Covid-19: Impact on commercial contracts – Russia
How is the applicable law determined by the courts in case of commercial contracts?
Section VI of the Russian Civil Code (“RCC”) generally allows contractual parties to choose the governing law of their contract, if one of the parties is a foreign legal entity or if the contract involves another “foreign element", for instance, if the contract were to be performed outside of Russia.
In certain instances, the choice of foreign governing law may be restricted. For instance, agreements concerning immovable assets that are located in Russia (e.g. a lease of an office building) should be governed by Russian law. There are also general limitations to the application of foreign law by a Russian court. In particular, the following restrictions apply:
- The application of foreign law may be limited on the grounds of public policy, in particular where the consequences of such application would be contrary to the “legal order (public order)” of the Russian Federation. This is applied in exceptional circumstances where the consequences of applying foreign law would be in “obvious contradiction” with fundamental principles of the Russian legal order.
- Further limitations apply with regard to mandatory provisions of the law of a foreign jurisdiction if, at the time of choosing the governing law, all of the circumstances concerning the contractual relationship of the parties are connected with that foreign jurisdiction only.
- The application of foreign law is also limited by overriding mandatory provisions of the law of Russia or of another jurisdiction which the agreement has its closest connection with, because the mandatory provisions state so expressly or “bear special significance” (including for the protection of rights and interests of market participants). Whilst the latter appears to broaden the principle that public law (e.g. bankruptcy, tax, currency control law, etc.) takes precedence over private conflict of laws rules, it is not entirely clear which overriding mandatory rules (such rules also exist in the civil legislation such as the RCC) may be treated as “bearing special significance”.
In the absence of an express or implied choice of law clause, the applicable law is determined pursuant to Section VI RCC, which inter alia refers to the characteristic performance as the determining factor. For example, contracts for the sale of goods will normally be governed by the law of the country of the seller’s main place of business.
Some contracts with Russian parties may also be governed by the United Nations Convention on Contracts for the International Sale of Goods 1980 (“CISG”), which also expressly addresses force majeure (see our separate chapter on CISG).
Are there any statutory provisions relating to force majeure?
Pursuant to Article 401 of the RCC, unless otherwise provided by the contract, a person shall not be liable for non-performance or undue performance of its obligations assumed in the course of its entrepreneurial activities, if the performance of these obligations is impossible due to an “irresistible force” (i.e. an extraordinary and unavoidable event in the given circumstances) (“force majeure”).
The RCC does not provide a list of circumstances that qualify as force majeure, but stipulates which circumstances cannot be regarded as force majeure. In particular, a breach of obligations owed to the debtor by its counterparties, the lack of necessary goods in the market or the lack of funds of the debtor shall not be deemed to be a force majeure event.
To be qualified as a force majeure event in the meaning of the RCC and in order for the counterparty to seek relief, the event has to be, simultaneously, of an extraordinary and unavoidable nature, i.e.:
- it has to be exceptional, such that its occurrence must be unusual in the given circumstances; and
- no reasonable person carrying on a similar business with that of the party in breach could avoid such event or its consequences.
Burden of proof
The party invoking force majeure shall bear the burden of proof and has to prove (i) the occurrence of the event, (ii) its extraordinary and unavoidable nature, and (iii) a causal link between the force majeure event and the affected party’s failure to perform the relevant obligations. Force majeure may be proven by various means of evidence including acts of the state authorities, documentation, correspondence, witnesses’ evidence, etc.
On 21 April 2020, the Presidium of the Russian Supreme Court issued Review No. 1 on selected issues of court practice relating to the implementation of legislation and measures aimed to combat the spread of the new coronavirus infection (COVID-19) in Russia (“Review No. 1”). Review No. 1 expressly recognises that circumstances caused by the spread of the new coronavirus as well as restrictive measures taken by the public authorities to limit such spread (e.g. mandatory lockdown measures, travelling restrictions, etc.), can be recognised as a force majeure event if they meet the criteria of an “extraordinary and unavoidable nature”, and that there is a proven causal link between these circumstances and failure to perform the obligations. That said, according to Review No. 1, recognition of Covid-19 as a force majeure event is not universal and may vary depending on the type of activities, conditions in which activities are carried out, the region in which the debtor is acting, etc. Accordingly, the existence of force majeure circumstances should be established for each particular case (including the term of the obligation, the nature of the obligation, whether parties acted reasonably and in good faith, etc.).
