contract amended or terminated by the court. One of the instances where such right is explicitly provided for in law is when the initially intended cost of construction works is exceeded by not less than 10 per cent of the amount agreed to in the contract. A change of circumstances will be considered adverse if the court agrees that, should the parties have been able to reasonably foresee such change, they would not have entered into the contract in question, or would have negotiated substantially different terms. However, amendment of contractual terms by the court is an exception from the general rule that a contract may be terminated in case of an adverse change of circumstances - the court shall amend the terms only where the termination of the contract will be contrary to the public interest or would cause the parties more substantial damages than would performance of the contract on terms amended by the court.

Does the buyer’s signature of a protocol of delivery and acceptance, stating that the buyer’s acceptance of the vessel shall be final and binding so far as conformity of the vessel to the contract and specifications is concerned, preclude a subsequent claim for breach of performance warranties or for defects latent at the time of delivery?

No. Even if a buyer has signed such a protocol, he or she is entitled to claim against the builder for defects that are owing to the underperformance of the builder within a term of five years of the date of delivery. However, it would be up to the buyer to prove that such defects exist and that the builder is responsible for them.

Can suppliers or subcontractors of the shipbuilder exercise a lien over the vessel or work or equipment ready to be incorporated in the vessel for any unpaid invoices? Is there an implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances?

It is unlikely that suppliers or subcontractors of the builder would be able to exercise a lien over the vessel, because in accordance with Russian law (both in general and in respect of ships under construction or repair), a necessary precondition for the exercise of a lien is physical possession by the creditor of the particular item of the debtor’s property. Therefore, it is most likely that only the builder will be able to exercise such right. Also, the general rule of Russian civil law provides that goods sold on condition of payment due after delivery of the goods remain pledged in favour of the seller until they are paid for. Therefore, there is also a slight possibility that the equipment in question may be under the original supplier’s pledge. However, another general rule provides that the pledge is terminated by acquisition against consideration by a third party that was not aware, and should not have been aware, that the item in questions was pledged.

Does a reservation of title by a subcontractor or supplier of materials and equipment survive affixing to or incorporation in the vessel under construction?

As a general rule, items incorporated into a vessel under construction will cease to be treated as separate items and, depending on the value of works relative to the value of materials and equipment, it will be either the owner of the incorporated equipment and materials or the builder that will obtain the title to a newly constructed vessel. However, considering the realities of an average shipbuilding project, this may be treated as a purely hypothetical situation and the title will most likely (depending on the provisions of the shipbuilding contract in question and in particular on how the parties have agreed to regulate the issue of passing of title in the contract) be acquired either by the builder or the buyer. If there are any unpaid debts to suppliers of equipment and materials, the party obtaining title to the vessel will assume the obligation to discharge those debts.

Assuming title to the vessel under construction vests with the builder, can third-party creditors of the builder obtain a security attachment or enforcement lien over the vessel or equipment to be incorporated in the vessel to secure their claim against the builder?

Depending on whose property such items shall be at the respective time (customer’s or builder’s), third-party creditors may seek enforcement or security of claims against the respective parties, including application of the appropriate security measures such as arrest.

Can a subcontractor’s or manufacturer’s warranty be assigned to the buyer? Does legislation entitle the buyer to make a direct claim under the subcontractor’s or manufacturer’s warranty?

Yes. The law allows the parties (provided that they directly agreed so in the contract) to entitle the buyer and subcontractors to be able to claim against each other directly. By default, each of them will only be able to direct their claims to the contractor that has direct legal relations with both sides.

Where a builder defaults in the performance of the contract, is there a legal requirement to put the builder in default by sending an official notice before the buyer’s remedies begin to accrue? What remedies will be open to the buyer?

Where the builder has permitted violations of the terms of the contract that resulted in a loss of quality or in other defects in the vessel, including violations of the design and other technical specifications in accordance with which the vessel was being built, the customer is normally entitled:

• to demand that the builder remedy the defects at no extra cost to the customer and within a reasonable time;
• to demand a proportionate decrease in price of the vessel; or
• where the contract entitles the customer to remedy the defects by itself or by hiring third-party contractors, compensation of the ensuing expenses.

If the defects have not been remedied as demanded by the customer or if they are substantial and incurable, the customer is entitled to treat the contract as repudiated and claim against the builder for the compensation of losses.

Are there any remedies available to the shipowner in the event of protracted failure to construct or continue construction by the shipbuilder apart from the contractual provisions?

As a general rule that also applies to shipbuilding contracts, in case of delay, the debtor that delays performance may be held liable for any losses of the creditor incurred owing to the delay. If a delay has been so substantial that the creditor has lost interest in the performance, the creditor is entitled to refuse to accept the object of the performance (in this instance the vessel itself), thereby terminating the contract and to claim losses from the shipbuilder.

Would a buyer’s contractual right to terminate for the builder’s insolvency be enforceable in your jurisdiction?

Yes, the parties may agree to terminate the contract in case of either party’s insolvency. However, this would not affect the order of mutual settlements, which would still need to be performed in accordance with the requirements set by the legislation on bankruptcy. Thus, the customer’s claims against the builder (if any) would need to be brought and will be satisfied in the same order as claims of any other creditors of similar ranking; any customer’s debts to the builder’s estate will also be recovered in general order.

What institution will most commonly be agreed on by the parties to decide disputes?

More often than not, the parties choose arbitration to deal with disputes arising from shipbuilding contracts. Particularly when the vessel is being built for a foreign customer, the parties will choose an arbitration institution outside Russia, and the most popular place of arbitration is London. However, in contracts without a foreign element, disputes may be left to be decided by the competent Russian courts (there are no specialised courts dealing with shipbuilding disputes) or specialised arbitrations, of which the most widely known is the Maritime Arbitration Commission at the Chamber of Commerce and Industry of the Russian Federation, which has its seat in Moscow.

Would a buyer’s contractual right to take possession of the vessel under construction and continue construction survive the bankruptcy or moratorium of creditors of the builder?

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In your jurisdiction, do parties tend to incorporate an ADR clause in shipbuilding contracts?

ADR and mediation have not yet gained popularity in Russia as methods of resolving commercial disputes, but in 2010, a special federal law was adopted, the main aim of which was to provide a basic framework for the development of alternative dispute resolution.

Where the buyer defaults in the performance of the contract, what remedies will be available to the builder? What are the consequences of the builder’s cancellation of the contract?

Depending on the particulars of the breach, either party may demand compensation of losses incurred (including, where appropriate, interest, lost profits, costs of works and services rendered by third-party contractors hired in place of the defaulting builder, etc), payment of penalties (if agreed on), termination of the contract, return of amounts paid and enforcement of security measures agreed on (guarantees, suretyships, pledges).