A thorny question

-- 12 May 2009 --
TEXT: E. Istomina
PHOTO: khz - Fotolia.com

 

To survive many Russian companies try to renegotiate or walk away from their contracts. Courts will have to clarify where exactly Russian law stands in relation to frustration of contracts.

But the task is not simple: taking into account how the government rules the crisis, the issue risks becoming not of law, but of justice.

 

Law of excuses

The doctrine of frustration aims, as Lord Justice Bingham once said, 'to give effect to the demands of justice, to achieve a just and reasonable result, to do what is reasonable and fair, as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in circumstances'.

It operates by changing of the terms or discharging completely a contract where, after formation of the contract, something occurs which makes the performance impossible or something radically different from what the parties expected at the time of entry into the contract.

Although there are general principles where all, or almost all agree, there are remarkable national variations in what constitutes frustration and what are the remedial powers of the courts.

To say that courts never invoke the frustration article would be factually incorrect
 

In the UK and the US the doctrine remains of limited practical significance: the principle of the sanctity of contracts, and fear to create an escape route for those who entered into a bad bargain make courts to follow a rather restrictive approach. As Lord Roskill once put it, the doctrine of frustration is 'not lightly invoked to relieve contracting parties of the normal consequences of imprudent bargains.' More importantly, the courts tend to take a simplistic approach to the court's powers: invocation of the frustration doctrine normally means the termination of a contract.

Civil law countries adopt more liberal attitude not only to circumstances in which the doctrine can be applied, but also grant broader powers to courts, and admit adjustment of a contract and the apportionment of the loss between the parties as a form of relief.

Article 6:111 of the Principles of European Contract Law states that 'if performance of the contract becomes excessively onerous because of a change of circumstances, the parties are bounded to enter into negotiations with a view to adapting the contract or terminating it' and 'if the parties fail to reach agreement ... the court may ... adapt the contract in order to distribute between the parties in a just and equitable manner the losses and gains resulting from the change of circumstances.' Similar provisions are in the article 6.2.3. of the Unidroit Principles for International Commercial Contracts.

 

In Russia

The Chairman of the Supreme Arbitrazhniy Court of Russia, Anton Ivanov, in interview to 'Vedomosti' doubted that courts would be willing to change the terms of credits agreements on the basis of the frustration clause of the Russian Civil Code.

Although a number of the landmark cases have still to be heard the 44-year-old lawyer from St.Petersburg said that after the beginning of the crisis the amount of cases 'where parties are trying to abuse their procedural rights with the purpose not to pay debts' has increased and that the today's fall of the market is not as substantial as in 1998 and 'if courts did not discharge or adjust contracts then ... I doubt that the practice would go this way now.'

This view may be, and most likely is, true. However, to say that courts never invoke the frustration article would be factually incorrect.

For instance, on March 13, 2004 the St.Petersburg Court, whose decision was later confirmed in appeal and cassation, reduced the interest payable by Sberbank according to the deposit agreement due to 'the change of financial and economical situation in the country which the bank could not have foreseen.'

The money supply in the economy has dried out, and some deep pockets got filled
 

On July 4, 2006 the Kaluzhskiy Arbitrazhniy Court terminated a leasing agreement of an energy station. The plaintiff, a state owned energy company, sought to discharge the agreement on the basis that the exploitation of the energy station was not commercially viable and that the holding group, to which it belonged, was reorganised. This case involved state interference and, arguably, the self-induced frustration by the state company. The court decided in favour of the plaintiff, and the decision was later supported by the Supreme Arbitrazhniy Court.

On 14 March, 2007 the court of Cassation of the Moscow District terminated a 25-years rent agreement of land between OJSC 'DAOS' and city of Dolgoprudniy, near Moscow, on the grounds that the statutory provisions which regulated the rent payments had changed.

The most striking part, however, is that provisions of article 451 of the Civil Code of Russia, the 'frustration article', are among the most liberal in the world not only in relation to the circumstances in which courts can intervene but also in terms of their remedial powers. It follows, almost word by word, the Principles of the European Contract Law.

 

Road paved with good intentions

The difference in approach to the doctrine of frustration between common law and civil law countries is that in the UK and the US the principle of the private autonomy is supreme. In Europe the view that the loss must fall on one party or the other is perceived as unduly simplistic, and the courts are more willing 'to moderate the rigours of freedom and sanctity of contract'.

The Kremlin sees banks as the backbone and the pipeline of its anti-crisis procedures. It is assumed that the government supports banks, and banks feed the economy. In practice, however, this does not work.

The Russian Central Bank, unlike most other countries, raised its interest rates, slowly devalued rouble - so banks could speculate against the national currency. Nothing was done to boost consumption: although the income tax was reduced, the indirect taxes were left untouched.

The money supply in the economy has dried out, and some deep pockets got filled. Huge state reserves do not trickle through to business. Companies, all or almost all, are starving for credit and are now ready to trade shares for cash.

Willingly or not the Kremlin has played for the money, but against the business. It may be true that frustration must not be applied or applied very narrowly, but it is also true that the result can be a massive and, mostly, unjust redistribution of property.

 

 

To survive many Russian companies try to renegotiate or walk away from their contracts. Courts will have to clarify where exactly Russian law stands in relation to frustration of contracts.

But the task is not simple: taking into account how the government rules the crisis, the issue risks becoming not of law, but of justice.

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