The Russian Supreme Court has made an important clarification regarding monetary obligations. It has stated that although, as a general rule, the lack of necessary funds should not be a ground for exemption from liability, where such lack of funds is caused by restrictive measures taken by public authorities and, in particular, where there is a ban on certain activities or a self-isolation regime, it may be recognised as a ground for exemption from liability for non-performance or improper performance of obligations under Article 401 of the RCC. The exemption from liability is possible provided that a reasonable and prudent participant of the market engaged in the activities similar to those of the debtor could not have avoided the adverse financial consequences caused by the restrictive measures (e.g., in case of a significant reduction in profit due to the mandatory closure of a restaurant).
As part of its role, the Chamber of Commerce and Industry of the Russian Federation (the “CCI”) evidences the occurrence of force majeure events under foreign trade transactions and international treaties, and recently started issuing “force majeure certificates” in the context of the Covid-19 outbreak. The Russian Supreme Court in its Review No. 1 mentioned that certificates and conclusions of the authorised bodies and organisation may be taken into account in disputes relating to force majeure. However, although the CCI force majeure certificates may certainly be used as evidence in court, Russian courts may not consider CCI certificates as complete evidence for force majeure and must review all the available evidence.
The occurrence of the force majeure event does not completely release the counterparty (the debtor) from its contractual obligation, if the performance of such obligation remains possible after the force majeure terminates. Accordingly, if the force majeure event constitutes a temporary impediment for the performance of the obligation, the performance will be suspended for the duration of such event (without any liability), but will be resumed upon the termination of the event. However, the other party (i.e. the creditor) may unilaterally terminate the contract if, due to the delay caused, it is no longer interested in the performance. In this case, the debtor is not liable for any damages caused as a result of the force majeure event.
The party relying on the exemption set out in Article 401 of the RCC must take all reasonable steps to mitigate any losses caused by the force majeure event. In particular, it must give notice to the other party about the occurrence of such event within reasonable time, otherwise it may be liable for damages.
How are force majeure clauses in commercial contracts applied and interpreted in practice?
It is common in the Russian market to include detailed force majeure clauses in commercial contracts. However, their wording differs widely (e.g. regarding scope and consequences), given that Article 401 of the RCC expressly permits the modification of the statutory rules. For example:
- The contract may limit the scope of the force majeure concept to an exhaustive list of events, even though the list can be extensive. However, it is not guaranteed that a Russian court will be guided by the provisions agreed between the parties rather than by the general provisions of the RCC.
- The contract may also provide for the consequences of the occurrence of a force majeure event, e.g. termination or temporary suspension of obligations followed by the termination of the contract if the suspension exceeds a certain period.
- It may finally exclude the application of Article 401 of the RCC to obtain release from a contractual obligation, although it is not guaranteed that a Russian court will accept such an exclusion.
Consequently, the application and interpretation of a force majeure clause will always be made on a case-by-case-basis and subject to the circumstances.
In the absence of statutory provisions and / or contractual arrangements on force majeure, which instruments are available to avoid the performance of contractual obligations?
Russian law offers several alternative instruments to avoid the performance of contractual obligations in the absence of contractual arrangements on force majeure. As outlined in detail below, the key alternatives are (i) the impossibility of performance and (ii) significant changes in the circumstances. There are also specific rules for particular types of contracts, such as contracts for the performance of work or for the provision of services.
Impossibility of performance
First, under Article 416 of the RCC, an obligation shall terminate where its performance becomes impossible due to the circumstances for which neither party is responsible (de facto impossibility). A typical example would be the destruction of a painting that is to be sold (provided that neither party is responsible for such a destruction). The relevant obligation is terminated automatically without any act or choice of the parties. This is a key difference to force majeure. Based on Russian case law, for Article 416 to apply, no party shall be responsible for the cause of the impossibility and the impossibility of performance must be (i) objective (i.e. no person is able to perform the obligation), (ii) absolute (i.e. the fact that an obligation has become more onerous or difficult to perform is not sufficient to qualify as impossibility), (iii) unconditional, and (iv) permanent or of indefinite duration.
Second, Article 417 of the RCC specifies that if, due to an act of a state or municipal authority, the performance under the contract has become impossible in full or in part (de iure impossibility), the respective obligation shall terminate in full or in part. The concept is quite similar to de facto impossibility. However, the “permanency criterion” is not applicable here as by nature the act of the state or municipal authority is a temporary one. As in the case of the de facto impossibility, once the performance becomes legally impossible, the obligation is discharged rather than suspended.
We are not aware of any previous case law that applied the concept of impossibility in the context of a pandemic. Although Review No. 1 has expressly recognised that Articles 416 and 417 may be applicable in these circumstances, how these clauses will be applied by the courts in practice is yet to be seen.
Substantial change of circumstances (Article 451 of the RCC)
The concept of “substantial change of circumstances” under Russian law is similar to the concepts of “frustration” or “hardship” in other jurisdictions (for details see our cross-border guide on hardship, which also includes a Russian chapter). A change of circumstances shall be considered “substantial” under Russian law if the change is so extensive that, if the parties could have reasonably foreseen it, they would either have not executed the contract at all or would have executed it on significantly different terms. All of the following conditions must be satisfied:
- When entering into an agreement, the parties proceeded on the basis that such circumstances would not arise.
- The change in circumstances could not be avoided with the degree of care and caution that was required in light of the nature of the contract and the conditions of the trade.
- The performance of the agreement without amending its terms would have affected the balance between the parties’ interests to such an extent and would have entailed such a loss for the interested party that it would have been significantly deprived of what it could have expected when entering into the agreement.
- It does not follow from the usual business practice or the nature of the agreement that the risk of the change of circumstances shall be borne by the interested party.
If those conditions are satisfied and if the other party refused to amend or terminate the contract, the aggrieved party may file a court claim to either terminate the contract or to amend its terms. However, the court can allow the amendment of the contract (as opposed to its termination) under Article 451 of the RCC only in exceptional cases, where the termination of the agreement is against public interests or will result in damage to the parties which would substantially exceed the expenses required to perform the agreement on the amended terms. It is also worth noting that, under Article 328 of the RCC, a party under a reciprocal obligation shall not be entitled to seek performance in court by its counterparty without performing its own obligation first.
Russian courts apply Article 451 quite cautiously. There have only been a few cases where they considered whether epidemics and the respective restrictive measures can be regarded as a substantial change of circumstances and the approach taken by the courts has not been consistent. Therefore there remains some uncertainty regarding the application of the doctrine in such cases.
The parties are free to exclude application of Article 451, and they cannot make a claim on its basis in such a case.
What else needs to be considered by clients that are party to a contract which is affected by Covid-19?
The key is checking the terms of the contract. The party affected by Covid-19 should consider what obligations they actually have, whether they have any discretion as to the method or timing of performance and whether there are any express provisions allowing them not to perform the obligations or to postpone the performance. The contracts may also contain specific limitations of liability which may be helpful in case of a breach of an obligation. In this context, it is worth noting that the principle of good faith is one of the fundamental principles of Russian civil law and that the obligation to observe the principle of good faith during negotiations has been expressly enshrined in the RCC. Accordingly, the parties to an agreement governed by Russian law should be very mindful of this underlying principle of Russian law when discussing the wording of the force majeure or any other relevant provisions or remedial actions under the existing contracts.
Moreover, it is essential to give a timely notification to the counterparty of any circumstances which may affect the performance of the obligations and to offer concrete solutions. It may be reasonable to enter into an additional agreement listing the agreed measures (e.g. suspension or postponement of obligations, alternative providers or performance methods, etc.).
If the parties are unable to agree on any remedial measures, it is necessary to collect a comprehensive set of documents which may confirm the occurrence of the force majeure event, the impossibility to perform the obligation and/or the substantial change of circumstances (as applicable) and steps taken by the affected party to mitigate the consequences.
The parties should also review their insurance coverage to identify potential claims against insurers. That said, most standard insurance products do not provide cover for damages arising under commercial contracts as a result of pandemics.